NISM Series VIII: Equity Derivatives | Chapter 9: Accounting & Taxation | Full Study Notes

CHAPTER 9: ACCOUNTING AND TAXATION

9.1 ACCOUNTING

Forward Contracts Accounting

  • For Hedging:

    • Amortize premium or discount (spot vs. forward rate) over the contract's life.

    • Recognize exchange differences (settlement/reporting date vs. previous date) in the year's P&L.

    • Recognize profit/loss from forward contract cancellation/renewal in the year's P&L.

  • For Trading/Speculation:

    • No premium or discount is recognized.

    • Recognize gain or loss (difference between contract/previous year-end forward rate and year-end forward rate) in the P&L for the period.

    • Recognize profit/loss from forward contract cancellation/renewal in the year's P&L.

Accounting for Equity Index and Stock Futures (Books of Client)

1. At Inception (Initial Margin)

  • Initial margins paid are debited to "Initial Margin - Equity Index/Equity Stock Futures Account".

  • No accounting entry is made for the contract itself at inception, only for the margin.

  • Journal Entries:

    • Deposit Kept: Deposit for Initial Margin A/c Dr. to Bank A/c.

    • Margin Paid/Adjusted: Initial Margin A/c Dr. to Deposit for Initial Margin A/c (or Bank).

    • Margin Released: Bank A/c Dr. to Initial Margin A/c.

2. Daily Settlement (MTM Margin)

  • Daily adjustments are made based on market movement.

  • Losses are debited and gains are credited to the "Mark-to-Market Margin - Equity Index/Stock Futures Account".

  • Journal Entries:

    • Margin Paid: M to M Margin A/c Dr. to Bank/Deposit for M to M Margin A/c.

    • Margin Received: Bank/Deposit A/c Dr. to M to M Margin A/c.

3. Open Interests at Balance Sheet Date

  • Debit Balance (Loss): Listed under Current Assets. A provision for anticipated loss must be created by debiting P&L.

  • Credit Balance (Profit): Listed under Current Liabilities. Anticipated profits are ignored (Prudence Principle).

  • Provision Entry: Profit & Loss A/c Dr. to Provision for Loss on Equity Stock/Index Futures A/c.

4. Final Settlement / Squaring-up

  • Profit/Loss is the difference between final settlement price and contract price.

  • If Profit: Mark-to-Market Margin A/c Dr. to Profit & Loss A/c.

  • If Loss: Profit & Loss A/c Dr. to Mark-to-Market Margin A/c.

  • Initial margin is released upon settlement.

Accounting for Equity Index/Stock Options

1. For Buyer (Holder)

  • Premium Paid: Treated as an expense. Equity Index/Stock Option Premium A/c Dr. to Bank A/c.

  • Year-end OTM: If premium paid > market premium, create a loss provision.

  • Final Settlement (Cash): Income is recorded if the settlement price > strike price.

2. For Seller (Writer)

  • Initial Margin: Treated as a Current Asset. Equity Index/Stock Option Margin A/c Dr. to Bank A/c.

  • Premium Received: Treated as income. Bank A/c Dr. to Equity Index/Stock Option Premium A/c.

  • Daily MTM: Seller is subject to daily MTM margin payments.

3. Delivery-Settled Options (Stock Options)

  • Call Buyer: Equity Shares A/c Dr. to Bank/Cash A/c (at strike price).

  • Put Buyer: Bank/Cash A/c Dr. to Equity Shares A/c (at strike price).

  • Premium: Paid/received premium is transferred to P&L at settlement.

9.2 TAXATION OF DERIVATIVES

Business Income

  • Gains/Losses from derivatives on recognized exchanges are taxed as Business Income (Non-speculative).

  • Losses can be set off against any business income (except salary) and carried forward for 8 years.

  • FPIs: Gains/Losses are treated as Capital Gains.

  • Presumptive Taxation: Small traders (turnover < ₹2 crores) can opt for Section 44AD (taxed on 6% of turnover).

Securities Transaction Tax (STT)

STT paid on derivative trades is deductible under the Income Tax Act.

Transaction TypeSTT Rate (Historical)Payable By
Sale of Options0.0625% (on premium)Seller
Exercised Options0.125% (on settlement price)Buyer
Sale of Futures0.0125% (on trade price)Seller
Physical Delivery0.1%Both Buyer & Seller

Dhaval Visariya

AMFI Registered Distributor (ARN-327925) | Software Developer & Finance Enthusiast

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Disclaimer: I am an AMFI Registered Mutual Fund Distributor. Views expressed here are for educational purposes. Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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