NISM Series IV · Chapter 9: Accounting and Taxation of IRD

L1 · Foundation

Foundation — How derivatives are accounted for, and the five key principles

Which regulator's accounting treatment applies to whom; the ICAI Guidance Note on Accounting for Derivative Contracts (Revised 2021) and its five key principles; recognition at fair value and what "exit price" means; the seven minimum requirements before hedge accounting may be applied; and the definition of a derivative under AS 30.

20 min read · Worth 5% of the paper · Written from pages 294–303 of the official NISM workbook · Updated 18 September 2026

Chapter 9 — Accounting and Taxation

Weightage: 5%, over the shortest chapter in the workbook. It divides cleanly into two halves — accounting (ICAI Guidance Note, AS 30, Ind AS 109) and taxation (business income, turnover, tax audit, set-off and carry forward). The taxation half carries the more numerous and more testable rules.

1. Which accounting rules apply to whom

The RBI's Rupee Interest Rate Derivatives (Reserve Bank) Directions, 2019 specify that for OTC and exchange traded interest rate derivatives:

In plain words: the RBI does not write its own accounting rules for these derivatives. It points to ICAI standards, or to each participant's own regulator.

The ICAI's own Guidance Note works the same way round. Its scope provision states that:

In plain words: banks and NBFCs follow the RBI, housing finance companies follow the NHB, and insurers follow IRDAI. Only where that regulator is silent does the ICAI Guidance Note apply.

So the hierarchy is: your own regulator's treatment first; the ICAI Guidance Note as the fallback.

2. The ICAI Guidance Note on Accounting for Derivative Contracts (Revised 2021)

2.1 The five key principles

The accounting for derivatives covered by the Guidance Note is based on these key principles:

(i) ⚠️ ALL derivative contracts should be RECOGNISED ON THE BALANCE SHEET and MEASURED AT FAIR VALUE.

(ii) If an entity decides NOT to use hedge accounting, it should account for its derivatives at FAIR VALUE with CHANGES IN FAIR VALUE being recognised IN THE STATEMENT OF PROFIT AND LOSS.

(iii) If an entity decides TO APPLY hedge accounting, it should be able to CLEARLY IDENTIFY its RISK MANAGEMENT OBJECTIVE, the RISK IT IS HEDGING, and HOW IT WILL MEASURE the derivative instrument if its risk management objective is being met — and DOCUMENT this adequately AT THE INCEPTION of the hedge relationship AND ON AN ON-GOING BASIS.

(iv) An entity MAY decide to use hedge accounting for CERTAIN derivative contracts, and for derivatives not included as part of hedge accounting it will apply principles (i) and (ii) above.

(v) ADEQUATE DISCLOSURES of accounting policies, risk management objectives and hedging activities should be made in its financial statements.

In plain words: every derivative goes on the balance sheet at fair value. Without hedge accounting, changes in value go straight to profit and loss. Hedge accounting is a choice, and it needs clear, documented objectives from the start. Whatever the choice, the accounts must explain it.

2.2 Recognition at fair value

All derivatives are recognised on the balance sheet and measured at fair value, "since a derivative contract represents a CONTRACTUAL RIGHT OR AN OBLIGATION."

In plain words: fair value is the exit price. It is what you would get to sell the position, or pay to hand it over.

Two refinements to that measurement:

⚠️ "The fair value would ALSO INCORPORATE THE EFFECT OF CREDIT RISK associated with the fulfilment of future obligations".
⚠️ "The EXTENT AND AVAILABILITY OF COLLATERAL should be FACTORED IN while arriving at the fair value of a derivative contract".

That last point connects back to everything learned in Chapter 7: a position backed by margin at a clearing corporation carries less counterparty risk than an uncollateralised OTC position, and the accounting is expected to reflect the difference.

In plain words: credit risk and collateral both affect that value.

3. Hedge accounting

In plain words: hedge accounting is optional. A company may use it, but it does not have to.

Where it does so designate, it must AS A MINIMUM:

(i) IDENTIFY its risk management objective.

(ii) DEMONSTRATE how the derivative contract helps meet that objective.

(iii) SPECIFY how it plans to MEASURE THE FAIR VALUE of the derivative instrument if the contract is effective in meeting that objective — INCLUDING THE RELEVANT HEDGE RATIO.

(iv) DOCUMENT this assessment AT INCEPTION of the hedging relationship AND SUBSEQUENTLY AT EVERY REPORTING PERIOD.

(v) ⚠️ In cases of hedging a FUTURE CASH FLOW, DEMONSTRATE that the cash flows are HIGHLY PROBABLE of occurring.

(vi) CONCLUDE that the risk being hedged COULD IMPACT the statement of profit and loss.

(vii) ADEQUATELY DISCLOSE its accounting policies, risk management objectives and hedging activities in its financial statements.

In plain words: to use it, the company must state its goal and show how the derivative serves it. It must say how it will measure the derivative, including the hedge ratio. It must document all this at the start and at every reporting date. A hedge of future cash flows needs those cash flows to be highly likely. The risk must be one that could hit profit and loss. And the accounts must disclose it all.

⚠️ A caution specific to exchange-traded instruments: "Certain derivative instruments that are traded on stock exchanges — such as foreign exchange futures contracts or equity options / equity futures — DO NOT HAVE SUCH REQUIREMENTS, and in those cases in particular it will be IMPORTANT TO DEMONSTRATE COMPLIANCE with the above criteria BEFORE hedge accounting can be applied."

In other words, buying an exchange-traded future does not by itself create a hedge for accounting purposes. The documentation must exist.

In plain words: no valid hedge designation means fair value, with every change going straight to profit and loss.

4. The definition of a derivative under AS 30

Accounting Standard (AS) 30, "Financial Instruments: Recognition and Measurement", issued by the Council of the ICAI, specifies the accounting of derivative contracts. Its objective is "to establish principles for RECOGNISING AND MEASURING financial assets, financial liabilities and some contracts to buy or sell NON-FINANCIAL items."

In plain words: AS 30 set the rules for recognising and measuring financial assets and liabilities.

In plain words: a derivative has three features. Its value moves with something else. It needs little or no money upfront. And it settles later.

⚠️ Compare this with the IAS 39 / AS 30 criteria met in Chapter 2 — value linked to the underlying, settlement on a future date, and no full cash outlay on the trade date. Same three ideas, expressed in the accounting standard's own language.

4.1 Where AS 30 now stands

In plain words: AS 30 no longer applies. Ind AS 109 replaced it when India moved to Ind AS.

The current position:

Type of entity	Applicable guidance
Companies following the Ind AS framework	⚠️ Ind AS 109, Financial Instruments, now governs the accounting for derivatives
Entities NOT following Ind AS	⚠️ The Guidance Note on Accounting for Derivative Contracts (latest revised edition 2021) is the applicable guidance for derivatives not covered by other specific Accounting Standards like AS 11

So a question naming AS 30 as the current standard is testing whether you know it has been superseded.

Think of it like this

Fair value is the exit price — what the resale market would pay

You own a two-year-old car. Its fair value is not what you paid for it, and not what you hope it is worth. It is what a knowledgeable, willing buyer would actually pay you today.

The Guidance Note says exactly this: "Fair value in the context of derivative contracts represents the 'EXIT PRICE' — i.e., the price that would be PAID TO TRANSFER A LIABILITY or the price that would be RECEIVED WHEN TRANSFERRING AN ASSET to a knowledgeable, willing counterparty."

Two adjustments follow, and both are intuitive once you keep the resale buyer in mind. "The fair value would also incorporate the effect of CREDIT RISK associated with the fulfilment of future obligations" — a buyer pays less for a promise from a shaky counterparty. And "the extent and availability of COLLATERAL should be factored in" — the same promise backed by security is worth more.

That is why an OTC swap with a weak counterparty and an identical exchange-traded position cleared through a CCP do not necessarily carry the same fair value.

Hedge accounting is an election, not a fact

A married couple may file taxes jointly or separately. Being married does not automatically produce a joint return — you have to elect it, and satisfy the conditions.

Hedge accounting works the same way. "An entity is PERMITTED BUT NOT REQUIRED to designate a derivatives contract as a hedging instrument." And crucially, economic reality is not enough on its own.

The Guidance Note warns specifically about exchange-traded instruments: they "do not have such requirements, and in those cases in particular it will be IMPORTANT TO DEMONSTRATE COMPLIANCE with the above criteria BEFORE hedge accounting can be applied."

So a treasurer who buys bond futures against a real exposure has an economic hedge — but until he has identified the risk management objective, demonstrated how the contract meets it, specified the measurement method and hedge ratio, and DOCUMENTED all of it at inception and at every reporting period, he does not have a hedge for accounting purposes. Without the paperwork, the derivative simply goes to fair value through profit and loss, with all its volatility landing in this year's numbers.

Fair value hedge versus cash flow hedge — the bond you own and the salary you expect

Two different worries call for two different accounting models.

Worry one: you own a fixed rate bond and its value swings as rates move. The swing is happening now, to something you already hold. That is a FAIR VALUE HEDGE — hedging "the risk of a fair value change of assets and liabilities ALREADY RECOGNISED in the balance sheet, or a firm commitment that is not yet recognised." The workbook's own example: hedging a fixed rate bond with an interest rate swap, changing the interest rate from fixed to floating.

Worry two: you expect a large receipt six months from now and do not know what rate you will be able to invest it at. Nothing is on your balance sheet yet — only a future cash flow. That is a CASH FLOW HEDGE — hedging "the risk of changes in HIGHLY PROBABLE FUTURE CASH FLOWS."

And the accounting differs in a way worth remembering: in a cash flow hedge "any gain or loss determined to be an EFFECTIVE hedge is recognised IN EQUITY" — a cash flow hedge reserve, or Other Comprehensive Income under Ind AS. Why? "This is intended to AVOID VOLATILITY in the statement of profit and loss in a period when the gains and losses on the hedged item are NOT RECOGNISED therein." The hedged item has not hit the P&L yet, so the hedge should not either.

Why exchange traded derivatives are business income, not speculation

The Income-tax Act treats speculative business harshly: "any loss arising from speculative transaction could be set off ONLY from speculative income." A loss you can only use against a very narrow class of income is a loss you may never use at all.

And the general test looks bad for derivatives: "a transaction is deemed as SPECULATIVE if it is periodically or ultimately settled OTHERWISE THAN THROUGH ACTUAL DELIVERY OR TRANSFER." Cash settled interest rate futures never involve delivery.

Section 43(5) rescues them. It "has specifically EXCLUDED certain derivative transactions from the meaning of speculative transaction, AS THESE INSTRUMENTS ARE USED FOR HEDGING UNDERLYING ASSETS" — and an "ELIGIBLE TRANSACTION in respect of trading in derivatives... CARRIED OUT IN A RECOGNISED STOCK EXCHANGE shall NOT be deemed to be a speculative transaction."

Note the two conditions doing the work: it must be a derivative under the SCRA, and it must be on a recognised stock exchange. Get both and the loss becomes ordinary business loss — set off against any normal business income, and against other heads too, though never against salary.

Turnover for a derivatives trader is not what you might expect

In an ordinary shop, turnover is the value of goods sold. If you bought and sold Rs 40 lakh of stock, your turnover is Rs 40 lakh.

Derivatives turnover works nothing like that. "The total of FAVOURABLE AND UNFAVOURABLE DIFFERENCES is taken as turnover" — you add up the profits and the losses, both as positive numbers.

The workbook's own example makes the point starkly. A trader loses Rs 40,000 on one position and makes Rs 15,000 on another. His contract values ran into crores. His turnover is Rs 55,000 — 40,000 plus 15,000.

Two additions complete the rule: premium received on sale of options is included (unless already counted in determining net profit for the transaction), and the difference on any reverse trades also forms part of turnover.

Why does this matter? Because tax audit applicability is determined on the basis of turnover — Rs 2 crore, Rs 10 crore, the presumptive scheme threshold. Computing it as contract value instead of net differences would push almost every active trader into an audit they do not owe.

Key terms in this chapter

Advance tax: Payable where tax liability on total taxable income from all sources exceeds Rs 10,000 in the financial year. ETIRD income, being non-speculative business income at slab rates, attracts it.
AS 30: The ICAI standard on Financial Instruments: Recognition and Measurement, which defined a derivative by three characteristics — value changing with an underlying, little or no initial net investment, and settlement at a future date. It has since been withdrawn and replaced by Ind AS 109.
Carry forward of business loss: An unabsorbed loss may be carried forward for up to 8 assessment years and set off only against business income, and only if the return of income was filed on or before the due date.
Cash flow hedge: A hedge of variability in highly probable future cash flows. The effective portion is recognised in equity — a cash flow hedge reserve, or Other Comprehensive Income under Ind AS — to avoid profit and loss volatility before the hedged item is recognised.
Critical terms match, dollar offset and regression: The three commonly used methods named for assessing hedge effectiveness. No single method is prescribed — the choice depends on the facts of each hedging programme and the entity's risk management objective.
Current versus non-current presentation: Trading derivatives are always current; hedges of recognised items follow the hedged item's classification; hedges of forecast transactions follow the derivative's settlement date; and multi-settlement instruments follow where the predominant cash flows fall.
Eligible transaction: A trade in derivatives as defined in clause (ac) of section 2 of the SCRA, 1956, carried out on a recognised stock exchange — the two conditions that together secure non-speculative treatment.
Embedded derivative: A derivative component inside a non-derivative host contract. It must be separated and accounted for on its own if not closely related to the host; where it cannot be measured reliably, the entire hybrid contract is designated FVTPL.
Fair value (exit price): The price that would be paid to transfer a liability or received on transferring an asset to a knowledgeable, willing counterparty — incorporating the effect of credit risk and the extent and availability of collateral.
Fair value hedge: A hedge of the risk that the fair value of a recognised asset or liability, or an unrecognised firm commitment, will change — such as hedging a fixed rate bond with an interest rate swap. Gains and losses go to profit and loss.
Fair Value Through Profit or Loss (FVTPL): The default measurement for a derivative not in a hedging relationship — recognised at fair value with gains and losses taken to profit and loss immediately.
FPI capital gains treatment: Securities held by FPIs are always capital assets, so their derivative gains are always capital gains — generally short-term, since positions are usually held for less than 12 months.
Hedge accounting: An optional designation that aligns the recognition of gains and losses on a derivative with those on the item it hedges. It requires a documented risk management objective, measurement method and hedge ratio, at inception and every reporting period.
Hedge effectiveness: The degree to which changes in the fair value or cash flows of the hedged item are offset by those of the hedging instrument. Ineffectiveness is the extent to which the instrument moves more or less than the item.
ICAI Guidance Note on Accounting for Derivative Contracts: The 2021 revised guidance applying where the entity's own regulator has prescribed no accounting treatment. It requires all derivatives to be recognised on the balance sheet at fair value and sets the conditions for hedge accounting.
Ind AS 109: The standard based on IFRS 9 that now governs classification and measurement, impairment, hedge accounting and derecognition for companies on the Ind AS roadmap, fully replacing AS 30 for them.
Net investment hedge: A hedge of the foreign currency exposure on a net investment in a non-integral foreign operation. Effective gains and losses go to equity, ineffective ones to profit and loss immediately, and deferred amounts to profit and loss on disposal.
Regulator-first accounting hierarchy: Banks and NBFCs follow RBI, housing finance companies follow NHB and insurers follow IRDAI; the ICAI Guidance Note applies only where the concerned regulator has prescribed no treatment for derivative contracts.
Section 115BAC (new tax regime): An optional regime under which the taxpayer forgoes Chapter VI-A deductions, cannot set off brought forward business losses and cannot carry business losses forward — often a poor bargain for a trader holding accumulated losses.
Section 43(5): The provision excluding eligible derivative transactions carried out on a recognised stock exchange from the meaning of speculative transaction, so ETIRD income is ordinary business income despite never involving delivery.
Section 44AB(a): The tax audit provision that applies where trading turnover exceeds Rs 10 crore, irrespective of profit or loss.
Section 44AB(e): The tax audit provision applying below Rs 2 crore turnover, but only where there is a loss or profit under 6%, the taxpayer opted out of the presumptive scheme in the last five years, and total income exceeds the basic exemption limit.
Section 44AD presumptive scheme: An option up to Rs 2 crore turnover to declare profits at 6% of turnover — 6% rather than 8% because payment always comes through banking channels. No books, no audit, advance tax in one instalment by 15 March, but no further expenses allowed.
Set-off in the year of loss: An ETIRD business loss may be set off against income under any other head, with one exception — it can never be set off against salary income.
Speculative transaction: Under the Income-tax Act, a transaction periodically or ultimately settled otherwise than through actual delivery or transfer. Losses from it can be set off only against speculative income.
The no-netting rule: Balance sheet amounts must be gross, the only exception being basis adjustment under cash flow hedges. Amounts in the profit and loss for derivatives not designated as hedges may however be presented net.
The Rs 2 crore to Rs 10 crore relief: No tax audit applies in this band irrespective of profit or loss, because more than 95% of exchange traded derivative transactions are executed digitally.
Trading turnover (derivatives): The total of favourable and unfavourable differences, both counted as positives, plus premium received on sale of options and the difference on reverse trades. It is far smaller than contract value, and it determines tax audit applicability.

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Original explanatory writing based on the official NISM workbook for Series IV, which is published and copyrighted by NISM. Check figures against the current edition at nism.ac.in.

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