Accounting

Accounting in the context of equity derivatives refers to the systematic recording, measurement and reporting of all financial events arising from futures and options contracts on equity securities.

The scope includes initial recognition of the contract, subsequent fair‑value adjustments (mark‑to‑market), settlement of cash or physical delivery, and the impact on profit and loss (P/L) and equity. SEBI’s regulations require brokers and distributors to maintain proper books so that the true economic position of the client is transparent.

For the NISM exam, you will be asked to differentiate between cash‑basis and accrual‑basis accounting, identify the correct journal entries at opening and closing, and compute the MTM impact on a daily basis.

• Opening entry records the contract at fair value (usually zero for futures).
• Daily MTM entries capture unrealised gains or losses.
• Closing entry reverses the position and recognises realised P/L.

The primary standard governing derivative accounting in India is Ind AS 109 – Financial Instruments. It prescribes initial recognition at fair value, subsequent measurement at fair value through profit or loss (FVTPL), and disclosure of risk exposures.

Before Ind AS 109 became mandatory, many entities followed the older Indian GAAP (AS 11) which allowed a mixed approach of cost and fair‑value measurement. The transition to Ind AS 109 eliminated the option to treat derivatives as “held for trading” without MTM.

Exam‑relevant points: identify which standard applies, know the key measurement requirement (fair value), and recognise that the profit or loss from MTM flows directly to the income statement.

Mark‑to‑Market is the daily process of re‑valuing open derivative positions at their current market price. The difference between the previous day’s fair value and today’s fair value is recorded as an unrealised gain or loss.

For futures, the MTM amount is settled in cash through the margin account. For options, the change in the option’s premium is reflected in the P/L, while the premium paid initially is treated as an expense (if the option expires worthless) or as part of the cost basis (if exercised).

In the exam, you may be given opening price, closing price and contract size. You must calculate the MTM amount, post it to the margin account and recognise the impact on the profit and loss statement.

When a futures contract is entered, the initial journal entry records the contract at zero fair value, but the margin posted is shown as a cash outflow.

Daily MTM adjustments are posted as follows: Debit or Credit the "Derivative – Futures" account and the opposite entry to "Profit and Loss – Derivatives". The margin account is simultaneously adjusted to reflect cash settlement of the MTM amount.

At expiry, the final settlement price is used to close the position. The realised P/L is transferred from the derivative account to the profit and loss account, and any remaining margin is released back to the cash account.

Buying an option requires paying a premium upfront. The entry debits "Option Premium – Asset" and credits cash. The premium is initially recorded as an asset because it may generate future economic benefit if the option is exercised.

If the option expires worthless, the premium is written off: debit "Profit and Loss – Options" and credit "Option Premium – Asset". If the option is exercised, the premium becomes part of the cost of acquiring (call) or disposing (put) the underlying shares.

When selling (writing) an option, the premium received is credited to "Option Premium – Liability" and the liability is re‑measured daily to fair value, with the change recognised in P/L.

Margin is the collateral required by exchanges to cover potential losses. In accounting, the margin posted is recorded as a cash outflow (debit "Margin Account", credit "Cash").

Each day, the MTM result is settled against the margin account. A positive MTM (gain) increases the margin balance, while a negative MTM (loss) reduces it, possibly triggering a margin call.

For the exam, remember that margin movements do not affect profit directly; they merely reflect cash flow. The profit or loss is captured in the "Derivative – Futures/Options" and "Profit and Loss" accounts as described earlier.

Under Indian tax law, profits from equity derivatives are taxed as business income if the trader is a dealer, or as capital gains if the contracts are held as investments. The distinction hinges on the frequency of transactions and the intent of the holder.

For futures and options that are settled in cash, the realised profit or loss on expiry is taxable in the year of settlement. Short‑term capital gains (STCG) tax at 15% applies only to listed equity shares; derivative profits are generally taxed at the applicable slab rates for individuals or at the corporate tax rate for firms.

Exam focus: identify the correct tax head (business income vs capital gains), know the applicable rate (15% for STCG on shares, slab rates for derivatives), and understand the treatment of premium paid on options (capitalised and deducted when the option is exercised or written off).

Many candidates forget to adjust the margin account when recording daily MTM entries, leading to mismatched cash balances.

Another frequent error is to apply the capital‑gains tax rate of 15% to derivative profits. Remember that derivatives are taxed as business income unless they qualify as capital assets under specific criteria.

Finally, students sometimes reverse the sign of the profit‑loss formula, reporting a gain as a loss. Always verify the direction of the price movement relative to the position (long vs short) before assigning the sign.