There are many situations in businesses where a Parent Company issues some kind of written piece of paper (we usually call it guarantee) to a lender on behalf of its Group Companies to provide assurance for repayment of loan in case of default.
While making any financial statement analysis, we all will agree that these kind of assurances/ exposures given on behalf of such Group Companies should have some value (if this is given being part of the group) in it and it should then be reflected from the financial statements of the Issuer.
Under the current Indian accounting systems, there is no quantification of such exposures required and issuer needs to simply disclose the fact by way of notes to the account. Now, after the introduction of Ind-As/ IFRS for Indian companies, there will altogether be different accounting/ quantification required to comply with these new accounting standards.
As per Ind-As 109, Financial Guarantee contract means “A contract that requires the issuer to make specified payments to reimburse the holder for a loss it incurs because a specified debtor fails to make payment when due in accordance with the original or modified terms of a debt instrument”.
Ind-As 109 “Financial Instruments” section 5.1 states that, All financial Instruments should be valued at its fair value on initial recognition (which normally be its transaction price)” and since financial guarantee falls under financial instrument definition (as per Ind AS-32) hence it will also be valued at its fair value on Initial recognition. However if financial Instruments meet the definition of Insurance Contracts then those will be covered under Ind-As 104 “Insurance Contracts”.
Now, let’s discuss very specific accounting treatment/ requirement as per new accounting regime and various other associated notes while interpreting accounting for Financial Guarantees-
This above indicative/ suggested accounting treatments will be applicable to the issuer of such financial guarantee, however holder will be accounting this instance as prepaid premium and then amortized over the period into its profit & loss account.
There would be specific criteria to identify financial guarantee contracts which will be covered under this provision. For example- the reference obligation for such guarantee should be debt instrument only and issuer should compensate what lender has lost (not more than the loss) etc.
The above article is based on the interpretation/ practical instances used in various industries and will not be taken as advice as there would be other facts/ circumstances which can change measurement/ recognition criteria for the Instruments.
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