different periods sometimes referred to as an accounting mismatch

Transcription

1 Matching the change in FV of the hedging instrument and the hedged item in profit or loss for the same period Hedge accounting is only an issue when normal accounting would put the two fair value changes in different periods sometimes referred to as an accounting mismatch 61 Hedge accounting recognisesthe offsetting effects of changes in the fair values or the cash flows of the hedging instrument and the hedged item. Strict conditions must be met before hedge accounting is possible: there must be formal designation and documentation of a hedge, including the risk management strategy for the hedge. the hedging instrument must be expected to be highly effective in achieving offsetting changes in fair value or cash flows of the hedged item that are attributable to the hedged risk. 62

2 Reliable measurement of effectiveness formal hedge documentation + risk management policy FORMAL DESIGNATION The hedge is expected to be and is highly effective 63 THE HEDGE IS EXPECTED TO BE AND HAS BEEN HIGHLY EFFECTIVE PROSPECTIVE TEST (highly effective) AT INCEPTION X AT EACH REPORTING DATE X AND RETROSPECTIVE TEST ([80-125%]) X 64

3 Highly probable forecast transaction FIRM COMMITMENT ASSET LIABILITY Single item Group of similar items (sharing the same risk) Net investment in foreign operations Proportions of an item 65 Fixed rate assets/liabilities Assets/liabilities in foreign currencies Firm commitments Fair Value Cash Flow Variable rate assets/liabilities Highly probable forecast transactions Net investments in foreign operations Foreign Exchange 66

4 Hedge exposure to fair value changes of recognised asset or liability or unrecognisedfirm commitment (or portion of these attributable to a particular risk) Hedge of the foreign currency risk of a firm commitment Recognition of gains and losses on hedged item and hedging instrument in profit and loss and adjust the carrying amount of the hedged item (if not measured at cost) 67 Entity borrows 1,000, 3 years, 5% fixed rate, payable at the end, measured at amortised cost Hedged with a derivative whose value is linked to an interest rate index End of year 1, market rate = 6%. FV of 50 payable in 1 year at 6% + 1,050 payable 2 years at 6% = 50 x ,050 x = 982, but this 18 gain is not recognised Value of the derivative declines to -20 Note: there is small ineffectiveness = 2 68

5 Financial position when loan made: Cash 1,000 Loan payable 1,000 Adjust loan end of year 1 to reflect rate change: Loan payable (hedge acct) 18 P&L (18 gain 20 loss) 2 Derivative (Liability) 20 Financial position end of year 1: Cash 1,000 Derivative (Liability) 20 Loan payable 982 Equity (2) 69 Hedge of the exposure to variability in cash flows attributable to a particular risk associated with a recognisedasset or liability or a highly probable forecast transaction Hedge of the foreign currency risk of a firm commitment Portion of hedge deemed to be effective: gains and losses recognised in OCI Portion of hedge deemed to be ineffective: gains and losses recognised in profit or loss Treatment of cumulative gains or losses differs based on what type of asset or liability is subsequently recognised 70

6 Entity sells goods for 1,000 floating rate 3-year note receivable Interest rate risk managed with a derivative (interest rate swap) End of year 1 interest rates increase PV of cumulative cash flows increase by 100 But FV of swap decreases by 105 Note: Some hedge ineffectiveness 71 Opening financial position: Receivable 1,000 Equity 1,000 Ineffective portion of hedge: P&L OCI (Equity) 100 Derivative (Liability) 105 Closing financial position: Receivable 1,000 Equity (OCI) 5 (ineffective portion of hedge) 100 (effective portion of hedge) Derivative (Liability) 105 Equity

7 Hedge of a net investment in a foreign operation as defined in IAS 21 accounted for similarly to cash flow hedges 73 Entity A has a wholly-owned subsidiary, Entity B. Entity has a CU functional currency and Entity B has a FCU functional currency. Entity A paid FCU100,000 for the investment in net assets at fair value of FCU80,000. Goodwill of FCU20,000 was recognised. At acquisition, Entity A loaned Entity CU15,000 (exchange rate was FCU2:CU1). Settlement is not planned or expected in the near future. 74

8 At acquisition, Entity A designates the net investment in Entity B as a hedged item in its consolidated financial statements. The maximum amount that can be designated is FCU130,000 Net assets at FV: Goodwill: Loan: FCU80,000 FCU20,000 FCU30,000 If the loan was expected to be settled in the foreseeable future, it would not form part of the net investment

9 Replace IAS 39 Recognition and Measurement with IFRS 9 Financial Instruments in phases Phase I: Classification and measurement (completed) Phase II: Impairment (in progress) Phase III: Hedge accounting (in progress) 77 Reduces complexity only two classification categories single impairment model (only FI s at amortised cost) embedded derivatives no longer separated from financial asset host contracts Aligns measurement of financial assets with entity s business model and contractual cash flow characteristics of instruments Own credit risk issue addressed Elimination of tainting rules that caused bonds to be measured at fair value even if the business model was to hold 78

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