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Note that terms, e.g., derivatives, are defined in IFRS 9, or IAS 39 and are used in IAS 32 with the meaning specified in IAS 39 and IFRS 9 (IAS 39 will transition to IFRS 9).


From IFRS Workbook 2018

A firm commitment is a binding agreement for the exchange of a specified quantity of resources at a specified price on a specified future date or dates.

A forecast transaction is an uncommitted but anticipated future transaction.

A hedging instrument is a designated derivative or (for a hedge of the risk of changes in foreign currency exchange rates only) a designated non-derivative financial asset or non-derivative financial liability whose fair value or cash flows are expected to offset changes in the fair value or cash flows of a designated hedged item (paragraphs 72-77 and Appendix A paragraphs AG94-AG97 elaborate on the definition of a hedging instrument).

A hedged item is an asset, liability, firm commitment highly probable forecast transaction or net investment in a foreign operation that (a) exposes the entity to risk of changes in fair value or future cash flows and (b) is designated as being hedged (paragraphs 78-84 and Appendix A paragraphs AG98-AG101 elaborate on the definition of hedged items).

Hedge effectiveness is the degree to which changes in the fair value or cash flows of the hedged item that are attributable to a hedged risk are offset by changes in the fair value or flows of the hedging instrument (see Appendix A paragraphs AG105-AG113A).

88 A hedging relationship qualifies for hedge accounting under paragraphs 89-102 if, and only if, all of the following conditions are met.

a)   At the inception of the hedge there is formal designation and

documentation of the hedging relationship and the entity’s risk management objective and strategy for undertaking the hedge. That documentation shall include identification of the hedging instrument, the hedged item or transaction, the nature of the risk being hedged and how the entity will assess the hedging

  1. At the inception of the hedge there is formal designation and documentation of the hedging relationship and the entity’s risk management objective and strategy for undertaking the hedge. That documentation shall include identification of the hedging instrument, the hedged item or transaction, the nature of the risk being hedged and how the entity will assess the hedging
  1. instrument’s effectiveness in offsetting the exposure to changes in the hedged item’s fair value or cash flows attributable to the hedged risk.
  1. The hedge is expected to be highly effective (see Appendix A paragraphs AG105-AG113A) in achieving offsetting changes in fair value or cash flows attributable to the hedged risk, consistently with the originally documented risk management strategy for that particular hedging relationship. [Refer also: Basis for Conclusions paragraphs BC136-BC136BJ
  1. For cash flow hedges, a forecast transaction that is the subject of the hedge must be highly probable and must present an exposure to variations in cash flows that could ultimately affect profit or loss.
  1. The effectiveness of the hedge can be reliably measured, the fair value or cash flows of the hedged item that are attributable to the hedged risk and the fair value of the hedging instrument can be reliably measured.
  1. The hedge is assessed on an ongoing basis [Refer: paragraph AG106 and determined actually to have been highly effective throughout the financial reporting periods for which the hedge was designated.

Note that above we referenced that IAS 39 will transition to IFRS 9 that rewrote the hedging criterion. IAS 39 was considered excessively

complicated and difficult to interpret. Ironically, leases, IFRS 16 and the revenue standard, IFRS 15, replacing IAS 18 are also noted  as complicated and complex to interpret and implement with many entities, especially with IFRS 16, struggling to meet the effective compliance deadlines.

  1. Under older rules in IAS 39, companies did not have much choices of hedging instruments. Either they took some derivatives, or alternatively they could take also non-derivative financial asset or liability in a hedge of a foreign currency risk. Not much. IFRS 9 allows you to use broader range of hedging instruments, so now you can use any non-derivative financial asset or liability measured at fair value through profit or loss.

Example: Let’s say you have large inventories of crude oil and you would like to hedge their fair value. Therefore you make an investment into some fund with portfolio of commodity – linked instruments. In line with IAS 39, you cannot apply hedge accounting, because in a fair value hedge, you can use only some derivative as your hedging instrument. In line with IFRS 9, you can apply hedge accounting, because IFRS 9 allows designating also non-derivative financial instrument measured at fair value through profit or loss. I assume your investment into the fund would meet this condition.

  1. What can be your hedged item? With regard to non-financial items IAS 39 allows hedging only a non-financial item in its entirety and not just some risk component of it. IFRS 9 allows hedging a risk component of a non-financial item if that component is separately identifiable and measurable.

Example: an airline might face significant price risk involved in jet fuel. The prices of jet fuel might change due to several reasons: rising inflation, changing crude oil price and many other factors. Therefore, an airline might decide to hedge only a benchmark crude oil price risk component included in the price of jet fuel. Such a hedging might be performed by acquiring commodity forward contracts to buy crude oil.

In line with IAS 39, an airline would not have been able to account for this commodity forward contract as for a hedge. The reason is that an airline’s hedged item is just one risk component of a non-financial asset (jet fuel) and IAS 39 allows hedging non-financial items only in their entirety.

In line with IFRS 9, an airline can apply hedge accounting because IFRS 9 allows designating separate risk component of non-financial item as a hedged item.


Accounting Theory – Advanced Part 23 (IAS 33 Financial Instruments Presentation)

The picture on top: Burak K

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Peter Welch
Peter Welch

GlobalCfo.LLC is an expert at developing entrepreneurs and building 3-5 year business plans and cash flow projections as a prerequisite for accessing financing sources. GlobalCfo.LLC targets accounting standards compliance and theory, sound infrastructure /process mapping and COSO 2013-17/solid internal controls, ERM, and last but not least documentation /Policy and Procedures and other manuals. Additionally, interim CFO services (or Rent-a-CFO by the hour/day) are offered locally or remotely as well as training at all levels and all functions, not just accounting; e.g., management and leadership skills. Pre/Post-M&A is also offered.

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