IFRS 9 Appendix B Hedge accounting time value of options

Last Updated on 12/02/2020 by 75385885

IFRS 9 Financial instrumentsIFRS 9 Appendix B Hedge accounting time value of options

IFRS 9 Appendix B Hedge accounting time value of options

B6.5.29 An option can be considered as being related to a time period because its time value represents a charge for providing protection for the option holder over a period of time.

However, the relevant aspect for the purpose of assessing whether an option hedges a transaction or time-period related hedged item are the characteristics of that hedged item, including how and when it affects profit or loss.

Hence, an entity shall assess the type of hedged item (see paragraph 6.5.15(a)) on the basis of the nature of the hedged item (regardless of whether the hedging relationship is a cash flow hedge or a fair value hedge):

  1. the time value of an option relates to a transaction related hedged item if the nature of the hedged item is a transaction for which the time value has the character of costs of that transaction. An example is when the time value of an option relates to a hedged item that results in the recognition of an item whose initial measurement includes transaction costs (for example, an entity hedges a commodity purchase, whether it is a forecast transaction or a firm commitment, against the commodity price risk and includes the transaction costs in the initial measurement of the inventory). As a consequence of including the time value of the option in the initial measurement of the particular hedged item, the time value affects profit or loss at the same time as that hedged item. Similarly, an entity that hedges a sale of a commodity, whether it is a forecast transaction or a firm commitment, would include the time value of the option as part of the cost related to that sale (hence, the time value would be recognised in profit or loss in the same period as the revenue from the hedged sale).
  2. the time value of an option relates to a time-period related hedged item if the nature of the hedged item is such that the time value has the character of a cost for obtaining protection against a risk over a particular period of time (but the hedged item does not result in a transaction that involves the notion of a transaction cost in accordance with (a)). For example, if commodity inventory is hedged against a fair value decrease for six months using a commodity option with a corresponding life, the time value of the option would be allocated to profit or loss (ie amortised on a systematic and rational basis) over that six-month period. Another example is a hedge of a net investment in a foreign operation that is hedged for 18 months using a foreign-exchange option, which would result in allocating the time value of the option over that 18-month period.

B6.5.30 The characteristics of the hedged item, including how and when the hedged item affects profit or loss, also affect the period over which the time value of an option that hedges a time-period related hedged item is amortised, which is consistent with the period over which the option’s intrinsic value can affect profit or loss in accordance with hedge accounting.

For example, if an interest rate option (a cap) is used to provide protection against increases in the interest expense on a floating rate bond, the time value of that cap is amortised to profit or loss over the same period over which any intrinsic value of the cap would affect profit or loss:

  1. if the cap hedges increases in interest rates for the first three years out of a total life of the floating rate bond of five years, the time value of that cap is amortised over the first three years; or
  2. if the cap is a forward start option that hedges increases in interest rates for years two and three out of a total life of the floating rate bond of five years, the time value of that cap is amortised during years two and three.

B6.5.31 The accounting for the time value of options in accordance with paragraph 6.5.15 also applies to a combination of a purchased and a written option (one being a put option and one being a call option) that at the date of designation as a hedging instrument has a net nil time value (commonly referred to as a ‘zero-cost collar’).

In that case, an entity shall recognise any changes in time value in other comprehensive income, even though the cumulative change in time value over the total period of the hedging relationship is nil. Hence, if the time value of the option relates to:

  1. a transaction related hedged item, the amount of time value at the end of the hedging relationship that adjusts the hedged item or that is reclassified to profit or loss (see paragraph 6.5.15(b)) would be nil.
  2. a time-period related hedged item, the amortisation expense related to the time value is nil.

B6.5.32 The accounting for the time value of options in accordance with paragraph 6.5.15 applies only to the extent that the time value relates to the hedged item (aligned time value). The time value of an option relates to the hedged item if the critical terms of the option (such as the nominal amount, life and underlying) are aligned with the hedged item.

Hence, if the critical terms of the option and the hedged item are not fully aligned, an entity shall determine the aligned time value, ie how much of the time value included in the premium (actual time value) relates to the hedged item (and therefore should be treated in accordance with paragraph 6.5.15). An entity determines the aligned time value using the valuation of the option that would have critical terms that perfectly match the hedged item.

B6.5.33 If the actual time value and the aligned time value differ, an entity shall determine the amount that is accumulated in a separate component of equity in accordance with paragraph 6.5.15 as follows:

  1. if, at inception of the hedging relationship, the actual time value is higher than the aligned time value, the entity shall:
    1. determine the amount that is accumulated in a separate component of equity on the basis of the aligned time value; and
    2. account for the differences in the fair value changes between the two time values in profit or loss.
  2. if, at inception of the hedging relationship, the actual time value is lower than the aligned time value, the entity shall determine the amount that is accumulated in a separate component of equity by reference to the lower of the cumulative change in fair value of:
    1. the actual time value; and
    2. the aligned time value.

Any remainder of the change in fair value of the actual time value shall be recognised in profit or loss.

Previous chapter: IFRS 9 Appendix B Hedge accounting

Next chapter: IFRS 9 Appendix B Acct Forwards and Spreads

Last Updated on 12/02/2020 by 75385885

Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). Individual jurisdictions around the world may require or permit the use of (locally authorised and/or amended) IFRS Standards for all or some publicly listed companies.  The information provided on this website is for general information and educational purposes only and should not be used as a substitute for professional advice. The specific status of IFRS Standards should be checked in each individual jurisdiction. Use at your own risk. Annualreporting is an independent website and it is not affiliated with, endorsed by, or in any other way associated with the IFRS Foundation. For official information concerning IFRS Standards, visit IFRS.org or the local representative in your jurisdiction.

IFRS 9 Appendix B Hedge accounting time value of options

IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options

IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options IFRS 9 Appendix B Hedge accounting time value of options