Accounting for derivatives primarily revolves around the concept of Mark-to-Market (MTM). Since derivatives are contracts with future value, their daily profits or losses must be reflected in the books of accounts to show their true value. This is a continuous process throughout the life of the contract.
For Futures Contracts:
There is no premium paid or received upfront.
Only margin money is deposited with the broker to cover potential losses.
Daily MTM settlement entries are passed in the books. For example, if a futures position gains ₹2,000, it is a profit credited. If it loses ₹1,500, it is a loss debited.
For Options Contracts:
The option buyer pays the premium upfront, which is recorded as a cost.
The option seller (writer) receives the premium upfront, which is recorded as income.
At expiry or exercise, the final settlement is based on the intrinsic value and is adjusted accordingly in the books.
9.2 Disclosure Requirements 📄
As per the Companies Act and Indian Accounting Standards (AS/Ind-AS), companies that deal in derivatives must disclose several key pieces of information in their financial statements. This is to ensure transparency and proper risk reporting.
Open Derivative Positions: The details of all outstanding contracts.
MTM Value: The current mark-to-market value of all derivatives.
Risk Management Policies: The company's policies and strategies for managing the risks associated with derivatives.
9.3 Taxation of Derivatives in India 💰
The tax treatment of derivatives is a critical topic. The Income Tax Act, 1961, has specific provisions for futures and options (F&O) transactions on recognized stock exchanges.
Non-Speculative Business Income: Under Section 43(5) of the Income Tax Act, profits and losses from F&O trading on a recognized exchange are treated as non-speculative business income. This is a very important distinction. It means that losses from F&O trading can be set off against any other non-speculative business income (but not against salary income).
9.4 Turnover Calculation for F&O 📊
For the purpose of an income tax audit, the 'turnover' in F&O is calculated differently from regular sales. An audit is mandatory if a taxpayer's turnover exceeds the threshold (₹1 crore or ₹10 crore if less than 5% of receipts and payments are in cash). The turnover for F&O is calculated as the absolute value of profits and losses.
Components of Turnover:
The total of all favorable (positive) and unfavorable (negative) differences on settlement of futures.
The premium received on selling options.
The difference on settlement of options.
Example: If a trader has a profit of ₹50,000 and a loss of ₹30,000, the turnover is the sum of the absolute values: |₹50,000| + |₹30,000| = ₹80,000.
9.5 GST on Derivatives 💵
The Goods and Services Tax (GST) is not applicable to the trading of securities themselves. However, it is levied on the services provided by the broker and other intermediaries.