Financial instruments, are initially recognised at the fair value after transaction cost. Subsequently, it is recognised based on the adopted method of measurement (i.e. Amortisation of Cost Method (ACM)., Fair Value through OCI (FVTOCI) or Fair Value through PL).
Generally, ACM is used for subsequent measurement and realisation unless, entity choose to use FVTOCI or FVTPL considering its position on the holding period and expected realisation of gains. In any instance we have to create an Amortisation Table to amortise the initially recognised value.
Financial instruments are measured at their amortised balance in ACM method and fair value in FVTOCI or FVTPL. Where any gain or loss arises during revision of balance compared to the amortised balance it is recognised through OCI (i.e. FVTOCI Reserve) in FVTOCI method or through P&L in FVTPL method. The FVTOCI Reserve is classifiable to P&L upon sale of the instrument.
The amortisation of the balance is done based on the Effective Interest Rate (EIR). Effective interest rate is the rate at which the discounted repayments becomes equal to the recognised value. It is same as the market rate where there is no transaction cost is associated with the financial instrument.
Generally, equity and derivative instruments are allowed to be recognised and measured as per FVTPL but equity instruments can be recognised and measured as per FVTOCI but then it cannot be changed to FVTPL later and corresponding FVTOCI reserve shall not be classifiable to P&L, thus has to be transferred to retained earnings instead of P&L upon sale.
Let us take an example where there is a 5% debentures issued by an entity of Rs 1,000,000 at a concessional interest rate of 5% for a tenor of 5 years redeemable at par without an upfront fees of Rs 50,000. Where the market rate for similar debentures is 10%. Then the fair value for recognition is Rs 1,000,000 and it is amortised as per table 4 based on the intial recognition value as per table 1 and 2 with an EIR as per table 3.