Forecast transaction

Definition relating to hedge accounting

A forecast transaction is an uncommitted but anticipated future transaction.

A forecasted transaction is essentially a future transaction that is probable and does not meet the definition of a firm commitment. Forecasted transactions can be contractually established or probable because of an entity’s past or expected business practices.

Because no transaction or event has yet occurred and the transaction or event when it occurs will be at the prevailing market price, a forecasted transaction does not give an entity any present rights to future benefits or a present obligation for future sacrifices.

Hedged Transaction Criteria Applicable to Cash Flow Hedges Only

A forecasted transaction is eligible for designation as a hedged transaction in a cash flow hedge if all of the following additional criteria are
met:

  1. The forecasted transaction is specifically identified as either of the following:
    1. A single transaction
    2. A group of individual transactions that share the same risk exposure for which they are designated as being hedged. A forecasted purchase and a forecasted sale shall not both be included in the same group of individual transactions that constitute the hedged transaction.
  2. The occurrence of the forecasted transaction is probable.
  3. The forecasted transaction meets both of the following conditions:
    1. It is a transaction with a party external to the reporting entity (except as permitted by IFRS 9 6.3.5).
    2. It presents exposure to variations in cash flows for the hedged risk that could affect reported earnings.

Certain criteria must be met for a forecasted transaction to be eligible for designation as a hedged transaction.

This Example illustrates the requirement for specific identification of the hedged transaction.

Entity A determines with a high degree of probability that it will issue $5,000,000 of fixed-rate bonds with a 5-year maturity sometime during the next 6 months, but it cannot predict exactly when the debt issuance will occur. That situation might occur, for example, if the funds from the debt issuance are needed to finance a major project to which Entity A is already committed but the precise timing of which has not yet been determined. To qualify for cash flow hedge accounting, Entity A might identify the hedged forecasted transaction as, for example, the first issuance of five-year, fixed-rate bonds that occurs during the next six months.

Specific identification of the transaction

To qualify for cash flow hedge accounting, an entity must specifically identify the single forecasted transaction (or group of transactions) that gives rise to the cash flow exposure that is being hedged.

The specifically identified transaction may be:

  • the specific asset or liability for which the forecasted transaction relates; or
  • the first cash flows received or paid to a specific amount in a particular period (without reference to the specific asset or liability) when hedging a group of similar forecasted transactions.

The key is that the designation is specific enough so that when the transaction occurs, it is clear whether that transaction is or is not the hedged transaction.

Formal documentation. IFRS 9 requires an entity to formally document certain details around the specifically identified forecasted transaction, including:

  • timing of when the forecasted transaction is expected to occur;
  • specific asset or liability involved (if applicable); and
  • the expected currency amount and/or the physical quantity (e.g. number of items or unit of measure).

Probability of a transaction

An assessment of the likelihood that a forecasted transaction will take place should not be based solely on management’s intent because intent is not verifiable. The transaction’s probability should be supported by observable facts and the attendant circumstances. Consideration should be given to the following circumstances in assessing the likelihood that a transaction will occur.

  1. The frequency of similar past transactions
  2. The financial and operational ability of the entity to carry out the transaction
  3. Substantial commitments of resources to a particular activity (for example, a manufacturing facility that can be used in the short run only to process a particular type of commodity)
  4. The extent of loss or disruption of operations that could result if the transaction does not occur
  5. The likelihood that transactions with substantially different characteristics might be used to achieve the same business purpose (for example, an entity that intends to raise cash may have several ways of doing so, ranging from a short-term bank loan to a common stock offering).

To qualify for cash flow hedge accounting, a forecasted transaction needs to be probable.

IFRS 9 defines probable as ’the future event or events are likely to occur.’ The term ‘probable’ requires a significantly greater likelihood of occurrence than the phrase ‘more likely than not’. The assessment of the likelihood that a transaction will occur is not based solely on management’s intent, but rather is supported by observable facts and circumstances. IFRS 9 provides guidance to consider when assessing the timing and probability of forecasted transactions:

  • time until forecasted transaction is expected to occur;
  • quantity of forecasted transaction;
  • effect of counterparty creditworthiness;
  • probability of forecasted acquisition of marketable debt security; and
  • uncertainty of timing within a range.

Formal documentation. In its formal hedge documentation, an entity should specify the circumstances that were considered in concluding that a transaction is probable.

For a forecasted transaction to qualify as a hedged transaction, it generally needs to be a transaction with a party external to the reporting entity.

Therefore, transactions between a parent and its consolidated subsidiaries do not qualify for hedge accounting at the consolidated level. However, a subsidiary may apply cash flow hedge accounting to a forecasted transaction in its stand-alone financial statements if the transaction is with a ‘party external to the reporting entity’ in the stand-alone financial statements.

What is the difference between a ‘party external to the reporting entity’ and an ‘unrelated party’?

To qualify as a hedged transaction, a forecasted transaction needs to be with a ‘party external to the reporting entity’.

Using the term ‘party external to the reporting entity’ limits the prohibition on hedging forecasted transactions only to transactions with entities that are consolidated by the reporting entity.

As a result, transactions with parties such as equity method investees, affiliates, unconsolidated joint ventures, shareholders and directors are not excluded from being forecasted transactions in a cash flow hedge. This assumes the effects of the forecasted transaction will not be eliminated or the forecasted transaction is not specifically prohibited (e.g. forecasted sale of an equity method investment) and all other criteria are met.

Forecast transaction

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