IFRS 9 Hedge accounting

Hedge accounting is an accountancy practice, the aim of which is to provide an offset to the mark-to-market movement of the derivative in the profit and loss account.

Hedge documentation

IFRS 9 6.4 requires an entity to meet all of 4 criteria for the combination of the hedging instrument and the hedged item or transaction (the ‘hedging relationship’) and evidence the positive qualification for these criteria in formal documentation (authorised by an appropriate level of management of an enity)  to qualify for hedge accounting.

Criterion 1

Criterion 2

Criterion 3

Criterion 4

Eligibility of hedged items or transactions

Eligibility of hedged risk(s)

Eligibility of hedging instruments

Hedge effectiveness

Evidenced in formal documentation

Hedge accounting is permitted only if all of the applicable criteria are met. Here the hedge documentation requirements are discussed/explained.

Formal designation and documentation at hedge inception

Concurrent designation and documentation of a … Read more

Cash flow hedge documentation

In addition to the general documentation requirements discussed in ‘Hedge documentation‘, there are incremental documentation requirements specific to cash flow hedges. These primarily relate to the documentation around the specific identification of a forecasted transaction.

A forecasted transaction needs to be described with sufficient specificity such that when the transaction occurs, it is clear whether that transaction is or is not the hedged transaction. It is required that an entity formally documents certain details around the specific identification of the forecasted transaction, including:

Timing

Timing of when the forecasted transaction is expected to occur (e.g. specific date or period).

IFRS 9 requires an entity to specify and document the date or period within which the forecasted transaction

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Fair value hedge documentation

In addition to the general documentation requirements discussed in ‘Hedge documentation‘, there are incremental documentation requirements specific to fair value hedges relating to firm commitments and hedging relationships designated under the last-of-layer method.

Firm commitments

Documentation includes a reasonable method for recognizing in profit or loss the asset or liability that represents the gain or loss on the hedged firm commitment.

The subsequent accounting for assets or liabilities recognized as a result of applying fair value hedge accounting to an unrecognized firm commitment is as follows:

  • In a hedge of a firm commitment (rather than of a recognized asset or liability), adjustments of the hedged item (firm commitment) result in the recognition of assets or liabilities
  • For
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Hedge of forecast foreign currency purchases

This narrative can also be used as a sort of starting point to the hedge documentation required for each hedging relationship at inception. Part 1 of 3

Here is part 2 of 3

and here is part 3 of 3

The Case

Type of hedge: cash flow hedge

Hedged risk: FX risk – spot component only

Key features: Spot rate designated, Basis adjustment required for inventory, Cost of hedging approach elected – Forward points taken to OCI, Inclusion of time value of money in measuring hedge ineffectiveness

Background and assumptions

Company A is a French company with a EUR functional currency. Its reporting dates are 30 June and 31 December.

Company A produces and sells Read more

Hedge of forecast foreign currency purchases

This narrative can also be used as a sort of starting point to the hedge documentation required for each hedging relationship at inception. Part 2 of 3

Here is part 1 of 3

and here is part 3 of 3

The Case

Type of hedge: cash flow hedge

Hedged risk: FX risk – spot component only

Key features: Spot rate designated, Basis adjustment required for inventory, Cost of hedging approach elected – Forward points taken to OCI, Inclusion of time value of money in measuring hedge ineffectiveness

  • Continue: Effectiveness tests and accounting entries

1 July 20×5

Hedge effectiveness assessment

As described in the hedge documentation, critical terms of the hedging instrument and the hedged items Read more

Hedge of forecast foreign currency purchases

This narrative can also be used as a sort of starting point to the hedge documentation required for each hedging relationship at inception. Part 3 of 3

Here is part 1 of 3

and here is part 2 of 3

The Case

Type of hedge: cash flow hedge

Hedged risk: FX risk – spot component only

Key features: Spot rate designated, Basis adjustment required for inventory, Cost of hedging approach elected – Forward points taken to OCI, Inclusion of time value of money in measuring hedge ineffectiveness

  • Continue: Effectiveness tests and accounting entries

31 July 20×6

Hedge effectiveness assessment

The hedge continues to meet the effectiveness requirements going forward as no change has occurred in the Read more

Light Sweet Crude Oil commodity swap

If you need some background on commodity swaps, read this…..

The case

An entity annual purchase 500 barrels of Light Sweet Crude Oil. These purchases are made in a regular pattern over the year. To ensure the price risk the entity enters into a commodity swap-contract with a contract volume of 500 barrels and a duration of one year. The purchase price for 500 barrels Light Sweet Crude Oil is fixed at USD 88.37.

At settlement date of the commodity swap-contract, the average exchange spot price of Light Sweet Crude Oil on the Chicago Mercantile Exchange was USD 91.21.

As a result, the entity receives USD 1,420 or 500 barrels x (91.21 – 88.37) or USD … Read more

Example 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. 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.

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

Hedge accounting: statements of cash flows

[From Guidance on implementing IFRS 9 Financial Instruments]

How should cash flows arising from hedging instruments be classified in statements of cash flows?

Cash flows arising from hedging instruments are classified as operating, investing or financing activities, on the basis of the classification of the cash flows arising from the hedged item. While the terminology in IAS 7 has not been updated to reflect IFRS 9, the classification of cash flows arising from hedging instruments in the statement of cash flows should be consistent with the classification of these instruments as hedging instruments under IFRS 9.

 

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Hedged item – Hedge of a net position

Q: When can an entity hedge a net position?

Considerations:
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).

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