Important Accounting Aspects Related to Trading in Commodity Derivatives

Mark‑to‑Market (MTM) is the daily settlement mechanism mandated by SEBI for all exchange‑traded commodity derivatives. At the end of each trading day the exchange calculates the difference between the contract’s closing price and its price at the beginning of the day (or the previous settlement price). This difference is credited or debited to the trader’s margin account, thereby reflecting the real‑time profit or loss.

For accounting purposes, MTM creates a floating profit or loss that must be recognised in the profit‑and‑loss (P&L) statement of the trading entity. The amount is treated as an operating item because the positions are generally held for speculative or hedging purposes, not as long‑term investments. The MTM figure is also the basis for calculating the taxable income for the financial year.

Exam relevance: NISM frequently asks candidates to compute MTM profit/loss, to identify the journal entry for the daily settlement, and to differentiate MTM from cash‑settlement at expiry. Remember that MTM is realised daily, whereas cash settlement occurs only at contract expiry.

• MTM ensures that the exchange’s clearing house remains solvent by collecting or returning margin each day.
• The daily MTM amount is posted to the “Trading Account – Commodity Derivatives”.

When a futures contract is bought, the trader records a debit to the “Futures Trading Account” for the contract value and a credit to the “Margin Account” for the initial margin deposited. The contract value equals the contract size multiplied by the purchase price.

At the end of each day, the MTM amount calculated in the previous block is posted. A positive MTM (profit) results in a debit to the “Margin Account” and a credit to the “Futures Trading Account”. Conversely, a negative MTM (loss) is recorded as a debit to the “Futures Trading Account” and a credit to the “Margin Account”.

When the position is closed (offset by an opposite trade), the net profit or loss accumulated through daily MTM entries is transferred to the “Profit & Loss Account”. The journal entry at expiry mirrors the closing trade, ensuring that the margin account returns to zero.

• Initial entry: Debit Futures Trading Account, Credit Margin Account.
• Daily MTM entry: Debit/Credit Margin Account, Credit/Debit Futures Trading Account.

For an option buyer, the premium paid is capitalised as a debit to the “Options Premium Account” and a credit to the “Cash/Bank Account”. The premium is the maximum loss the buyer can incur, so it is treated as an expense until the option is exercised or expires.

If the option is exercised, the buyer records the underlying commodity purchase (for a call) or sale (for a put) at the strike price, along with the previously paid premium. The net effect on the P&L is the difference between the market price at exercise and the strike price, less the premium.

For an option seller (writer), the premium received is credited to the “Options Premium Received” account and debited from cash. The writer must set aside a margin as per exchange rules, recorded as a debit to “Margin Account”. Daily MTM is also applied to the option’s mark‑to‑market value, similar to futures.

• Buyer entry: Debit Options Premium Account, Credit Cash/Bank.
• Seller entry: Credit Options Premium Received, Debit Cash/Bank; Debit Margin Account for required margin.

Under the Indian Income‑Tax Act, gains from commodity futures and options are taxed as business income if the trader is a dealer, or as speculative income if the activity is non‑business. For a non‑dealer, the profit is treated as "income from other sources" and taxed at the applicable slab rate.

Losses from speculative commodity transactions can be set off only against speculative gains in the same financial year; they cannot be carried forward. However, if the trader is a dealer, losses can be set off against any business income and can be carried forward for eight years.

Exam tip: The NISM exam distinguishes between "dealer" and "non‑dealer" status. Always check the question stem for the word “dealer” before applying loss‑set‑off rules.

• Short‑term capital gains (STCG) arise only when the commodity is a capital asset, which is rare for exchange‑traded contracts.
• Business income is computed after deducting expenses such as brokerage, transaction charges, and GST paid.

Goods and Services Tax (GST) is applicable on the brokerage, transaction charges and the premium of options contracts. The exchange‑traded commodity contracts themselves are exempt from GST because they are considered financial services.

For option buyers, GST is payable on the premium at the prevailing rate of 18% (CGST + SGST). The buyer can claim Input Tax Credit (ITC) only if the premium is used for business purposes. Option sellers must charge GST on the premium they receive and remit it to the government.

Brokerage fees, clearing charges and other service fees are also subject to 18% GST. These amounts are deductible as business expenses while computing taxable income.

• GST is not levied on the MTM profit or loss.
• Failure to account for GST on option premium is a common exam mistake.

Margins are the security deposits required by the exchange to cover potential losses. They are recorded as a separate “Margin Account” (asset) on the balance sheet. The initial margin is debited from cash/bank and credited to the margin account when the position is opened.

Daily MTM adjustments increase or decrease the margin account. If the margin falls below the maintenance level, a margin call is issued and the trader must top up the account. The additional amount is again recorded as a debit to cash and a credit to the margin account.

When the position is closed, the margin account is cleared – the remaining balance is transferred back to cash/bank, and any excess margin is recognised as a gain or loss in the trading account.

• Margin is not an expense; it is a temporary asset/liability.
• Incorrectly treating margin as an expense leads to overstated losses.

Ind AS 109 (Financial Instruments) requires entities to classify derivative contracts as either held for trading or hedging instruments. Commodity derivatives used for speculation are classified as “held for trading” and measured at fair value through profit or loss (FVTPL). Hedging instruments, used to mitigate price risk of a physical commodity, are measured at fair value with changes recognised in other comprehensive income (OCI) if the hedge qualifies.

For a qualifying cash flow hedge, the effective portion of the fair‑value change is recorded in OCI, while the ineffective portion goes directly to P&L. This classification impacts both the presentation in the financial statements and the tax treatment.

Exam relevance: NISM often asks which accounting treatment applies to a speculative futures contract versus a hedge. Remember the key phrase – “speculative = FVTPL, hedge = fair value with OCI (if qualifying)”.

• Entities must disclose the nature of the derivative, the risk management objective, and the accounting policy.
• Re‑measurement is done at each reporting date, using the same MTM methodology as SEBI.

One frequent error is treating the initial margin as an expense. Margin is a collateral asset and should be recorded in a separate margin account, not deducted from profit.

Another mistake is double‑counting GST – students sometimes add GST on both the brokerage and the MTM profit. Remember, GST is levied only on service fees and option premiums, not on the profit earned from price movements.

Finally, overlooking the distinction between dealer and non‑dealer status leads to incorrect loss‑set‑off treatment. Always verify the status before applying the eight‑year carry‑forward rule.

• Check the question for “dealer” keyword.
• Separate margin accounting from expense accounting.