IFRS 9 Accounting for hedging relationships | Annualreporting.info

Cash flow hedge of a net position

Many entities are exposed to foreign exchange risk arising from purchases and sales of goods or services denominated in foreign currencies. Cash inflows and outflows occurring on forecast transactions in the same foreign currency are often economically hedged on a net basis. For example, consider an entity that has forecast foreign currency sales of FC100 and purchases of FC80, both in 6 months. It hedges the net exposure using a single foreign exchange forward contract to sell FC20 in 6 months.

Hedging of such a net position does not qualify for hedge accounting under IAS 39. However, hedge accounting could still be achieved by designating the foreign exchange forward contract as hedging FC20 of the FC100 forecast sales. By doing Read more

Accounting for macro hedging

Financial institutions, particularly retail banks, have as a core business, the collection of funds by depositors that are subsequently invested as loans to customers. This typically includes instruments such as current and savings accounts, deposits and borrowings, loans and mortgages that are usually accounted for at amortised cost. The difference between interest received and interest paid on these instruments (i.e., the net interest margin) is a main source of profitability.

A bank’s net interest margin is exposed to changes in interest rates, a risk most banks (economically) hedge by entering into derivatives (mainly interest rate swaps). Applying the hedge accounting requirements (as defined in IAS 39 or IFRS 9) to such hedging strategies on an individual item-by-item basis Read more

Foreign currency forward contracts

Forward element of forward contracts and foreign currency basis spread of financial instruments


General requirements

Under IAS 39, entities using foreign currency forward contracts in hedging relationships can designate the instrument in its entirety or designate the spot element only. Designating the spot element only results in the forward points (often also called the ‘forward element’) to be accounted for at fair value.

When designating the entire instrument, IAS 39 allows the hedged item alternatively to be measured at the forward rate instead of the spot rate. For example, when hedging a highly probable forecast transaction, the hedged item, once transacted, would be measured at the forward rate at designation.

This is often referred to as the Read more

Foreign currency basis spreads

IFRS 9 also introduces a new accounting treatment for currency basis spreads. The currency basis spread, a phenomenon that became very significant during the financial crisis, is a charge embedded in financial instruments that compensates for aspects such as country and liquidity risk. This charge only applies to transactions involving the exchange of foreign currencies at a future point in time (as, for example, in currency forward contracts or CCIRS).

Historically, the difference between the spot and forward prices of currency forward contracts and CCIRS represented the differential between the interest rates of the two currencies involved. However, basis spreads increased significantly during the financial crisis and with the following sovereign debt crisis, and have become a significant and Read more

Examples fair value hedge

Fair value hedge of changes in the benchmark interest rate for a variable-rate debt obligation

On January 1, Year 1 ABC Corp. issues a floating-rate non-amortizing debt instrument with a maturity of two years. The variable-rate liability resets every six months at the six-month LIBOR rate.Examples fair value hedge

The six-month LIBOR rate on January 1, Year 1 is 2.5%.

At the same time, ABC enters into a six-month interest rate swap agreement with a notional amount equal to the face amount of the debt instrument. Under the terms of the swap agreement, ABC will receive the six-month LIBOR rate and pay the one-month LIBOR rate (for example 2.3%).

ABC wants to designate the interest rate swap as a fair value hedge of Read more

Hedged item – Hedge of a net position

Q: When can an entity hedge a net position?

Considerations: Hedged item – Hedge of a net position
A EUR-functional currency entity has a sales department that sells certain items in USD. At the same time, the purchasing department buys certain products in USD. Each department is unaware of the other’s activities, but both want to hedge their forecast USD sales and purchases respectively. Assume that the sales department has USD100,000 of sales in six months’ time, so it enters into a forward contract with the entity’s central treasury department (that is a separate entity within the same group).

The purchasing department has highly probable forecast purchases of USD90,000, also in six months’ time, and it also enters into … Read more