Forward Contract Accounting Example IND-AS: Understanding the Basics

In the world of finance, forward contracts are common instruments used to manage risk or speculate on future market movements. These contracts involve an agreement between two parties to buy or sell a particular asset at a specific price and date in the future. Companies that engage in such contracts must follow specific accounting standards, and under the Indian Accounting Standards (IND-AS), there are specific rules to be followed for forward contract accounting.

Let`s understand these rules with the help of an example.

Suppose Company A has signed a forward contract with Company B to purchase 1000 barrels of crude oil at a price of Rs. 5000 per barrel after three months. The current market price of crude oil is Rs. 4500 per barrel. Company A has to account for this transaction under IND-AS.

Step 1: Initial Recognition

The first step is to recognize the forward contract on the balance sheet. Company A should record the contract as a financial asset at its fair value. In this case, the fair value of the contract is zero since no upfront payment is required.

Step 2: Valuation at the end of each reporting period

At the end of each reporting period, the fair value of the contract should be calculated and recorded on the balance sheet. For this, the future price of crude oil is estimated based on the current market conditions. Suppose, after one month, the current market price of crude oil is Rs. 4800 per barrel. The fair value of the contract will be calculated as follows:

(5000-4800) x 1000 = Rs. 20,00,000

Here, 5000 is the contract price, 4800 is the current market price, 1000 is the number of barrels, and Rs. 20,00,000 is the fair value of the contract.

Step 3: Recognizing the gain or loss

At the end of the contract, any gain or loss should be recognized in the profit and loss account. In this example, if the market price of crude oil at the end of three months is Rs. 5500 per barrel, the gain will be calculated as follows:

(5500-5000) x 1000 = Rs. 50,00,000

The gain of Rs. 50,00,000 will be recorded in the profit and loss account.

Conclusion

Under IND-AS, it is essential to follow the accounting standards for forward contract accounting. Companies must be aware of the rules and regulations and take appropriate steps to ensure compliance with the accounting standards. Proper accounting of forward contracts helps in better management of risk and ensures transparency in financial reporting.