International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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given the fact IFRS 9 does not include an accounting solution for dynamic risk
management, entities are permitted an accounting policy choice to continue applying
the hedge accounting requirements of IAS 39 instead of those in IFRS 9. [IFRS 9.7.2.21].
See 11.2 below.
Furthermore, for a fair value hedge of the interest rate exposure of a portfolio of
financial assets or financial liabilities (and only for such a hedge), an entity may apply
the related hedge accounting requirements in IAS 39 instead of those in IFRS 9. This
choice relates only to a fair value portfolio hedge as described in IAS 39 81A, 89A and
AG114-AG132 of IAS 39 (see 11.2 below). A decision to continue to apply this IAS 39
guidance is not part of the accounting policy choice to defer IAS 39 mentioned above.
The chapter focuses on the hedge accounting requirements of IFRS 9. The main
differences between hedge accounting under IFRS 9 and the hedge accounting
requirements in IAS 39 are discussed at 14 below.
In developing IFRS 9, the IASB decided not to carry forward any of the hedge
accounting related Implementation Guidance that accompanied IAS 39. However the
IASB emphasised that not carrying forward the implementation guidance did not mean
that it had rejected the guidance. Implementation Guidance only accompanies, but is
not part of the standard. [IFRS 9.BC6.93-95]. An entity might have relied on particular
Implementation Guidance in IAS 39 as an interpretation of the IAS 39 hedge accounting
guidance. In that case, the entity could also interpret the same outcome based on the
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IFRS 9 hedge accounting guidance. Hence much of the Implementation Guidance in
IAS 39 remains relevant for the application of IFRS 9.
Accordingly, whilst this chapter predominantly focuses on the guidance included with
IFRS 9, on occasion IAS 39 Implementation Guidance is included where this is
considered to be relevant and helpful.
1.4
Objective of hedge accounting
The objective of the IFRS 9 hedge accounting requirements is to ‘represent, in the
financial statements, the effect of an entity’s risk management activities’. The aim of the
objective is ‘to convey the context of hedging instruments for which hedge accounting
is applied in order to allow insight into their purpose and effect’. [IFRS 9.6.1.1]. This is
achieved by reducing the accounting 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, but with some important improvements when
compared to IAS 39.
This is a rather broad objective that focuses on an entity’s risk management activities
and reflects what the Board wanted to achieve with the new accounting requirements.
However, this broad objective does not override any of the hedge accounting
requirements, which is why the Board noted that hedge accounting is only permitted if
all the new qualifying criteria are met (see 6 below). [IFRS 9.BC6.82].
1.5
Hedge accounting overview
Given the stated objective of IFRS 9 is for hedge accounting to represent an entity’s risk
management activities where possible, the first step in achieving hedge accounting
under IFRS 9 is to identify the relevant risk management strategy and the objective for
a particular hedge relationship. These form the foundations for hedge accounting under
IFRS 9 (see 6.2 below).
Consistent with IAS 39, the standard defines three types of hedge relationships:
• a fair value hedge: a hedge of the exposure to changes in fair value that is
attributable to a particular risk and could affect profit or loss;
• a cash flow hedge: a hedge of the exposure to variability in cash flows that is
attributable to a particular risk and could affect profit or loss; and
• a hedge of a net investment in a foreign operation. [IFRS 9.6.5.2].
An entity may choose to designate a hedging relationship between a hedging instrument
and a hedged item in order to achieve hedge accounting. [IFRS 9.6.1.2]. Prior to hedge
accounting being applied, all of the following steps must have been completed:
• identification of eligible hedged item(s) and hedging instrument(s) (see 2 and
3 below);
• identification of an eligible hedged risk (see 2 below);
• ensuring that hedge relationship meets the definition of one of the permitted
types (a fair value, cash flow or net investment hedge) (see 5 below);
• satisfying the qualifying criteria for hedge accounting (see 6 below); and
• formal designation of the hedge relationship (see 6.3 below).
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Once these requirements are met, hedge accounting can be applied prospectively, but
the ongoing qualifying criteria and assessments must continue to be met, otherwise
hedge accounting will cease. (See 8 below).
The table below summarises the application of hedge accounting for the three types of
hedge relationships:
Figure 49.1:
Accounting for hedge relationships
Hedge type
Fair value
Cash flow
Net investment
Carrying amount adjusted
for changes in fair value
Hedged item
with respect to the hedged
N/A N/A
risk. Adjusted through
profit or loss.
No change to carrying
No change to carrying
Hedging
amount, but effective
amount, but effective
N/A
instrument
portion of change in fair
portion of change in fair
value is recorded in OCI.
value is recorded in OCI.
Resultant
Ineffective portion
Ineffective portion
Ineffective portion
profit or loss
As it can be seen from the above, for a fair value hedge, an adjustment is made to the
carrying value of the hedged item to reflect the change in value of the hedged risk, with
an offset to profit or loss for the change in value of the hedging instrument. Where the
offset is not complete, this will result in ineffectiveness to be recorded in profit or loss
(see 7.4 below).
However, for both a cash flow and net investment hedge, the carrying amount of the
hedged item, which for a cash flow hedge may not even yet be recognised, is unchanged.
The effect of hedge accounting is to defer the effective portion of the change in value
of the hedging instrument in other comprehensive income. Any ineffective portion will
remain in profit or loss as ineffectiveness.
See 7 below for more details on accounting for eligible hedges.
2 HEDGED
ITEMS
2.1 General
requirements
The basic requirement for a hedged item is for it to be one of the following:
• a recognised asset or liability;
• an unrecognised firm commitment;
• a highly probable forecast transaction; or
• a net investment in a foreign operation.
The hedged item must be reliably measurable and can be a single item, or a group of
items (see 2.5 below). A hedged item can also
be a component of such an item(s) (see 2.2
and 2.3 below). [IFRS 9.6.3.1, 6.3.2, 6.3.3].
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Recognised assets and liabilities can include financial items and non-financial items such
as inventory. Most internally-generated intangibles (e.g. for a bank, a core deposit
intangible – see 2.6.7 below) are not recognised assets and therefore cannot be hedged
items. However, firm commitments that are not routinely recognised as assets or
liabilities absent the effects of hedge accounting for such items can be eligible hedged
items, this would include loan commitments (see Chapter 41 at 3.5). [IFRS 9.6.3.1].
The term ‘highly probable’ is not defined in IFRS 9, but is often interpreted to mean a
much greater likelihood of happening than ‘more likely than not’. The implementation
guidance within IAS 39 contained some guidance as to how the term highly probable
should be applied within the context on hedge accounting, this guidance can be
considered relevant for IFRS 9 hedge accounting. See 2.6.1 below.
A net investment in a foreign operation is defined in paragraph 8 of IAS 21 – The Effects
of Changes in Foreign Exchange Rates – to be the amount of the reporting entity’s
interest in the net assets of that operation (see Chapter 15 at 6).
An aggregated exposure that is a combination of an exposure that could qualify as a
hedged item and a derivative may be designated as a hedged item (see 2.7 below).
[IFRS 9.6.3.4].
Only assets, liabilities, firm commitments and forecast transactions with an external
party qualify for hedge accounting. [IFRS 9.6.3.5]. 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. [IFRS 9.6.3.6]. (See 4.3.2 below).
Financial assets and liabilities need not be within the scope of IFRS 9 to qualify as
hedged items. For example, although rights and obligations under lease agreements are
for most purposes scoped out of IFRS 9, lease payables or finance lease receivables still
meet the definition of a financial instrument and could therefore be hedged items in a
hedge of interest rate or foreign currency risk. However, following the introduction of
IFRS 16 – Leases (see Chapter 24), entities that previously hedged the full foreign
currency risk from future forecast operating lease payments will no longer need to apply
hedge accounting. This is because the foreign exchange risk in the hedging instrument
will naturally offset the IAS 21 retranslation of the lease liability. However, for entities
that did not economically hedge the full foreign currency risk arising from future
forecast operating lease payments, there may be an additional incentive to do so, as the
full foreign exchange risk of the lease has a more immediate impact on profit or loss
through the IAS 21 retranslation of the lease liability than under IAS 17 – Leases.
In the case of a financial liability containing an embedded derivative (see Chapter 42 at 4),
if the embedded derivative is accounted for separately from the host instrument, the
hedged item would be the host instrument or components thereof (see 2.2 and 2.3 below);
basing it on the hybrid instrument (i.e. the instrument including the embedded derivative)
or the cash flows from the hybrid is not permitted. This is because derivatives are only
permitted as a hedged item as part of an eligible aggregated exposure. As an embedded
derivatives is only accounted for separately if it is not closely related to the host instrument,
it is unlikely to meet the criteria for an eligible aggregated exposure (see 2.7 below).
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An entity may designate an item in its entirety or a component of an item as the hedged
item in a hedging relationship. An entire item comprise all changes in the cash flows or
fair value of an item. A component compromises less than the entire fair value change
or cash flow variability of an item. In that case an entity may designate only the following
types of components (including combinations) as hedged items:
• only changes in the cash flows or fair value of an item attributable to a specific risk
or risks (i.e. a risk component), including one sided risks (see 2.2 below);
• one or more selected contractual cash flows; and
• components of a nominal amount, i.e. a specified part of the amount of an item
(see 2.3 below). [IFRS 9.6.3.7].
The reference to one sided risks refers to an ability to designate only changes in the
cash flows or fair value of a hedged item above or below a specified price or other
variable. The intrinsic value of a purchased option hedging instrument (assuming that it
has the same principal terms as the designated risk), but not its time value, reflects a one
sided risk in a hedged item. For example, an entity can designate the variability of future
cash flow outcomes resulting from a price increase of a forecast commodity purchase,
without including the risk of a price decrease within the hedge relationship. Such a
situation may arise if the entity wanted to retain the opportunity to benefit from lower
commodities prices, but protect itself against an increase. In such a situation, only cash
flow losses that result from an increase in the price above the specified level are
designated. The hedged risk does not include the time value of the purchased option.
[IFRS 9.6.3.7].
Only the portion of cash flows or fair value of a financial instrument that are designated
as the hedged item are subject to the hedge accounting requirements. The accounting
for other portions that are not designated as the hedged item remains unchanged.
The guidance also adds that to be eligible for hedge accounting, a risk component must be
a separately identifiable component of the financial or non-financial item, and the changes
in the cash flows or fair value of the item attributable to changes in that risk component
must be reliably measurable. [IFRS 9.B6.3.8]. This is considered further below at 2.2.
There is no requirement to designate a hedged item only on initial recognition.
Designation of hedged items sometime after their initial recognition (e.g. after a previous
hedge relationship is discontinued) is permitted, although some additional complexity
may arise when identifying risk components (see 2.4.1 below). [IFRS 9.B6.5.28].
2.2 Risk
components
2.2.1 General
requirements
Instead of hedging the total changes in fair values or cash flows, risk managers often
enter into derivatives to hedge only specific risk components. Managing a specific risk
component reflects that hedging all risks is often not economical and hence not
desirable, or even not possible (because of a lack of suitable hedging instruments).
If designated, the usual hedge accounting requirement apply to a risk component in the
same way as they apply to other hedged items that are not risk components. For
example the qualifying criteria apply, including that the hedging relationship must meet
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the hedge effectiveness requirements, and any hedge ineffectiveness must be measured
and recognised, albeit only with respect to the hedged risk, and not the full item.
[IFRS 9.B6.3.11].
IFRS 9 permits an entity to designate a risk component of a financial or non-financial
item as the hedged item in a hedging relationship. Designation of a risk component
means that only changes in the cash flows or fair value of the hedged item with respect
to the designated risk are subject to the hedge accounting requirements. So instead of
considering value changes in the hedged item with respect to all risks that are value
drivers, only value changes in the hedged item with respect to the designated risk
component are considered for hedge accounting purposes. This is valuable as it is
common for entities to economically hedge a specific risk within a hedged item rather
than its full price risk. The ability to designate risk components in a hedge relationship
is an important step in enabling entities to achieve the IASB’s objective for hedge
accounting, which is to ‘represent, in the financial statements, the effect of an entity’s
risk management activities’.
It should be noted, however, that only eligible risk components can be designated in
hedge relationships. IFRS 9 provides guidance on this topic which is discussed in the
sections below.
The key requirements for designating a risk component are that risk component is less
than the entire item (see 2.4 below), it must be a separately identifiable component of
the item and the changes in the cash flows or fair value of the item attributable to the
changes in that risk component must be reliably measurable. [IFRS 9.B6.3.7, B6.3.8]. A risk
component can be contractually specified in the contract (see 2.2.2 below) but non-
contractually specified risk components may also be eligible (see 2.2.3 below).
[IFRS 9.B6.3.10].
When identifying what risk components qualify for designation as a hedged item, in
particular whether they are separately identifiable and reliably measurable, an entity
assesses such risk components within the context of the particular market structure to
which the risk(s) relate and in which the hedging activity takes place. [IFRS 9.B6.3.9]. This