Accounting. Advanced Hedging

Transcription

1 Accounting Advanced Hedging under IFRS 9 Second Edition JUAN RAMIREZ WlLEY

2 Table of Contents Preface xxi CHAPTER1 The Theoretical Framework - Recognition of Financial Instruments Accounting Categories for Financial Assets Financial Asset Categories Financial Assets at Amortised Cost Financial Assets at Fair Value through Other Comprehensive Income Financial Assets at Fair Value through Profit or Loss Financial Assets - Initial and Subsequent Recognition Reclassifications The Amortised Cost Calculation: Effective Interest Rate Example of Effective Interest Rate Calculation - Fixed Rate Bond Effective Interest Rate Calculation - Floating Rate Debt Examples of Accounting for Fixed Rate Bonds Example of a Fixed Rate Bond at Amortised Cost Example of a Fixed Rate Bond Recognised at FVOCI Accounting Categories For Financial Liabilities Financial Liability Categories Partial Repurchases of Financial Liabilities Changes in Credit Risk in Financial Liabilities at FVTPL The Fair Value Option Hybrid And Compound Contracts Embedded Derivatives in Assets or Liabilities - Hybrid Instruments Liability Compound Instruments 22 CHAPTER 2 The Theoretical Framework - Hedge Accounting Hedge Accounting - Types of Hedges Derivative Definition Hedge Accounting 24 Vil

3 viii TABLE OF CONTENTS Accounting for Derivatives ^ Undesignated or Speculative Types of Hedges Fair Vahie Hedge Cash Flow Hedge Net Investment Hedge Hedged Item Candidates Hedged Item Candidates Forecast Transaction versus Firm Commitment Hedging Instrument Candidates Hedging Relationship Documentation Hedge Effectiveness Assessment Qualifying Criteria for Hedge Accounting Hedge Ratio Effectiveness Assessment Effectiveness Assessment Methods The Critical Terms Method The Simple Scenario Analysis Method The Regression Analysis Method The Monte Carlo Simulation Method Suggestions Regarding the Assessment Methods The Hypothetical Derivative Simplification Rebalancing Accounting for Rebalancings Discontinuation of Hedge Accounting Options And Hedge Accounting Intrinsic Value versus Time Value In-, At-or Out-of-the-Money Accounting Treatment for the Time Value of Options Example of Option Hedging a Transaction Related Item - Actual Time Value Exceeding Aligned Time Value Example of Option Hedging a Transaction Related Item - Actual Time Value Lower Than Aligned Time Value Example of Option Hedging a Time-Period Related Item - Actual Time Value Exceeding Aligned Time Value Example of Option Hedging a Time-Period Related Item - Actual Time Value Lower Than Aligned Time Value Written Options Forwards and Hedge Accounting 70 CHARTER 3 Fair Valuation - Credit and Debit Valuation Adjustments Fair Valuation - Overview of IFRS Definition of Fair Value Fair Value Hierarchy Level 1 Financial Instruments Level 2 Financial Instruments 75

4 Table of Contents ix Level 3 Financial Instruments Mid-to-Bid and Mid-to-Offer Adjustments Credit and Debit Valuation Adjustment Funding Valuation Adjustment Model Uncertainty Adjustment Day 1 Profit (or Loss) Case Study - Credit Valuation Adjustment of an Interest Rate Swap Simple One-Period Model of Default Working Example of CVA in a Swap Debit Valuation Adjustments Combining CVA and DVA Calculating CVA and DVA Using Monte Carlo Simulation Overnight Index Swap Discounting 95 CHAPTER 4 An Introduction to Derivative Instruments FX Forwards Product Description Forward Points Interest Rate Swaps Product Description IFRS 9 Accounting Implications Cross-Currency Swaps Product Description IFRS 9 Accounting Implications Standard (Vanilla) Options Product Description Standard Equity Options Standard Foreign Exchange Options Interest Rate Options - Caps, Floors and Collars Exotic Options Barrier Options Knock-out Barrier Options - Product Description Knock-in Barrier Options - Product Description Range Accruals 121 CHAPTER 5 Hedging Foreign Exchange Risk Types of Foreign Exchange Exposure Introductory Definitions Functional Currency and Presentation Currency Relevant Dates in an FX Transaction Summary of IAS 21 Translation Rates Monetary versus Non-monetaiy Items Translation Rates 125

5 X TABLE OF CONTENTS 5.4 Foreign Currency Transactions " Summary of Most Commonly Used FX Derivatives Case Study: Hedging A Forecast Sale and Subsequent Receivable with an FX Forward (Forward Element Included in Hedging Relationship) Background Setting the Hedging Relationship Term Hedging Relationship Documentation Hedge Effectiveness Assessment - Hypothetical Derivative Hedge Effectiveness Assessment Performed at Hedge Inception Fair Valuation of Hedged Item and Hypothetical Derivative at the Relevant Dates Accounting Entries - Hedge Objective Unchanged: No Discontinuation Accounting Entries - Hedge Risk Management Objective Changed: Discontinuation Case Study: Hedging a Forecast Sale with an FX Forward Setting the Hedging Relationship Term Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at Hedge Inception Fair Valuation of Hedged Item and Hypothetical Derivative at the Relevant Dates Accounting Entries When the Forward Element is Included in the Hedging Relationship Accounting Election When the Forward Element is Excluded from the Hedging Relationship Accounting When the Forward Element is Excluded from the Hedging Relationship and Recognised in Profit or Loss Accounting When the Forward Element is Excluded from the Hedging Relationship and Aligned Portion Temporarily Recognised in OCI Final Remarks: Inclusion versus Exclusion of the Forward Element Case Study: Hedging a Forecast Sale and Subsequent Receivable with a Tunnel Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at Hedge Inception Fair Valuation of Hedged Item and Hypothetical Derivative at the Relevant Dates Calculation of Effective and Ineffective Amounts Accounting Entries Accounting Entries - Discontinuation by Changing Risk Management Objective 17g Final Remarks ^ Case Study. Hedging A Forecast Sale and Subsequent Receivable with a Participating Forward 2 gg Participating Forward Hedge Accounting Issues i 2

6 Table of Contents xi Alternative 1: Participating Forward Split into a Forward and an Option Alternative 2(a): Participating Forward in its Entirety Alternative 2(b): Participating Forward in its Entirety - Readjusting the Hedge Ratio Gase Study: Hedging a Highly Expected Foreign Sale with a Knock-In Forward (Introduction) Accounting Optimisation of the Knock-in Forward Gase Study: Hedging a Forecast Sale And Subsequent Receivable with a Knock-In Forward (Splitting Alternative) Terms of the Split into a Forward and a Knock-out Option Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at Hedge Inception Fair Valuations of Derivative Contracts and Hypothetical Derivative at the Relevant Dates Calculation of Effective and Ineffective Amounts Accounting Entries Gase Study: Hedging A Forecast Sale and Subsequent Receivable with a Knock-In Forward (Instrument In Its Entirety) Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at Hedge Inception Fair Valuations of Hedging Instrument and Hypothetical Derivative at the Relevant Dates Calculation of Effective and Ineffective Amounts Accounting Entries Case Study: Hedging A Forecast Sale and Subsequent Receivable with a Knock-In Forward (Rebalancing Approach) Quantity of Hedged Item Estimation Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at Hedge Inception Fair Valuations at the Relevant Dates Effective and Ineffective Amounts at the Relevant Dates Accounting Entries Case Study: Hedging A Highly Expected Foreign Sale with a Kiko Forward Hedge Accounting Optimisation Hedge Accounting Application for Approach 1 - Forward plus Residual Derivative Hedging Relationship Documentation Hedge Effectiveness Assessment Performed at Hedge Inception Fair Valuations of Derivative Contracts and Hypothetical Derivative at the Relevant Dates 264 Accounting Entries 266 Wditional Remarks 269

7 xii TABLE OF CONTENTS 5.14 Case Study: Hedging A Forecast Sale and Subsequent Receivable with a Range Accrual (Part 1) Case Study: Hedging A Forecast Sale and Subsequent Receivable with a Range Accrual (Designation In Its Entirety) Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at Hedge Inception Fair Valuations and Calculations of Effective/Ineffective Amounts Accounting Entries Case Study: Hedging Forecast Sale and Subsequent Receivable with a Range Accrual (Splitting Approach) Accounting Entries Final Remarks Hedging On A Group Basis - The Treasury Centre Challenge Accounting Implications at Subsidiary Level Accounting Implications at Consolidated Level Hedging Forecast Intragroup Transactions Example of Hedge of Forecast Intragroup Transaction 293 CHAPTER 6 Hedging Foreign Subsidiaries Stand-Alone Versus Consolidated Financial Statements Subsidiary Financial Statements Parent-Only Financial Statements Consolidated Financial Statements The Translation Process Basic Procedures prior to Translation Specific Translation Procedures Hyperinflationary Economies The Translation Differences Account Special Items That Are Part of a Net Investment Goodwill and Fair Value Adjustments Long-Term Investments in a Foreign Subsidiary Disposal of a Foreign Operation Effect Of Minority Interests on Translation Differences Hedging Net Investments In Foreign Operations Net Investment Hedge Issuing Foreign Currency Debt Net Investment Hedge Using Derivatives Case Study: Accounting for Net Investments In Foreign Operations Elements of the Net Assets of a Foreign Subsidiary Translation Process on Acquisition Date Translation Process on First Reporting Date 307

8 Table of Contents xiii 6.8 Case Study: Net Investment Hedge with a Forward Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at Hedge Inception Fair Values and Calculation of Effective and Ineffective Amounts Accounting Entries - Forward Points Included in Hedging Relationship Accounting Entries - Forward Points Excluded from Hedging Relationship Implications of the FX Forward Points Case Study: Net Investment Hedge Using Foreign Currency Debt Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at Hedge Inception Other Relevant Information Accounting Entries Final Remarks Net Investment Hedging With Cross-Currency Swaps Case Study: Net Investment Hedge with a Floating-To-Floating Cross-Currency Swap Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at Hedge Inception Other Relevant Information Accounting Entries Final Remarks Case Study: Net Investment Hedge with a Fixed-To-Fixed Cross-Currency Swap Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at Hedge Inception Other Relevant Information Accounting Entries Case Study: Hedging Intragroup Foreign Dividends Effects of Intercompany Foreign Dividends on Individual and Consolidated Statements Hedging Intercompany Foreign Dividends with an FX Forward Case Study: Hedging Foreign Subsidiary Eamings Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at Hedge Inception Other Relevant Information Accounting Entries Final Remarks Case Study: Integral Hedging of an Investment in a Foreign Operation 364

9 CHAPTER7 Hedging Interest Rate Risk 7.1 Common Interest Rate Hedging Strategie: 7.2 Separation Of Embedded Derivatives in Structured Debt Instruments 7.3 Interest Accruals 7.4 Most Common Interest Rate Derivative Instruments 7.5 Case Study: Hedging a Floating Rate Liability With an Interest Rate Swap Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship Fair Valuations, Effective/Ineffective Amounts and Cash Flow Calculations Accounting Entries Final Remarks 7.6 Case Study: Hedging A Floating Rate Liability With a Zero-Cost Collar Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship Fair Valuations, Effective/Ineffective Amounts and Cash Flow Calculations Accounting Entries Final Remarks 7.7 Implications of Interest Accruals and Credit Spreads B ackground Information Credit Spread and Hedge Accounting Interest Accruals and Fair Valuations 7.8 Case Study: Hedging a Fixed Rate Liability With an Interest Rate Swap Background Information Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship Fair Valuations, Effective/Ineffective Amounts and Cash Flow Calculations Accounting Entries Concluding Remarks 7.9 Case Study: Hedging A Future Fixed Rate Issuance with an Interest Rate Swap Background Information Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship

10 Table of Contents XV Fair Valuations, Effective/Ineffective Amounts and Cash Flow Calculations Accounting Entries Concluding Remarks Case Study: Hedging A Future Floating Rate Issuance with an Interest Rate Swap Background Information Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship Fair Valuations, Effective/Ineffective Amounts and Cash Flow Calculations Accounting Entries Concluding Remarks Case Study: Hedging A Fixed Rate Liability with a Swap In Arrears Background Information Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship Fair Valuations, Effective/Ineffective Amounts and Cash Flow Calculations Accounting Entries Concluding Remarks Case Study: Hedging A Floating Rate Liability with a Kiko Collar B ackground Information Split between Hedge Accounting Compliant Derivative and Residual Derivative Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship Fair Valuations, Effective/Ineffective Amounts and Cash Flow Calculations Accounting Entries Concluding Remarks 467 CHAPTER 8 Hedging Foreign Currency Uabilities Case Study: Hedging a Floating Rate Foreign Currency Liability with a Receive-Floating Pay-Floating Cross-Currency Swap Background Information Determining Risk Components to Include in the Hedging Relationship 472

11 xvi TABLE OF CONTENTS Hedging Relationship Documentation ^' z Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship Fair Valuations, Effective/Ineffective Amounts and Cash Flow Calculations Accounting Entries 4^ Concluding Remarks 4^ 8.2 Case Study: Hedging a Fixed Rate Foreign Currency Liability with a Receive-Fixed Pay-Floating Cross-Currency Swap Background Information 4^ Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship Fair Valuations, Effective/Ineffective Amounts and Cash Flow Calculations Accounting Entries Concluding Remarks Case Study: Hedging A Floating Rate Foreign Currency Liability with a Receive-Floating Pay-Fixed Cross-Currency Swap Background Information Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship Fair Valuations, Effective/Ineffective Amounts and Cash Flow Calculations Accounting Entries Concluding Remarks Case Study: Hedging A Fixed Rate Foreign Currency Liability with a Receive-Fixed Pay-Fixed Cross-Currency Swap Background Information Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship Fair Valuations, Effective/Ineffective Amounts and Cash Flow Calculations Accounting Entries 55\ Concluding Remarks 561 CHAPTER 9 Hedging Equity Risk Recognition of Equity Investments In Other Companies Hedging Investments Consolidated under Equity Method 565

12 Table of Contents xvii Impairment of Equity Investments Debt Versus Equity Classification of Own Instruments Recognition as a Liability Recognition as an Equity Instrument Hybrid Securities - Preference Shares From an Issuer's Perspective Contractual Discretion Economic Compulsion Degree of Subordination Legal Form Entity's Historical Trend or Ability to Make Distributions Convertible Bonds - Issuer's Perspective Convertible Bonds Denominated in the Entity's Functional Currency - Fixed for Fixed Convertible Bonds Denominated in the Entity's Functional Currency - Fixed for Variable Convertible Bonds Denominated in a Foreign Currency Convertible Bonds - Investor's Perspective Derivatives on Own Equity Instruments Hedging Own Equity Instruments Derivatives on Own Equity Instruments Case Study: Accounting For A Stock Lending Transaction Accounting Entries Final Remarks Case Study: Accounting for a Mandatory Convertible Bond from an Issuer's Perspective Accounting for a Fixed Parity Mandatory Convertible Bond Accounting for a Variable Parity Mandatory Convertible Bond Case Study: Accounting for a Convertible Bond from an Issuer's Perspective Accounting for a Fixed-for-Fixed Convertible Bond Accounting for a Fixed-for-Variable Convertible Bond Case Study: Hedging Step-Up Callable Perpetual Preference Shares Accounting versus Credit Impact The Hedging Problem Accounting Entries Concluding Remarks Case Study: Base Instruments Linked To Debt Instruments Case Study: Parking Shares Through a Total Return Swap Asset Monetisation Strategy Accounting Entries Case Study: Hedging an Equity Investment with a Put Option Accounting Treatment of the Put Time Value when Excluded from the Hedging Relationship 602

13 xviii TABLE OF CONTENTS Accounting Treatment of the Put Time Value when Included in a Hedging Relationship Case Study: Selling A Forward on Own Shares Accounting Treatment of a Physically Settled Only Forward on Own Shares Accounting Treatment of a Forward on Own Shares Treated as a Derivative 612 CHAPTER 10 Hedging Stock-Rased Compensation Plans Types And Terminology of Stock-Based Compensation Plans Main Equity-Based Compensation Plans Terminology Accounting for Equity-Based Compensation Plans Vesting and Non-vesting Conditions Accounting for Stock Option Plans Accounting for Stock Appreciation Rights Case Study: ABC's Share-Based Plans Main Terms Accounting for ABC's Stock Option Plan Accounting for ABC's Stock Appreciation Rights Main SOP/SAR Hedging Strategies Underlying Risks in SOPs and SARs Hedging with Treasury Shares Hedging with Equity Swaps Hedging with an Enhanced Equity Swap Hedging with Standard Call Options Case Study: Hedging a Stock Option Plan with an Equity Swap Case Study: Hedging an SAR Plan with a Call 647 CHAPTER 11 Hedging Commodity Risk Main Commodity Underlyings Lease, Derivative and Own-Use Contracts Definitions of Lease, Derivative and Own-Use Contracts Use of Similar Contracts for both Own-Use and Trading Purposes Categorisation According to Settlement Terms Physically Settled Commodity Contracts Net Settled Commodity Contracts Commodity Contracts with Choice of Physical Delivery or Net Settlement Case Study: Hedging Gold Production with a Forward - Own-Use Application 559

14 Table of Contents xix 11.5 Case Study: Raising Financing Through a Gold Loan Case Study: Hedging a Silver Purchase Firm Commitment with a Forward - Fair Value Hedge Hedging Strategy Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship Fair Valuations of Hedging Instrument and Hedged Item Accounting Entries Case Study: Hedging Commodity Inventory with Futures Recognition of Inventories according to IAS Applying Hedge Accounting to Inventory Background Information Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship Fair Valuations of Hedging Instrument and Hedged Item Accounting Entries Case Study: Hedging a Highly Expected Purchase Of Oil With Futures and an FX Forward - Cash Flow Hedge Background Information Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at Hedging Relationship Inception Fair Valuations of Hedging Instrument and Hedged Item Accounting Entries Case Study: Airline Jet Fuel Consumption Hedge With Jet Fuel and Crude Oil - Risk Component Background Information Hedging Risk Components Hedging Relationship Documentation Hedge Effectiveness Assessment Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship Fair Valuations and Accounting Entries on 30 June 20X Concluding Remarks 707 CHAPTER 12 Hedging Inflation Risk Inflation Markets - Main Participants and Indices Inflation Market Participants Measuring Inflation from Indices 711

15 XX TABLE OF CONTENTS Main Inflation Indices Components of a Bond Yield and the Fisher Equation Breakeven Inflation Inflation-Linked Bonds Inflation Derivatives Zero-Coupon Inflation Swaps Non-cumulative Periodic Inflation Swaps Cumulative Periodic Inflation Swaps Inflation Caps and Floors Inflation Risk Under IFRS Hybrid Instruments Hedging Inflation as a Risk Component Case Study: Hedging Revenues Linked To Inflation Background Hedging Relationship Documentation Hedge Effectiveness Assessment - Hypothetical Derivative Hedge Effectiveness Assessment Performed at Start of the Hedging Relationship Fair Valuations of the ILS and the Hypothetical Derivative Accounting Entries Concluding Remarks Malching An Inflation-Linked Asset with a Floating Rate Liability 738 CHAPTER 13 Hedge Accounting: A Double Edged Sword Positive Influence on The Profit or Loss Statement Substantial Operational Resources Limited Access to Hedging Alternatives Risk of Reassessment of Highly Probable Transactions Low Compatibility With Portfolio Hedging Final Remarks 74g INDEX 749