International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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‘To the extent that an entity wants to apply hedge accounting, those hedging
relationships should be documented on or before the transition date. This is
consistent with the transition requirements for existing users of IFRSs and the
existing transition requirements of IFRS 1...’. [IFRS 9.BC7.52].
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4.5.2.B
Designation in anticipation of adoption of IFRS
If a first-time adopter, in anticipation of the adoption of IFRS, decides to designate a
transaction as a hedge under IFRS 9 and completes the required documentation
sometime before the transition date to IFRS, some have questioned whether upon
adoption of IFRS hedge accounting should be applied prior to the transition date. In our
view, as long as the hedge is properly designated and documented in accordance with
IFRS 9.6.4.1 prior to the date of transition, the first-time adopter should apply hedge
accounting from the date that it met the requirement. As explained in 4.5.2.A above, a
first-time adopter cannot designate a transaction retrospectively as a hedge under IFRS.
4.5.3
Reflecting cash flow hedges in the opening IFRS statement of
financial position
A first-time adopter may have deferred gains and losses on a cash flow hedge of a
forecast transaction under its previous GAAP. If, at the date of transition, the hedged
forecast transaction is not highly probable, but is expected to occur, the entire deferred
gain or loss should be recognised in the cash flow hedge reserve within equity.
[IFRS 1.IG60B]. This is consistent with the treatment required for a deferred gain or loss
expected to be recovered in the future (see Chapter 49). [IFRS 9.6.5.11].
How should an entity deal with such a hedge if, at the date of transition to IFRSs, the
forecast transaction is highly probable? It would make no sense if the hedge of the
transaction that is expected to occur were required to be reflected in the opening IFRS
statement of financial position, but the hedge of the highly probable forecast transaction
(which is clearly a ‘better’ hedge) were not.
Therefore, it must follow that a cash flow hedge should be reflected in the opening IFRS
statement of financial position in the way set out above if the hedged item is a forecast
transaction that is highly probable (see Case 1 of Example 5.9 below). Similarly, it follows
that a cash flow hedge of the variability in cash flows attributable to a particular risk
associated with a recognised asset or liability (such as all or some future interest
payments on variable rate debt) should also be reflected in the opening IFRS statement
of financial position. To do otherwise would allow an entity to choose not to designate
(in accordance with IFRS 9) certain cash flow hedges, say those that are in a loss
position, until one day after its date of transition, thereby allowing associated hedging
losses to bypass profit or loss completely. However, this would effectively result in the
retrospective de-designation of hedges to achieve a desired result, thereby breaching
the general principle of IFRS 1 (i.e. a first-time adopter cannot designate a hedge
relationship retrospectively).
If, at the date of transition to IFRSs, the forecast transaction was not expected to occur,
consistent with the requirements of paragraphs 6.5.6-6.5.7 and 6.5.12(b) of IFRS 9, a
first-time adopter should reclassify any related deferred gains and losses that are not
expected to be recovered into retained earnings.
Example 5.9:
Unrecognised gains and losses on existing cash flow hedge
Entity A has the euro as its functional currency. In September 2017 it entered into a forward currency contract
to sell dollars for euros in twelve months to hedge dollar denominated sales it forecasts are highly probable to
occur in September 2018. Entity A will apply IFRS 9 from 1 January 2018, its date of transition to IFRSs. The
historical cost of the forward contract is €nil and at the date of transition it had a positive fair value of €100.
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Case 1: Gains and losses deferred: Under Entity A’s previous GAAP, until the sales occurred the forward
contract was recognised in the statement of financial position at its fair value and the resulting gain or loss was
deferred in the statement of financial position as a liability or an asset. When the sale occurred, any deferred gain
or loss was recognised in profit or loss as an offset to the revenue recognised on the hedged sale.
This relationship must be reflected in Entity A’s opening IFRS statement of financial position whether or not
the hedge designation, documentation and effectiveness for hedge accounting under IFRS 9 (paragraph 6.4.1
(b)(c)) are met on the transition date: the deferred gain should be reclassified to other comprehensive income
and there is no adjustment to the carrying amount of the forward contract.
Case 2: Gains and losses unrecognised: Under Entity A’s previous GAAP the contract was not recognised in
the statement of financial position. When the sale occurred, any unrecognised gain or loss was recognised in
profit or loss as an offset to the revenue recognised on the hedged sales.
Although this Case is more problematic, we consider that it should be accounted for in the same way as
Case 1. The difference between the previous carrying amount of a derivative and its fair value would be
recognised in other comprehensive income.
4.5.4
Reflecting fair value hedges in the opening IFRS statement of
financial position
If a first-time adopter has, under its previous GAAP, deferred or not recognised gains
and losses on a fair value hedge of a hedged item that is not measured at fair value, the
entity should adjust the carrying amount of the hedged item at the date of transition.
The adjustment, which is essentially the effective part of the hedge that was not
recognised in the carrying amount of the hedged item under the previous GAAP, should
be calculated as the lower of:
(a) that portion of the cumulative change in the fair value of the hedged item that was
not recognised under previous GAAP; and
(b) that portion of the cumulative change in the fair value of the hedging instrument
and, under previous GAAP, was either (i) not recognised or (ii) deferred in the
statement of financial position as an asset or liability. [IFRS 1.IG60A].
4.5.5
Reflecting foreign currency net investment hedges in the opening
IFRS statement of financial position
IFRS 1 does not provide explicit guidance on reflecting foreign currency net
investment hedges in the opening IFRS statement of financial position. However,
IFRS 9 requires that ongoing IFRS reporting entities account for those hedges
similarly to cash flow hedges. [IFRS 9.6.5.13]. It follows that the first-time adoption
provisions regarding cash flow hedges (see 4.5.3 above) also apply to hedges of
foreign currency net investments.
A first-time adopter that applies the exemption to reset cumulative translation
differences to zero (see 5.7 below) should not reclassify pre-transition gains and
losses on the hedging instruments that were recognised in equity under previous
GAAP to profit or loss upon disposal of a foreign operation. Instead, those pre-
earnings to avoid a disparity between the treatment of the gains and losses on the
hedged item and the hedging instrument. This means that the requirement to reset
the cumulative translation differences also applies to related gains and losses on
hedging instruments.
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4.6
Hedge accounting: subsequent treatment
The implementation guidance explains that hedge accounting can be applied
prospectively only from the date the hedge relationship is fully designated and
documented. In other words, after the transition to IFRS, hedge accounting under
IFRS 9 can be applied only if the qualifying criteria in paragraph 6.4.1 of IFRS 9 are met.
Therefore, if the hedging instrument is still held at the date of transition to IFRSs, the
designation, documentation and effectiveness of a hedge relationship must be
completed on or before that date if the hedge relationship is to qualify for hedge
accounting from that date. [IFRS 1.IG60].
Before the date of transition to IFRSs an entity may have designated as a hedge a
transaction under previous GAAP that is a type that qualifies for hedge accounting under
IFRS 9, which consists only of eligible hedging instruments and eligible hedged items in
paragraph 6.4.1(a), but does not meet other qualifying criteria in IFRS 9 (i.e. 6.4.1 (b) and
(c)) at the transition date. In these cases it should follow the general requirements in
IFRS 9 for discontinuing hedge accounting subsequent to the date of transition to IFRSs
– these are dealt with in Chapter 49. [IFRS 1.B6].
For cash flow hedges, any net cumulative gain or loss that was reclassified to the cash
flow hedge reserve on the transition date to IFRS (see 4.5.3 above) should remain there
until: [IFRS 1.IG60B]
(a) the forecast transaction subsequently results in the recognition of a non-financial
asset or non-financial liability;
(b) the
forecast
transaction
affects profit or loss; or
(c) subsequently
circumstances change and the forecast transaction is no longer
expected to occur, in which case any related net cumulative gain or loss that had
been reclassified to the cash flow hedge reserve on the transition date to IFRS is
reclassified to profit or loss.
The requirements above do little more than reiterate the general requirements of
IFRS 9, i.e. that hedge accounting can only be applied prospectively if the qualifying
criteria are met, and entities should experience few interpretative problems in dealing
with this aspect of the hedge accounting requirements.
4.7
Hedge accounting: examples
The following examples illustrate the guidance considered at 4.5 to 4.6 above.
Example 5.10: Pre-transition cash flow hedges
Case 1: All hedge accounting qualifying criteria met from date of transition and thereafter
In 2011 Entity A borrowed €10m from a bank. The terms of the loan provide that a coupon of 3 month LIBOR
plus 2% is payable quarterly in arrears and the principal is repayable in 2026. In 2014, Entity A decided to
‘fix’ its coupon payments for the remainder of the term of the loan by entering into a twelve-year pay-fixed,
receive-floating interest rate swap. The swap has a notional amount of €10m and the floating leg resets
quarterly based on 3 month LIBOR.
In Entity A’s final financial statements prepared under its previous GAAP, the swap was clearly identified as
a hedging instrument in a hedge of the loan and was accounted for as such. The fair value of the swap was
not recognised in Entity A’s statement of financial position and the periodic interest settlements were accrued
and recognised as an adjustment to the loan interest expense. On 1 January 2018, Entity A’s date of transition
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to IFRSs, the loan and the swap were still in place and the swap had a positive fair value of €1m and a €nil
carrying amount. In addition, Entity A met all the qualifying criteria in IFRS 9 to permit the use of hedge
accounting for this arrangement throughout 2018 and 2019.
In its opening IFRS statement of financial position Entity A should:
• recognise the interest rate swap as an asset at its fair value of €1m; and
• credit €1m to a separate component of equity, to be reclassified to profit or loss as the hedged transactions
(future interest payments on the loan) affect profit or loss.
In addition, hedge accounting would be applied throughout 2018 and 2019.
Case 2: Hedge terminated prior to date of transition
The facts are as in Case 1 except that in April 2017 Entity A decided to terminate the hedge and the interest
rate swap was settled for its then fair value of €1.5m. Under its previous GAAP, Entity A’s stated accounting
policy in respect of terminated hedges was to defer any realised gain or loss on terminated hedging
instruments where the hedged exposure remained. These gains or losses would be recognised in profit or loss
at the same time as gains or losses on the hedged exposure. At the end of December 2017, A’s statement of
financial position included a liability (unamortised gain) of €1.4m.
IFRS 1 does not explicitly address hedges terminated prior to the date of transition. However, because the
terminated hedge relates to a transaction that has an ongoing risk exposure, the provisions of IFRS 9 on hedge
discontinuance should be applied to this relationship. Accordingly, in its opening IFRS statement of financial
position Entity A should:
• remove the deferred gain of €1.4m from the statement of financial position; and
• credit €1.4m to a separate component of equity, to be reclassified to profit or loss as the hedged
transactions (future interest payments on the loan) affect profit or loss.
Example 5.11: Existing fair value hedges
Case 1: All hedge accounting qualifying criteria met from date of transition and thereafter (1)
On 15 November 2017, Entity B entered into a forward contract to sell 50,000 barrels of crude oil to hedge
all changes in the fair value of certain inventory. Entity B will apply IFRS 9 from 1 January 2018, its date of
transition to IFRSs. The historical cost of the forward contract is $nil and at the date of transition the forward
had a negative fair value of $50.
In Entity B’s final financial statements prepared under its previous GAAP, the forward was clearly identified as
a hedging instrument in a hedge of the inventory and was accounted for as such. The contract was recognised in
the statement of financial position as a liability at its fair value and the resulting loss was deferred in the statement of financial position as an asset. In the period between 15 November 2017 and 1 January 2018 the fair value of
the inventory increased by $47. In addition, Entity B met all the qualifying criteria in IFRS 9 to permit the use
of hedge accounting for this arrangement throughout 2018 until the forward expired.
In its opening IFRS statement of financial position Entity B should:
• continue to recognise the forward contract as a liability at its fair value of $50;
• derecognise the $50 deferred loss asset on the forward contract;
• recognise the crude oil inventory at its historical cost plus
$47 (the lower of the change in fair value of
the crude oil inventory, $47, and that of the forward contract, $50); and
• record the net adjustment of $3 in retained earnings.
In addition, hedge accounting would be applied throughout 2018 until the forward expired.
Case 2: All hedge accounting qualifying criteria met from date of transition and thereafter (2)
In 2011 Entity C borrowed €10m from a bank. The terms of the loan provide that a coupon of 8% is payable
quarterly in arrears and the principal is repayable in 2026. In 2014, Entity C decided to alter its coupon payments
for the remainder of the term of the loan by entering into a twelve-year pay-floating, receive-fixed interest rate
swap. The swap has a notional amount of €10m and the floating leg resets quarterly based on 3 month LIBOR.
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In Entity C’s final financial statements prepared under its previous GAAP, the swap was clearly identified as
a hedging instrument in a hedge of the loan and accounted for as such. The fair value of the swap was not
recognised in Entity C’s statement of financial position and the periodic interest settlements on the swap were
accrued and recognised as an adjustment to the loan interest expense.
On 1 January 2018, Entity C’s date of transition to IFRSs, the loan and the swap were still in place and the
swap had a negative fair value of €1m and a €nil carrying amount. The cumulative change in the fair value
of the loan attributable to changes in 3 month LIBOR was €1.1m, although this change was not recognised
in Entity C’s statement of financial position because the loan was accounted for at amortised cost. In addition,
Entity C met all the qualifying criteria in IFRS 9 to permit the use of hedge accounting for this arrangement
throughout 2018 and 2019.
In its opening IFRS statement of financial position Entity C should:
• recognise the interest rate swap as a liability at its fair value of €1m; and
• reduce the carrying amount of the loan by €1m (the lower of the change in its fair value attributable to
the hedged risk, €1.1m, and that of the interest rate swap, $1m) to €9m.
In addition, hedge accounting would be applied throughout 2018 and 2019.
Case 3: Hedge terminated prior to date of transition
The facts are as in Case 2 above except that in April 2017 Entity C decided to terminate the fair value hedge