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).

The purchasing department has highly probable forecast purchases of USD90,000, also in six months’ time, and it also enters into an internal derivative with the central treasury department. Both the sales and purchasing departments view their derivative as a hedging instrument, but the group cannot apply hedge accounting, because the derivative is internal to the group and so it is eliminated on consolidation.

IFRS 10 Consolidated Financial Statements

However, in order to hedge the group’s exposure, the treasury department enters into a forward with a bank for USD10,000. By doing this, the group is economically hedged. However, under IAS 39, it was not possible to designate the net position of USD10,000 (comprised of USD100,000 sales and USD90,000 purchases) as a hedged item. Instead, the group had to designate USD10,000 out of the USD100,000 of future sales as the hedged item. This did not reflect the entity’s risk management strategy and is not how the entity tracked the appropriateness of the economic hedge relationship.

Under IFRS 9 can the group designate the net position of USD10,000 as the hedged item?

Consequential Explanation and Reasoning:
Yes. Under IFRS 9, a net position that incorporates offsetting positions can be designated as a hedged item, provided all items included in the group are individually eligible as hedged items and the items in the group are managed together on a group basis for risk management purposes. This means that the group can now apply hedge accounting to a net position comprised of sales of USD100,000 and purchases of USD90,000 with a USD10,000 derivative, which mirrors the entity’s risk management.

However, the hedging gains and losses on recycling must be presented as a separate line item in P&L (separate from the hedged items). An entity cannot present the post–hedging results of its commercial activities for the individual line items affected. [IFRS 9 para B6.6.15-16].

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