Commodity finance IFRS the 6 best examples

Commodity finance IFRS the 6 best examples – A key issue is whether the contract to deliver a non-financial item (the commodity) falls within the scope of IFRS 9 Financial Instruments. Although IFRS 9 would appear to apply only to financial assets and financial liabilities, certain contracts for non-financial items are also within its scope.

The scope of IFRS 9

In determining whether the transaction is within the scope of IFRS 9, key guidance is set out in IFRS 9 2.4. IFRS 9 2.4 notes that

This Standard shall be applied to those contracts to buy or sell a non-financial item that can be settled net in cash or in another financial instrument, or by exchanging financial instruments, Read more

IAS 32 Financial Instruments Presentation

IAS 32 Financial Instruments Presentation outlines the accounting requirements for the presentation of financial instruments, particularly as to the classification of such instruments into financial assets, financial liabilities and equity instruments. The standard also provide guidance on the classification of related interest, dividends and gains/losses, and when financial assets and financial liabilities can be offset.

Liabilities and equity

The issuer of a financial instrument shall classify the instrument, or its component parts, on initial recognition as a financial liability, a financial asset or an equity instrument in accordance with the substance of the contractual arrangement and the definitions of a financial liability, a financial asset and an equity instrument. IAS 32 Financial Instruments Presentation

The entity must on initial recognition … Read more

Offsetting of financial assets and financial liabilities

Offsetting of financial assets and financial liabilities – IAS 32 prescribes rules for the offsetting of financial assets and financial liabilities. It specifies that a financial asset and a financial liability should be offset and the net amount reported when and only when, an enterprise (IAS 32 42 ): Offsetting of financial assets and financial liabilities

  • has a legally enforceable right to set off the amounts; and
  • intends either to settle on a net basis, or to realize the asset and settle the liability simultaneously.

Offsetting is usually inappropriate when: Offsetting of financial assets and financial liabilities

  • several different financial instruments are used to emulate the features of a single financial instrument (a ‘synthetic instrument’);
  • financial assets and financial liabilities
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Embedded derivatives Equity kicker

Embedded derivatives Equity kicker – A more specific type of embedded derivative that is often found in practice relates to a type of funding provided by venture capital entities is the equity kicker. It is many times part of a sales of a part of a business of a listed company, financed by the venture capital entity. The intention is to prepare the separated business for an IPO within 3 – 5 years after this separation. Embedded derivatives Equity kicker

Example Mezzanine financing Equity kicker

A venture capitalist provides a subordinated loan, that in addition to interest and repayment of principal, contains terms that entitle the venture capitalist to receive shares of the borrower (separated business) free of charge or … Read more

Convertible notes Basic requirements

Convertible notes Basic requirements is a introduction of an important financing arrangement for high tech start ups all over the world. Convertible notes are financial instruments that fall within the scope of IAS 32 Financial Instruments: Presentation and IFRS 9 Financial Instruments.

IAS 32 contains the definitions of financial liabilities, financial assets and equity. Therefore, whether a financial instrument should be classified as liability or equity is dealt with under IAS 32.

As noted above, the standard approach in IFRS requires that a convertible instrument is dealt with by an issuer as having two ‘components’, being a liability host contract plus a separate conversion feature which may or may not qualify for classification as an equity instrument. Convertible notes Read more

Cash flow hedge reserve

Change in fair value attributable to spot’ is recognised in other comprehensive income (and in the cash flow hedge reserve in equity) as the hedged risk

IFRS 9 Inflation as a risk component

Inflation as a risk component – Under IAS 39, inflation cannot be designated as a hedged risk component for financial instruments, unless the inflation risk component is contractually specified. For non-financial instruments, inflation risk cannot be designated under IAS 39 as a risk component at all. Inflation as a risk component

Highlight – For financial instruments, IFRS 9 opens the door for designating a non-contractually specified inflation component as a hedged risk component – but only in limited circumstances. For non-financial instruments, the inflation component will be eligible for designation as the hedged item in a hedging relationship provided that it is separately identifiable and reliably measurable. Inflation as a risk component

For financial instruments, IFRS 9 introduces a rebuttable Read more

IFRS 9 Practical Hedge documentation template

This IFRS 9 Practical Hedge documentation template can be used as the basis for the formal documentation required by IFRS 9. However, every hedge is a specific transaction so changes should be made based on the actual situation to document. In section 9 there is room to add smaller additions and/or attachments to complete the hedge documentation at the required level.

1. Risk management objective and strategy

If not clear from the overall risk management strategy, include why the proposed hedging objective is consistent with the entity’s risk management strategy for undertaking hedges. Otherwise this section may make reference to the entity’s risk management department’s central documents.

2. Type of hedging relationship

☐ Fair value hedge  —–  ☐ Cash flow … Read more

Hedge accounting of hedges for commodity risks

Hedge accounting of hedges for commodity risks – Under the old rules of IAS 39, hedge accounting could be difficult to achieve in relation to commodity exposures. This was largely due to the fact that IAS 39 did not permit hedging of specific risk components of non-financial items (with the exception of FX risk). Hedge accounting of hedges for commodity risks

For example, a company with a known diesel purchase requirement over the next two to three years may wish to hedge its exposure using a diesel swap. Even though the swap is designed to be a valid economic hedge of the wholesale diesel price risk, the company would not be able to define the hedged risk specifically as such. … Read more

Foreign currency basis spreads

Foreign currency basis spreads is about one of the other changes from IAS 39 to IFRS 9 in respect of hedge accounting

What is the cross currency basis spread

In general, the cross currency basis is a measure of dollar shortage in the market. The more negative the basis becomes, the more severe the shortage. For dollar-funded investors, negative basis can work in their favour when they hedge currency exposures. In order to hedge foreign currency exposure, the dollar-funded investors lend out dollar today and receive it back in the future, earning additional cross currency basis spread on top of the yield of their foreign investments. Foreign currency basis spreads

In fact, for years the Reserve Bank of Australia has Read more