Accounting and Taxation

1Accounting for forward contracts (AS 11)

When the forward is a hedge:

• The premium or discount (difference between spot and forward rates) is amortised over the life of the contract.
• Exchange differences (change in value since inception or the last reporting date) go to the profit and loss account of the year.
• Profit or loss on cancelling or renewing the contract goes to P&L of the year.

When the forward is for trading or speculation:

• No premium or discount is recognised.
• The gain or loss, being the difference between the contract (or last year-end) forward rate and the year-end forward rate for the remaining maturity, goes to P&L.
• Cancellation or renewal profit or loss goes to P&L.

Remember

• Hedge: amortise the premium or discount. Trading: mark to the year-end forward rate.

Practise this concept (6 questions)

2Futures: initial margin

ICAI's guidance notes focus on the client's books; for brokers and clearing members a futures trade is like a share trade.

• No entry is made for the contract itself when it is entered into, because nothing is paid except margin.
• Initial (and additional) margin paid is debited to "Initial Margin – Equity Index/Stock Futures Account", shown under current assets.
• Any amount paid over the margin is shown separately as a deposit under current assets.
• If margin is given as bank guarantees or securities, there is no entry, only a note in the financial statements.

Example Margin of ₹50,000 on day 1, then ₹55,000, ₹45,000 and ₹47,000. Entries: Initial Margin Dr ₹50,000 to Bank; Initial Margin Dr ₹5,000 to Bank (extra margin); Bank Dr ₹10,000 to Initial Margin (refund); Initial Margin Dr ₹2,000 to Bank.

Remember

• No entry for the contract; only for margin.

3Futures: daily MTM and year-end open positions

• Daily settlement amounts paid or received go to "Mark-to-Market Margin – Equity Index/Stock Futures Account", best kept index-wise or stock-wise. If paid from a lump sum deposit with the member, use a "Deposit for MTM Margin" account, shown as a deposit under current assets at year end.
• At the balance sheet date, apply prudence:
  • a debit balance in the MTM account (net amount paid, an anticipated loss) needs a provision by debiting P&L. The debit balance is shown under current assets, loans and advances, less the provision;
  • a credit balance (net amount received, an anticipated profit) is ignored for P&L and shown as a current liability.
• Provisions are worked out index-wise or stock-wise, combining all series of that index or stock. Increase or reduce the opening provision through P&L.

Example A client has paid ₹5,000 of MTM margin on open futures at year end. Entry: P&L Dr ₹5,000 to Provision for Loss on Equity Futures.

Remember

• Anticipated losses are provided for; anticipated profits are ignored.

4Futures: settlement, square-off, default and disclosure

• On final settlement, profit or loss = final settlement price − contract price, recognised in P&L against the MTM margin account (MTM Dr to P&L for a profit; P&L Dr to MTM for a loss). The same applies on squaring up.
• If several contracts in the same series are open when one is squared up, the contract price is taken on a weighted average basis.
• Released initial margin: Bank (or deposit) Dr to Initial Margin.
• If a client defaults on daily settlement, the contract is closed out; the unpaid amount is taken from the initial margin, any excess is released and any shortfall is still owed. The profit or loss is recognised as above.
• Disclosures: bank guarantees and the book and market value of securities given as margin; and the number of open contracts and units, separately for long and short, index-wise or stock-wise.

Remember

• Square-off of one of several open contracts: weighted average price.

5Accounting for options

At inception:

• The writer pays margin → "Equity Index/Stock Option Margin Account", a current asset.
• The buyer debits the premium paid to "Equity Index/Stock Option Premium Account"; the writer credits the premium received to the same-named account.
• Lump-sum margin deposits go to a "Deposit for margin" account (current asset).

At the balance sheet date:

• The premium account is shown under current assets (buyer) or current liabilities (writer). One composite account may be used, but provisions are worked out stock-wise or index-wise.
• Buyer: provide for the amount by which the premium paid exceeds the market premium at year end (the loss if squared off now). Any excess of market premium over premium paid is ignored. The provision is deducted from the premium account in current assets.
• Writer: provide for the amount by which the market premium exceeds the premium received. Any excess of premium received over market premium is ignored. The premium and provision accounts go under current liabilities and provisions.
• With several open options on one stock or index (any strike, any expiry), net the gains and losses: provide for a net loss, ignore a net gain.

At final settlement (cash settled):

• Buyer: premium is an expense; on exercise, the favourable difference between settlement price and strike is income.
• Writer: premium is income; on exercise, the adverse difference paid is a loss. Released margin: Bank Dr to Option Margin.

On square-off: the difference between premium paid and received goes to P&L, using weighted average where several identical options are open.

Delivery-settled stock options: entries are the same up to settlement and if the option lapses. On exercise, shares change hands at the strike price:

• call buyer: Shares Dr, Bank Cr; put buyer: Bank Dr, Shares Cr;
• call writer: Bank Dr, Shares Cr; put writer: Shares Dr, Bank Cr;
• the premium still goes to P&L as for cash-settled options.

Cash-settled stock options are accounted for exactly like index options.

Disclosures: accounting policies and methods, margin given as bank guarantees or securities, and details of open options at year end for each index or stock.

Remember

• Buyer's premium: current asset. Writer's premium: current liability.
• Provide for losses; ignore unrealised gains.

6Taxation of derivatives

• For Indian residents, derivatives gains and losses on a recognised exchange are business income ("profits and gains of business or profession") and are non-speculative.
• Before FY 2005-06, they were treated as speculative under Section 43(5) (contracts settled without actual delivery), so losses could only be set off against speculative income. The Finance Act, 2005 excluded exchange-traded derivatives from the definition of speculative transactions.
• Losses can be set off against any other income of the year except salary. Unabsorbed losses can be carried forward for 8 assessment years, against non-speculative business income only, provided the return was filed by the due date.
• STT paid is allowed as a deduction.
• For FPIs, gains are capital gains, usually short-term, since most contracts mature within three months.
• Traders may use presumptive taxation under Section 44AD if turnover is up to ₹2 crore, declaring 6% of turnover as income with no deduction for expenses.

Remember

• Residents: non-speculative business income. FPIs: short-term capital gains.
• Carry forward 8 years; no set-off against salary.

Practise this concept (8 questions)

7Securities Transaction Tax

STT applies to purchases and sales of listed equity, derivatives and equity-oriented mutual fund units. For derivatives the exchange collects it and remits it to the government. Rates from 1 April 2026:

• STT applies to sell transactions in futures and options.
• When an option is exercised (voluntarily or at expiry) and is in the money, STT is charged on the settlement price.
• When a stock derivative is physically settled, delivery-based equity STT applies: 0.1% paid by both buyer and seller.
• A clearing member's STT = total STT of the TMs it clears for; a TM's STT = total of its clients'.

Remember

• Futures STT: seller, 0.05% of traded price. Options STT: seller, 0.15% of premium; exercised: buyer, 0.15% of settlement price.