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) recognition 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
exposes the entity to risk of changes in fair value or future cash flows and
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.
Nobody wants their business to fail. Although it’s impossible to predict the future with 100% accuracy, a cash flow forecast is a tool that will help you prepare for different possible scenarios in the future.
In a nutshell, cash flow forecasting involves estimating how much cash will be coming in and out of your business within a certain period and gives you a clearer picture of your business’ financial health
What is Cash Flow Forecasting?
Cash flow forecasting is the process of estimating how much cash you’ll have and ensuring you have a sufficient amount to meet your obligations. By focusing on the revenue you expect to generate and the expenses you need to pay, cash flow forecasting can help you better manage your working capital and plan for various positive or difficult scenarios.
A cash flow forecast is composed of three key elements: beginning cash balance, cash inflows (e.g., cash sales, receivables collections), and cash outflows (e.g., expenses for utilities, rent, loan payments, payroll).
Building Out Cash Flow Scenario Models
It’s always good to create best case, worst-case and moderate financial scenarios. Through cash flow forecasting, you’ll be able to see the impact of these three scenarios and implement the suitable course of action. You can use the models to predict what needs to happen especially during difficult and uncertain times.
In situations where variables shift quickly such as during a recession, it is highly recommended to review and update your cash flow forecasts regularly on a monthly or even weekly basis. By monitoring your cash flow forecast closely, you’ll be able to identify warning signs such as declining revenue or increasing expenses.
The key objective of IFRS 16 is to ensure that lessees recognise assets and liabilities for their major leases.
1. Lessee accounting model
A lessee applies a single lease accounting model under which it recognises all leases on-balance sheet, unless it elects to apply the recognition exemptions (see recognition exemptions for lessees in the link). A lessee recognises a right-of-use asset representing its right to use the underlying asset and a lease liability representing its obligation to make payments. [IFRS 16.22]
Disclosure financial risk management provides the guidance on the need for disclosure of the management policies, procedures and measurement practices in place at the operations within the reporting entity’s group of companies and an actual example of disclosures for financial risk management.
Disclosure Financial risk management guidance
Classes of financial instruments
Where IFRS 7 requires disclosures by class of financial instrument, the entity shall group its financial instruments into classes that are appropriate to the nature of the information disclosed and that take into account the characteristics of those financial instruments. The classes are determined by the entity and are therefore distinct from the categories of financial instruments specified in IFRS 9. Disclosure Financial risk management
As a minimum, the entity should distinguish between financial instruments measured at amortised cost and those measured at fair value, and treat as separate class any financial instruments outside the scope of IFRS 9. The entity shall provide sufficient information to permit reconciliation to the line items presented in the balance sheet. Guidance on classes of financial instruments and the level of required disclosures is provided in Appendix B to IFRS 7. [IFRS 7.6, IFRS 7.B1-B3]
Certain interest rate benchmarks including LIBOR, EURIBOR and EONIA are being or have recently been reformed.
What are interest rate benchmarks?
Interest rate benchmark are used to determine
the amount of interest payable for a wide range of financial products such as derivatives, bonds, loans, structured products and mortgages, and
the valuation of financial products.
The most common examples of interest rate benchmarks used in financial contracts across the world are the London Interbank Offered Rate (LIBOR) and for the Euro, the Euro Interbank Offered Rate (EURIBOR) and Euro Overnight Index Average (EONIA).
Why are these benchmarks being reformed?
As benchmark rates are fundamental to so many financial contracts, they need to be robust, reliable and fit for purpose. Each of these interest rate benchmarks subject to reform were based on the rates at which banks lend to each other in the interbank market.
Financial regulatory authorities have expressed their concern that because interbank lending transactions have significantly decreased in recent years, the benchmark rates may no longer be representative or reliable.
This concern has resulted in recommendations made by the Financial Stability Board towards the global financial industry to reform the major interest rate benchmarks and to develop a set of alternative rates that are more representative of the current financial environment.
IFRS Reporting disclosure amendments
The amendments made to IFRS 9 Financial Instruments, IAS 39 Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures provide certain reliefs in relation to interest rate benchmark reform. The reliefs relate to hedge accounting and have the effect that the reforms should not generally cause hedge accounting to terminate. However, any hedge ineffectiveness should continue to be recorded in the income statement. Given the pervasive nature of hedges involving interbank offered rates (IBOR)-based contracts, the reliefs will affect companies in all industries.
the extent of the risk exposure that the entity manages that is directly affected by the interest rate benchmark reform
how the entity is managing the process of transition to alternative benchmark rates
a description of significant assumptions or judgements that the entity made in applying the reliefs, and
the nominal amount of the hedging instruments in those hedging relationships. [IFRS 7.24H]
Information about how the entity is managing the transition process will provide users with an indication of the extent to which management is prepared for the transition. For example, this could include explanations about differences in fallback provisions between the hedged item and the hedging instruments.
The amendments are not clear whether the disclosure of the extent of the risk exposure that the entity manages could be provided on a qualitative rather than quantitative basis. However, numerical disclosures may be more useful for users.
Entities should consider whether further disclosure of the impending replacement of IBOR should be provided in other parts of the annual report, for example in management’s discussion and analysis.
Example Disclosure reform of interest rate benchmarks
This Example Disclosure Related party transactions shows the disclosures an entity would have to add if it has a loan with an interest rate based on 3-month GPB LIBOR and a cash flow hedge in the form of a floating-to-fixed rate interest rate swap that is referenced to LIBOR. The disclosures assume that the entity has adopted the hedge accounting requirements of IFRS 9.
While primarily illustrating the disclosures required by the amendments made to IFRS 7 and other hedge accounting disclosures affected by IBOR reform, extracts of other disclosures from the main body of the publication have been included, to provide some context for the additional disclosures.
New or revised disclosures are highlighted with shading. This appendix does not illustrate disclosures that may be required if the terms of the loan and the swap have moved to new benchmark rates.
12 Financial risk management (extracts)
12(a) Derivatives (extracts)
(iv) Hedge effectiveness (extracts)
Hedge ineffectiveness for interest rate swaps is assessed using the same principles as for hedges of foreign currency purchases. It may occur due to:
the credit value/debit value adjustment on the interest rate swaps which is not matched by the loan
differences in critical terms between the interest rate swaps and loans, and
the effects of the forthcoming reforms to GBP LIBOR, because these might take effect at a different time and have a different impact on the hedged item (the floating-rate debt) and the hedging instrument (the interest rate swap used to hedge the debt). Further details of these reforms are set out below. [IFRS 7.22B(c), IFRS 7.23D]
Ineffectiveness of CUXX,XXX has been recognised in relation to the interest rate swaps in other gains or losses in profit or loss for 2020 (2019 CUXX,XXX). The significant increase in ineffectiveness in the current year was caused by the expectation that the interest rate swap and the hedged debt will move from GBP LIBOR to SONIA at different dates. [IFRS 7.24C(b)(ii)]
The group’s main interest rate risk arises from long-term borrowings with variable rates, which expose the group to cash flow interest rate risk. Group policy is to maintain at least 50% of its borrowings at fixed rate, using floating-to-fixed interest rate swaps to achieve this when necessary.
Generally, the group enters into long-term borrowings at floating rates and swaps them into fixed rates that are lower than those available if the group borrowed at fixed rates directly. During 2020 and 2019, the group’s borrowings at variable rate were mainly denominated in Oneland currency units and US dollars. Except for the GBP LIBOR floating rate debt noted below, other variable interest rates were not referenced to interbank offered rates (IBORs) that will be affected by the IBOR reforms. [IFRS7.22A(a),(b), IFRS7.33(a),(b)]
Included in the variable rate borrowings is a 10-year floating-rate debt of CU10,000,000 (2019 CU10,000,000) whose interest rate is based on 3 month GBP LIBOR. To hedge the variability of in cash flows of this loan, the group has entered into a 10-year interest rate swap with key terms (principal amount, payment dates, repricing dates, currency) that match those of the debt on which it pays a fixed rate and receives a variable rate. [IFRS 7.24H(a)]
The group’s borrowings and receivables are carried at amortised cost. The borrowings are periodically contractually repriced (see below) and to that extent are also exposed to the risk of future changes in market interest rates.
The exposure of the group’s borrowings to interest rate changes and the contractual re-pricing dates of the borrowings at the end of the reporting period are as follows: [IFRS 7.22A(c), IFRS 7.34(a), IFRS 7.24H(b)]
Amounts in CU’000
% of total
Variable rate borrowings – GBP LIBOR
Variable rate borrowings – non-IBOR
Fixed rate borrowings – repricing or maturity dates:
– Less than one year
– 1 – 5 years
– Over 5 years
An analysis by maturities is provided in note 12(d) below. The percentage of total loans shows the proportion of loans that are currently at variable rates in relation to the total amount of borrowings.
Instruments used by the group
Swaps currently in place cover approximately 37% (2019 – 37%) of the variable loan principal outstanding. The fixed interest rates of the swaps range between 7.8% and 8.3% (2019 – 9.0% and 9.6%), and the variable rates of the loans are between 0.5% and 1.0% above the 90 day bank bill rate or LIBOR which, at the end of the reporting period, were 8.2% and x.x% respectively (2019 – 9.4% and x.x%). [IFRS 7.22B(a), IFRS 7.23B]
The swap contracts require settlement of net interest receivable or payable every 90 days. The settlement dates coincide with the dates on which interest is payable on the underlying debt. [IFRS 7.22B(a)]
Effects of hedge accounting on the financial position and performance
The effects of the interest rate swaps on the group’s financial position and performance are as follows:
Following the financial crisis, the reform and replacement of benchmark interest rates such as GBP LIBOR and other interbank offered rates (‘IBORs’) has become a priority for global regulators. There is currently uncertainty around the timing and precise nature of these changes. [IFRS 7.24H(b)]
To transition existing contracts and agreements that reference GBP LIBOR to SONIA, adjustments for term differences and credit differences might need to be applied to SONIA, to enable the two benchmark rates to be economically equivalent on transition.
Group treasury is managing the group’s GBP LIBOR transition plan. The greatest change will be amendments to the contractual terms of the GBP LIBOR-referenced floating-rate debt and the associated swap and the corresponding update of the hedge designation. However, the changed reference rate may also affect other systems, processes, risk and valuation models, as well as having tax and accounting implications. [IFRS 7.24H(c)]
The group has applied the following reliefs that were introduced by the amendments made to IFRS 9 Financial Instruments in September 2019:
When considering the ‘highly probable’ requirement, the group has assumed that the GBP LIBOR interest rate on which the group’s hedged debt is based does not change as a result of IBOR reform.
In assessing whether the hedge is expected to be highly effective on a forward-looking basis the group has assumed that the GBP LIBOR interest rate on which the cash flows of the hedged debt and the interest rate swap that hedges it are based is not altered by LIBOR reform.
The group has not recycled the cash flow hedge reserve relating to the period after the reforms are expected to take effect.
In calculating the change in fair value attributable to the hedged risk of floating-rate debt, the group has made the following assumptions that reflect its current expectations:
The floating-rate debt will move to SONIA during 2022 and the spread will be similar to the spread included in the interest rate swap used as the hedging instrument.
No other changes to the terms of the floating-rate debt are anticipated.
The group has incorporated the uncertainty over when the floating-rate debt will move to SONIA, the resulting adjustment to the spread, and the other aspects of the reform that have not yet been finalised by adding an additional spread to the discount rate used in the calculation. [IFRS 7.24H(d)]
Reform of interest rate benchmarks
Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks
Annualreporting provides financial reporting narratives using IFRS keywords and terminology for free to students and others interested in financial reporting. 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. 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.
Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks Reform of interest rate benchmarks
Disclosure Related party transactions provides a summary of IFRS reporting requirements regarding IAS 24 Related party transactions and a possible disclosure schedule. However, as this publication is a reference tool, no disclosures have been removed based on materiality. Instead, illustrative disclosures for as many common scenarios as possible have been included. Please note that the amounts disclosed in this publication are purely for illustrative purposes and may not be consistent throughout the example disclosure related party transactions.
All of the related party information required by IAS 24 that is relevant to the Reporting entity Plc has been presented, or referred to, in one note. This is considered to be a convenient and desirable method of presentation, but there is no requirement to present the information in this manner. Compliance with the standard could also be achieved by disclosing the information in relevant notes throughout the financial statements.
The disclosures required by IAS 24 apply to the financial statements when the information is material. According to IAS 1 Presentation of Financial Statements, materiality depends on the size and nature of an item. It may be necessary to treat an item or a group of items as material because of their nature, even if they would not be judged material on the basis of the amounts involved. This may apply when transactions occur between an entity and parties who have a fiduciary responsibility in relation to that entity, such as those transactions between the entity and its key management personnel. [IAS1.7]
Key management personnel compensation
While the disclosures under paragraph 17 of IAS 24 are subject to materiality, this must be determined based on both quantitative and qualitative factors. In general, it will not be appropriate to omit the aggregate compensation disclosures based on materiality. Whether it will be possible to satisfy the disclosure by reference to another document, such as a remuneration report, will depend on local regulation. IAS 24 itself does not specifically permit such cross-referencing.
Leveraged buyout IFRS 3 best reporting – In corporate finance, a leveraged buyout (LBO) is a transaction where a company is acquired using debt as the main source of consideration. These transactions typically occur when a private equity (PE) firm borrows as much as they can from a variety of lenders (up to 70 or 80 percent of the purchase price) and funds the balance with their own equity. Leveraged buyout IFRS 3 best reporting
1 The process and business reason
The use of leverage (debt) enhances expected returns to the private equity firm. By putting in as little of their own money as possible, PE firms can achieve a large return on equity (ROE) and internal rate of return … Read more
IFRS 9 contains an important simplification that, if a financial instrument has low credit risk, then an entity is allowed to assume at the reporting date that no significant increases in credit risk have occurred. The low credit risk concept was intended, by the IASB, to provide relief for entities from tracking changes in the credit risk of high quality financial instruments. Therefore, this simplification is only optional and the low credit risk simplification can be elected on an instrument-by-instrument basis.
This is a change from the 2013 ED, in which a low risk exposure was deemed not to have suffered significant deterioration in credit risk. The amendment to make the simplification optional was made in response to requests from constituents, including regulators. It is expected that the Basel Committee SCRAVL consultation document will propose that sophisticated banks should only use this simplification rarely for their loan portfolios.
For low risk instruments, the entity would recognise an allowance based on 12-month ECLs. However, if a financial instrument is not considered to have low credit risk at the reporting date, it does not follow that the entity is required to recognise lifetime ECLs. In such instances, the entity has to assess whether there has been a significant increase in credit risk since initial recognition that requires the recognition of lifetime ECLs.
The standard states that a financial instrument is considered to have low credit risk if: [IFRS 9.B5.22]
The financial instrument has a low risk of default
The borrower has a strong capacity to meet its contractual cash flow obligations in the near term
Adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfil its contractual cash flow obligations Low credit risk operational simplification
A financial instrument is not considered to have low credit risk simply because it has a low risk of loss (e.g., for a collateralised loan, if the value of the collateral is more than the amount lent (see collateral) or it has lower risk of default compared with the entity’s other financial instruments or relative to the credit risk of the jurisdiction within which the entity operates.
financial guarantee contracts (except those accounted for as insurance contracts).
IFRS 9 requires an expected loss allowance to be estimated for each of these types of asset or exposure. However, the Standard specifies three different approaches depending on the type of asset or exposure:
* optional application to trade receivables and contract assets with a significant financing component, and to lease receivables
or what does a lessee include in its lease liability?
At the commencement date, a lessee measures the lease liability as the present value of lease payments that have not been paid at that date. In a simple lease that includes only fixed lease payments, this can be a simple calculation (IFRS 16.26).
Worked example – Fixed lease payments are included in lease liabilities
Lessee B enters into a five year lease of a photocopier. The lease payments are 10,000 per annum, paid at the end of each year.
Because the annual lease payments are fixed amounts, B includes the present value of the five annual payments in the initial measurement of the lease liability.
Using a discount rate (determined as B’s incremental borrowing rate) of 5%, the lease liability at the commencement date is calculated as follows: