ca. nirmal ghorawat b. com (hons), aca 1. introduction – hedge accounting 2 accounting mismatch...

HEDGE ACCOUNTING(RELEVANT EXTRACT – IAS 39)

CA. NIRMAL GHORAWAT

B. Com (Hons), ACA

1

INTRODUCTION – HEDGE ACCOUNTING

2

Accounting

Mismatch

Recognition

Measurement

Timing Differences

Hedged Item is not yet Recognised

Hedged Item is not Measured at Fair Value

Hedge Accounting seeks to ELIMINATE these Accounting Mismatch.

It recognises the OFFSETTING EFFECTS on P & L of Changes in Fair Value of the Hedging Instrument and the Hedged ItemHedged ItemHedging Instrument

IAS 39

HEDGE ACCOUNTING - DEFINITIONS

3

Hedged Item

an Asset, Liability, Firm Commitment, Highly probable forecast transaction or Net Investment in Foreign Operation THAT: (a) Exposes the entity to RISK of changes in Fair Value or Cash Flows and (b) is DESIGNATED as being hedged.

Hedging Instrument

is DESIGNATED (a) a Derivative or (b) a Non-Derivative FA or FL (for a hedge of risk of changes in foreign currency rates only) – whose Fair Value or Cash Flows are expected to offset changes in Fair Value or Cash Flows of a Designated Hedged Item.

Hedge Effectiveness

the DEGREE to which changes in Fair Value or Cash Flows of the Designated Hedged Item Attributable to Hedged Risk are to offset by changes in Fair Value or Cash Flows of a Designated Hedged Instrument.

Firm Commitment

Binding Agreement – to Exchange – Specified Resource – Specified Price - Specified Future Date(s).

Forecast Transaction

An uncommitted but Anticipated Future transaction.

IAS 39

HEDGE ACCOUNTING

4

What can Qualify as a Hedging Instrument?

IAS 39 AG

Purchased Options

An HTM Investment for Foreign Currency

Risk

Written Options

Entity’s own equity instruments

AFS Investment in Unquoted Equity

Share not carried at Fair Value

Stock Index

HEDGE ACCOUNTING

5

What can Qualify as a Hedged Item?

IAS 39 AG

An Exposure to a risk that affects the

Income Statement

An AFS Security

A Loan / Receivable

Foreign currency monetary item

A HTM Investment for interest rate risk

An Investment in Associate or Subsidiary

Non financial asset or Liability

A general business Risk

Derivative

HEDGE ACCOUNTING

6

Types of Risk which can be Hedged

Exposure to these Risk can arise from changes in

IAS 39 recognises 3 types of Hedge Relationship1. Fair Value HedgeII. Cash Flow HedgeIII. Hedge of Net Investment in Foreign Operation

IAS 39

Forex

Credit

Equity

Interest

Commodity

Fair Value

Cash

Flows

Probable

Future Cash Flows

TYPES OF HEDGES

7

Fair value hedges Hedge of exposure to changes in fair value of a recognised

asset or liability; an unrecognised firm commitment; or an identified portion of any of the above two;

that is attributable to a particular risk; and would affect P&L.

Cash flow hedgesHedge of exposure to variability in cash flows that is:

attributable to a particular risk associated with a recognised asset or liability or a highly probable forecast transaction (also an inter-company one); and

would affect P&L. Hedge of a Net Investment in Foreign Operation

The Net Investment in Foreign Operation is the amount of a reporting entity’s interest in the net assets of that operation.

IAS 39

CONDITIONS FOR HEDGE ACCOUNTING

8

Formal Documentation at Inception Entity’s Risk Management Objective and Strategy Formal Designation of Hedging Relationship by

Identification of Hedging Instrument Related Hedged Item or Transaction Nature of Risk being Hedged How the Entity will assess the Hedging Instrument’s

EFFECTIVENESS.

Hedge Effectiveness – The Hedge should be expected to be Highly Effective in achieving offsetting changes in Fair Value or Cash Flow attributable to the hedged risk – At Inception and subsequent periods.

Hedge Effectiveness – can be Reliably measured.

IAS 39

HEDGE EFFECTIVENESS

9

Prospective Assessment At Inception and

throughout the life of Hedge

Testing Methods eg. Regression Analysis

Range of 80% - 125%

Retrospective Assessment At each Reporting Date and

throughout the life of Hedge

Testing Methods eg. Regression Analysis, etc.

Range of 80% - 125%

125 %100 %80 %

Ineffectiveness to P & L

Ineffectiveness to P & L

Discontinue Hedge Accounting

Discontinue Hedge Accounting

IAS 39

HEDGE ACCOUNTING – FAIR VALUE

10

Measurement of Hedged Item

Measurement of Hedging

Instrument

Without Hedge Accounting

At Amortised Cost OrAt Fair Value through

Equity (OCI)

At Fair Value through P & L.

With Hedge Accounting

Adjust the Carrying Amount to Fair Value

through P & L.


Fair value hedges Hedge of exposure to changes in fair value of a recognised

asset or liability; an unrecognised firm commitment; or an identified portion of any of the above two;

that is attributable to a particular risk; and would affect P&L.

IAS 39MEASUREMENT MISMATCH

RECOGNITION OF GAINS & LOSSES ON HEDGED ITEM AT FAIR VALUE THROUGH P & L.

11

HEDGE ACCOUNTING – FAIR VALUE

IAS 39MECHANICS

Change in Fair Value of Hedged

Item

P & L

Changes in Fair Value of Hedging Instrument

P & L P & L

Effective Ineffective

HEDGE ACCOUNTING – CASH FLOW

12



Instrument


Not yet Recognised in Accounts



Not yet Recognised in Accounts

At Fair Value through OCI.

Hedge of exposure to variability in cash flows that is: attributable to a particular risk associated with a recognised

asset or liability or a highly probable forecast transaction (also an inter-company one); and

would affect P&L.

IAS 39RECOGNITION MISMATCH

DEFER RECOGNITION OF GAINS & LOSSES ON HEDGING INSTRUMENT

13

HEDGE ACCOUNTING – CASH FLOW

IAS 39MECHANICS


Item

Not Recognised


OCI (Equity) P & L


Recycled when Hedged Item affects Earnings

HEDGE ACCOUNTING – NIFO

14



Instrument


Fair Value through Equity (OCI)



Fair Value through Equity (OCI)

At Fair Value through OCI.

Hedge of a Net Investment in Foreign Operation

The Net Investment in Foreign Operation is the amount of a reporting entity’s interest in the net assets of that operation.

IAS 39RECOGNITION MISMATCH

MATCH RECOGNITION IN EQUITY OF GAINS & LOSSES ON HEDGING INSTRUMENT

15

HEDGE ACCOUNTING – NIFO

IAS 39MECHANICS


Item

OCI (Equity)


OCI (Equity) P & L


Recycled on Disposal of Foreign Operation

DISCONTINUATION OF HEDGE ACCOUNTING

16

Prospective Discontinuation IF:: Hedging Instrument expires, is sold, terminated or

exercised. Hedge no longer meets the criteria for Hedge

Accounting. The entity revokes the Designation.

On Discontinuation

IAS 39

Fair Value Hedge Cash Flow Hedge

Future Changes in FV of

Hedging Instrument

P & L P & L

Hedged Item As per Applicable IAS (as if Not Hedged)

N/A

Amount Recognised till Date in Equity

N/A Transfer to P & L

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