Excellent Study IFRS 9 Eligible Hedged items

IFRS 9 Eligible Hedged items

the insured items of business risk exposures

Although the popular definition of hedging is an investment taken out to limit the risk of another investment, insurance is an example of a real-world hedge.

Every entity is exposed to business risks from its daily operations. Many of those risks have an impact on the cash flows or the value of assets and liabilities, and therefore, ultimately affect profit or loss. In order to manage these risk exposures, companies often enter into derivative contracts (or, less commonly, other financial instruments) to hedge them. Hedging can, therefore, be seen as a risk management activity in order to change an entity’s risk profile.

The idea of hedge accounting is to reduce (insure) this mismatch by changing either the measurement or (in the case of certain firm commitments) FRS 9 Eligible Hedged itemsrecognition of the hedged exposure, or the accounting for the hedging instrument.

The definition of a Hedged item

A hedged item is an asset, liability, firm commitment, highly probable forecast transaction or net investment in a foreign operation that

  1. exposes the entity to risk of changes in fair value or future cash flows and
  2. is designated as being hedged

The hedge item can be:

Only assets, liabilities, firm commitments and forecast transactions with an external party qualify for hedge accounting. As an exception, a hedge of the foreign currency risk of an intragroup monetary item qualifies for hedge accounting if that foreign currency risk affects consolidated profit or loss. In addition, the foreign currency risk of a highly probable forecast intragroup transaction would also qualify as a hedged item if that transaction affects consolidated profit or loss. These requirements are unchanged from IAS 39.

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Related IFRS posts

High level overview IFRS 9 Hedge accounting

High level overview IFRS 9 Hedge accounting

IFRS 9 Hedge accounting

High level overview IFRS 9 Hedge accounting

High level overview IFRS 9 Hedge accounting

Source: BDO IFRS at a glance

Or in some more detail…..

OBJECTIVE

The objective of hedge accounting is to represent, in the financial statements, the effect of an entity’s risk management activities that use financial instruments to manage exposures arising from particular risks that could affect profit or loss (or other comprehensive income, in the case of investments in equity instruments for which an entity has elected to present changes in fair value in other comprehensive income).

SCOPE

A hedging relationship qualifies for hedge accounting only if all the following criteria are met:

  1. the hedging relationship consists only of eligible hedging instruments and eligible hedged items.
  2. at
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Cash flow hedge

The cash flow hedge is one of three hedges defined in IFRS 9, the others are the fair value hedge and the hedge of a net investment, in use to 'insure' risks

Hedge accounting

Hedge accounting If investors purchase a high level of risk security, they may want to reduce risk with an opposing item purchase referred to as a hedge

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

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

Hedge of a net position

Q: When can an entity make use of a hedge of a net position?

Considerations: Hedge of a net position
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 USD 100,000 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). Hedge of a net position

The purchasing department has highly probable forecast purchases of USD 90,000, also … Read more

Example fair value hedge

Fair value hedge of changes in the benchmark interest rate for a variable-rate debt obligation Example fair value hedge

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.Example fair value hedge

The six-month LIBOR rate on January 1, Year 1 is 2.5%. Example fair value hedge

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 (for example 2.3%).

ABC wants to designate the interest Read more

Accounting for macro hedging

Accounting for macro hedging – Financial institutions, particularly retail banks, have as a core business, the collection of funds by depositors that are subsequently invested as loans to customers. This typically includes instruments such as current and savings accounts, deposits and borrowings, loans and mortgages that are usually accounted for Read more

Cash flow hedge of a net position

Cash flow hedge of a net position has changed from IAS 39 to IFRS 9, this section illustrates these changes for hedge accounting of a net position, by discussing the application under IAS 39 and the changes thereto under IFRS 9.

Many entities are exposed to foreign exchange risk arising from purchases and sales of goods or services denominated in foreign currencies. Cash inflows and outflows occurring on forecast transactions in the same foreign currency are often economically hedged on a net basis. For example, consider an entity that has forecast foreign currency sales of FC100 and purchases of FC80, both in 6 months. It hedges the net exposure using a single foreign exchange forward contract to sell FC20 in Read more