2.5.2
Hedging a component of a group
A group designation can also consist of a component of a group of items, such as a layer
component of a group. A component could also be a proportion of a group of items,
such as 50% of a fixed rate bond series with a total volume of CU 100 million. Whether
an entity designates a layer component or a proportionate component depends on the
entity’s risk management objective. [IFRS 9.6.6.1, 6.6.2].
The benefits of identifying a layer component, as discussed at 2.3 above, are relevant
when applied to a group of items. In fact, the bottom layer hedging strategy discussed in
Example 49.12 above is, in fact, a designation of a component of a group.
Example 49.18: Hedging a top layer of a portfolio of financial liabilities
A bank completes a bond issuance of CAD 50 million that is made up of 50,000 fixed rate bonds with a face
value of CAD 1,000 each. The bank expects that it will repurchase up to CAD 10 million of the issue before
maturity. Therefore it chooses to transact a receive fixed/pay variable interest rate swap with a notional
amount of CAD 10 million, in order to hedge the benchmark component of the fair value interest rate risk of
the volume that is expected to be repurchased. From an economic perspective, that hedge would allow
repurchases of up to CAD 10 million total face value for which the gain or loss from changes in the benchmark
interest rate would be compensated by the gain or loss on the swap. However, this can only be reflected in
the accounting if the entity designates a CAD 10 million top layer. The entity would revalue the first CAD
10 million of face value of the bond issue for changes in the benchmark risk, and would include a fair value
hedge gain or loss when determining the gain or loss on derecognition of the first CAD 10 million of bonds.
If it was not permitted to designate a layer of a group of items, entities would in such
cases either have to identify individual items within the group and designate them on a
4000 Chapter 49
standalone basis, or prorate the fair value hedge gain or loss to the entire bond issue
volume, as discussed in 2.3.2 above. The IASB believes this would result in arbitrary
accounting results and decided to allow a layer component designation for a group of
items. [IFRS 9.BC6.438, BC6.439].
A layer component of a group of items only qualifies for hedge accounting if:
• the layer is separately identifiable and reliably measurable;
• the risk management objective is to hedge a layer component;
• the items in the group from which the layer is identified are exposed to the same
hedged risk (so that measurement of the hedged layer is not significantly affected
by which particular items from the overall group form part of the hedged layer);
• for a hedge of existing items, the items in the group can be identified and tracked;
and
• any items in the group containing prepayment options meet the requirements for
components of a nominal amount (see 2.3.2 above). [IFRS 9.6.6.3].
Based on the information provided, the top layer in Example 49.18 above would meet
the criteria in order for a top layer to be designated.
A hedging relationship can include layers from several different groups of items. For
example, in a hedge of a net position of a group of assets and a group of liabilities
(see 2.5.1 above), the hedging relationship can comprise, in combination, a layer
component of the group of assets and a layer component of the group of liabilities.
[IFRS 9.B6.6.12].
2.5.3
Cash flow hedge of a net position
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.
Example 49.19: Economic ‘natural hedge’ of foreign currency cash flows
An entity with GBP as its functional currency anticipates foreign currency denominated sales of USD 100
in 12 months and also intends to purchase fixed assets of USD 80 in 12 months. USD 80 of the cash inflows
of the forecast sales are economically hedged together with the cash outflows for the forecast purchase of the
fixed assets. A single foreign exchange forward contract to sell USD20 in 6 months is transacted to hedge the
net position arising from the sales and purchases.
Designation of a net position in a cash flow hedge is limited to hedges of foreign
exchange risk under IFRS 9. The instance where this limitation should be applied is
defined in IFRS 9 paragraph 6.6.1(c) for hedged items as follows: ‘in the case of a cash
flow hedge of a group of items whose variabilities in cash flows are not expected to be
approximately proportional to the overall variability in cash flows of the group so that
offsetting or net risk positions arise’. [IFRS 9.6.6.1(c), B6.6.7, BC6.455].
Financial instruments: Hedge accounting 4001
The standard mechanics of cash flow hedge accounting cannot accommodate a hedged
net position whose gross cash flows affect profit or loss in different periods (see 7.2
below). Applying standard cash flow hedge accounting to Example 49.19, the gain or loss
accumulated in other comprehensive income (OCI) on the USD 20 of hedging
instrument would be reclassified to profit or loss when the revenue transaction occurs.
However, this will only offset the gain or loss on USD 20 of the USD 100 hedged revenue
while the remaining revenue of FC 80 and the fixed asset purchase of USD 80 (i.e. the
economic hedge) would still be measured at the spot rate. This would result in the
bottom line profit for the period(s) not reflecting the economic hedge.
IFRS 9 amends the standard cash flow hedge accounting for such a net position in that
the foreign exchange gain or loss on the USD 80 revenue cash flows that affect profit or
loss in the earlier period must be carried forward to offset the foreign exchange gain or
loss on the fixed asset purchase cash flows that will affect profit or loss in later periods.
This is achieved by deferring the gain or loss on the natural hedge in OCI, with a
reclassification to profit or loss once the offsetting cash flows affect profit or loss
(see 9.3.1 and Example 49.20 below).
However, the gross transactions that make up the net position are recognised when they
arise and will be measured at the spot foreign currency rate ruling at that time. They are
not adjusted to reflect the result of the hedge. The whole impact of hedge accounting
has to be presented in a separate line item in profit or loss. [IFRS 9.6.6.4].
This separate line item includes:
• The reclassification adjustment for gains or losses on the hedge of the net position.
• The gain or loss on the natural hedge, with the counter-entry being recognised in
OCI.
• The later reclassification adjustment of the gain or loss on the natural hedge from
OCI to profit or loss.
The rather complicated accounting described above is best illustrated using an example:
Example 49.20: Cash flow hedge of a foreign currency net position
An entity having CAD as functional currency anticipates sales of GBP 100m in 12 months and also plans a
major capital expenditur
e (fixed assets) of GBP 80m in 12 months. The anticipated sales and capital
expenditure (i.e. the group of forecast transactions) are designated as the hedged item and the resulting net
position is hedged with a forward contract to sell GBP 20m in 12 months. The fixed assets will be depreciated
on a straight-line basis over eight years. For simplicity, assume the spot rate equals the forward rate.
GBP/CAD spot rate
At inception of the hedge (beginning of year 1)
1.50
After 12 months (end of year 1)
1.60
4002 Chapter 49
The entity would record the following journal entries (amounts in millions):
Year 1
CAD
CAD
Other comprehensive income
2
Hedging derivative
2
To recognise the fair value loss from the hedging instrument in the statement of financial position and the
cash flow hedge reserve (GBP 20 × [1.50 – 1.60]).
Cash 160
Revenue from sales
160
To account for the sales volume of GBP 100 at the current spot rate of 1.60 (GBP 100 × 1.60).
Property, plant and equipment
128
Cash
128
To account for the purchase of GBP 80 fixed assets at the current spot rate of 1.60 (GBP 80 × 1.60).
CAD
CAD
Hedging derivative
2
Cash
2
To account for the settlement of the forward contract.
Net position hedging gains/losses
2
Other comprehensive income
2
To reclassify the cash flow hedge reserve from OCI to profit or loss.
Net position hedging gains/losses
8
Other comprehensive income
8
To defer the natural hedge gain from profit or loss to OCI (GBP 80 × [1.60 – 1.50]).
The net profit for the period is CAD 150, which represents the sale of GBP 100 at the hedged rate of 1.50
(albeit presented in two different line items).
Years 2 to 9
Depreciation 16
Property, plant and equipment
16
To account for the straight line depreciation of the fixed assets (CAD 128 × 12.5%).
Other comprehensive income
1
Net position hedging gains/losses
1
To reclassify part of the deferred gain from OCI to profit or loss (CAD 8 × 12.5%).
Financial instruments: Hedge accounting 4003
The net loss for each period is 15, which represents depreciation (at 12.5%) of a fixed asset of GBP 80
purchased at the hedged rate of 1.50.
Overview
Income
Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9
Total
statement
(CAD)
Revenue from
sale of goods
160
160
Depreciation
(16) (16) (16) (16) (16) (16) (16) (16)
(128)
Net position
hedging
gains/losses (10) 1 1 1 1 1 1 1 1 (2)
Profit for the
period
150
(15)
(15)
(15)
(15)
(15)
(15)
(15)
(15)
30
Statement of
Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9
financial
position
(CAD)
Cash
30 30 30 30 30 30 30 30 30
Property, plant
and equipment
128
112
96
80
64
48
32
16
0
Hedging
reserve (OCI)
(8)
(7)
(6)
(5)
(4)
(3)
(2)
(1)
0
The transactions within a net position still have to be measured at their spot rates, while
the effect of the hedge is presented in a separate line item. [IFRS 9.B6.6.15]. In other words,
although an entity may be economically hedged from a bottom line (or net) perspective,
volatility will still arise in the amounts reported for the individual hedged transactions
(on a gross basis), and it is only the bottom line of profit or loss that will reflect the
benefits of the hedge.
For a net position to qualify for cash flow hedge accounting the hedge documentation
has to include, for each type of item within the net position, its amount and nature as
well as the reporting period in which it is expected to affect profit or loss. This is
expected to be a relatively detailed record of what makes up the net position and how
it will impact profit or loss, including the depreciation profile, if relevant.
[IFRS 9.6.6.1(c)(ii), B6.6.7, B6.6.8].
4004 Chapter 49
2.5.4
Nil net positions
IFRS 9 also addresses hedges of nil net positions. This refers to when entities hedge a
group of items where the hedged items themselves fully offset the risk that is managed.
An example would be similar to the scenario illustrated by Example 49.19 above but
where the entity anticipates sales of GBP 100m in 12 months and also plans a major
capital expenditure of GBP 100m in 12 months. An entity is allowed to designate such a
nil net position in a hedging relationship, provided that:
• the hedge is part of a rolling net risk hedging strategy, whereby the entity routinely
hedges new positions of the same type over the course of time (for example when
transactions move into the time horizon for which the entity hedges);
• hedging instruments are used to hedge the net risk when the hedged net position
changes in size over the life of the rolling hedging strategy and is not a nil net position;
• the entity would normally apply hedge accounting to such net positions when the
net position is not nil; and
• not applying hedge accounting to the nil net position would result in inconsistent
accounting outcomes over time (because in a period in which the net position is
nil, hedge accounting would not be available for what is otherwise the same type
of exposure). [IFRS 9.6.6.6].
2.6
Other eligibility issues for hedged items
2.6.1 Highly
probable
Forecast transactions (or a component thereof) may only be eligible hedged items if they
are highly probable of occurring (see 2.1 above). [IFRS 9.6.3.3]. The term ‘highly probable’
is not defined in IFRS 9, but is often interpreted to have 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 and, this guidance can be considered relevant for
IFRS 9 hedge accounting. The IAS 39 guidance indicates that an assessment of the
likelihood that a forecast transaction will take place is not based solely on management’s
intention, it should be supported by observable facts and the attendant circumstances.
In such an assessment, an entity should consider the following:
• the frequency of similar past transactions;
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�� the financial and operational ability of the entity to carry out the transaction;
• whether substantial commitments of resources have been made to a particular
activity;
• the extent of loss of disruption of operations that could result if the transaction
does not occur;
• the likelihood that transactions with substantially different characteristics might be
used to achieve the same business purpose; and
• the entity’s business plan.
An entity may also need to consider the impact of wider industry and business drivers
as to whether cash flows are highly probable or not. For example:
Financial instruments: Hedge accounting 4005
• whether forecast cash flows in a subsidiary that is due to be sold can be considered
highly probable in the parent’s consolidated financial statements (see 7.2.4 below); or
• if a designated benchmark interest rate is no longer expected to exist, whether forecast
cash flows linked to that benchmark can be highly probable (see 8.3.2.C below).
The length of time until a forecast transaction is projected to occur is also a factor. Other
factors being equal, the more distant a forecast transaction is, the less likely it is that it
would be considered highly probable and the stronger the evidence required to
determine that it is highly probable.
For example, a transaction forecast to occur in 5 years will often be less likely to occur
than a transaction forecast to occur in one year. However, forecast interest payments
for the next 20 years on variable rate debt would typically be highly probable if
supported by an existing contractual obligation.
In addition, other factors being equal, the greater the physical quantity or future value
of the forecast transaction, in proportion to the entity’s total transactions of the same
nature, the less likely it is that the transaction would be considered highly probable. For
example, less evidence generally would be needed to support forecast highly probable
sales of 100,000 units in the next month than 950,000 units in that month, when recent
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 792
