at 4.3.1 and 4.3.2 below.
4.3.1
Intragroup monetary items
IFRS 9 allows the foreign currency risk of an intra-group monetary item (e.g. a payable
or receivable between two subsidiaries) to qualify as a hedged item in the consolidated
financial statements if it results in an exposure to foreign exchange rate gains or losses
under IAS 21 that are not fully eliminated on consolidation. Foreign exchange gains and
losses on such items are not fully eliminated on consolidation when they are transacted
between two group entities that have different functional currencies (see Chapter 15
at 6.3), [IFRS 9.6.3.6], as illustrated in the following example.
Example 49.42: Intragroup monetary items that will affect consolidated profit or loss
Company A has two subsidiaries, Company B and Company C. A and B have the euro as their functional
currencies, while C has the US dollar as its functional currency. On 31 March, C purchases goods from B for
US$110, payable on 30 June.
In this case, the intragroup monetary item of US$110 may be designated as a hedged item in a hedge of foreign
currency risk both by B in its separate financial statements and by A in its consolidated financial statements.
While B’s foreign currency receivable is eliminated against C’s foreign currency payable on consolidation, the
exchange differences that arise for B cannot be eliminated since C has no corresponding exchange differences.
Thus, the intragroup monetary item results in an exposure to variability in the foreign currency amount of the
intra-group monetary item that will affect profit or loss in the consolidated financial statements. Therefore,
the intragroup monetary item may be designated as a hedged item in a foreign currency hedge.6
Financial instruments: Hedge accounting 4045
4.3.2
Forecast intragroup transactions
IFRS 9 also contains a second exception allowing the foreign currency risk of a highly
probable forecast intragroup transaction to qualify as a hedged item in a cash flow hedge
in consolidated financial statements in certain circumstances. The transaction must be
denominated in a currency other than the functional currency of the entity entering into
that transaction (e.g. parent, subsidiary, associate, joint venture or branch) and the
foreign currency risk must affect consolidated profit or loss (otherwise it cannot qualify
as a hedged item). [IFRS 9.6.3.6].
Normally, royalty payments, interest payments and management charges between
members of the same group will not affect consolidated profit or loss unless there is
a related external transaction. However, by way of example, a forecast sale or
purchase of inventory between members of the same group will affect profit or loss
if there is an onward sale of the inventory to a party external to the group. Similarly,
a forecast intragroup sale of plant and equipment from the group entity that
manufactured it to a group entity that will use it in its operations may affect
consolidated profit or loss. This could occur, for example, because the plant and
equipment will be depreciated by the purchasing entity and the amount initially
recognised for the plant and equipment may change if the forecast intragroup
transaction is denominated in a currency other than the functional currency of the
purchasing entity. [IFRS 9.B6.3.5].
Although the standard refers exclusively to forecast intragroup transactions, we believe there
is no reason why these provisions should not also apply to intragroup firm commitments.
4.4
Hedged item and hedging instrument held by different group
entities
The IAS 39 implementation guidance explained that, in a group, it is not necessary for
the hedging instrument to be held by the same entity as the one that has the exposure
being hedged in order to qualify for hedge accounting in the consolidated financial
statements. [IAS 39.F.2.14]. This is illustrated in the following example.
Example 49.43: Subsidiary’s foreign exchange exposure hedged by parent
Company S is based in Switzerland and prepares consolidated financial statements in Swiss francs. It has an
Australian subsidiary, Company A, whose functional currency is the Australian dollar and is included in the
consolidated financial statements of S. A has forecast purchases in Japanese yen that are highly probable
and S enters into a forward contract to hedge the change in yen relative to the Australian dollar.
Because A did not hedge the foreign currency exchange risk associated with the forecast purchases in yen,
the effects of exchange rate changes between the Australian dollar and the yen will affect A’s profit or loss
and, therefore, would also affect consolidated profit or loss. Therefore that hedge may qualify for hedge
accounting in S’s consolidated financial statements provided the other hedge accounting criteria are met.
[IAS 39.F.2.14].
Whilst the above is based on implementation guidance from IAS 39, we believe that it
is still relevant under IFRS 9. This position was explicitly confirmed for hedges of net
investments within IFRIC 16 – Hedges of a Net Investment in a Foreign Operation. (See
5.3.3 below.)
4046 Chapter 49
One of the key qualifying criteria that must be met when a hedging instrument is held
by a different group entity in a fair value or cash flow hedge, is that the hedged risk
could affect profit or loss (see 5.1. and 5.2 below). This is illustrated using the fact pattern
in Example 49.43.
Example 49.44: Subsidiary’s foreign exchange exposure hedged by parent (2)
Using the same fact pattern as in Example 49.43 above, but in this case S has instead entered into a forward
contract to hedge the change in Swiss francs relative to the Australian dollar.
S cannot achieve cash flow hedge accounting for the forward contract to sell Swiss francs and buy yen in S’s
consolidated financial statements as there is no cash flow variability with respect to the Swiss francs/yen
exchange rates that will affect consolidated profit or loss.
Consolidated profit or loss will be impacted by movements in the yen/Australian dollar exchange rates, as
subsidiary A will recognise the purchase at the prevailing yen/Australian dollar exchange rate, consistent with
the designated risk in the hedging strategy in Example 49.43 above. [IAS 21.21].
S is only exposed to Australian dollar/Swiss franc exchange rates on translation of the purchase on consolidation,
which is not a cash flow exposure. [IAS 21.39(b)]. Hence cash flow hedge accounting cannot be achieved.
5
TYPES OF HEDGING RELATIONSHIPS
There are three types of hedging relationship defined in IFRS 9: [IFRS 9.6.5.2]
• fair value hedge: a hedge of the exposure to changes in the fair value of a
recognised asset or liability or an unrecognised firm commitment, or a component
of any such item, that is attributable to a particular risk and could affect profit or
loss (see 5.1 below);
• cash flow hedge: a hedge of the exposure to variability in cash flows that is
attributable to a particular risk associated with all or a component of recognised
asset or liability (such as all or some future interest payments on variable rate debt)
or a highly probable forecast transaction and could affect profit or loss (see 5.2
belo
w); and
• hedge of a net investment in a foreign operation: as defined in IAS 21 (see
Chapter 15 at 2.3 and 5.3 below).
These definitions are considered further in the remainder of this section.
5.1
Fair value hedges
An example of a fair value hedge is a hedge of the exposure to changes in the fair value
of a fixed rate debt instrument (not measured at fair value through profit or loss) as a
result of changes in interest rates – if interest rates increase, the fair value of the debt
decreases and vice versa. Such a hedge could be entered into either by the issuer or by
the holder. [IFRS 9.B6.5.1].
On the face of it, if a fixed rate loan that is measured at amortised cost or fair value
through OCI and is held until it matures (as is the case for many such loans), changes in
the fair value of the loan would not affect profit or loss. However, the fact that the loan
could be sold, in which case fair value changes would affect profit or loss means that
such a hedge relationship meets the definition set out in 5 above, that variability in the
Financial instruments: Hedge accounting 4047
hedged risk and could affect profit or loss. The same would be true of a fixed rate
borrowing for which settlement before maturity is very unlikely.
A variable rate debt may be the hedged item in a fair value hedge in certain
circumstances. For example, the fair value of such an instrument will change if the
issuer’s credit risk changes. Accordingly variable rate debt could be designated in a
hedge of all changes in its fair value. There may also be changes in its fair value relating
to movements in the market rate in the periods between which the variable rate is reset.
For example, if a debt instrument provides for annual interest payments reset to the
market rate each year, a portion of the debt instrument has an exposure to changes in
fair value during the year. [IAS 39.F.3.5].
The exposure to changes in the price of inventories that are carried at the lower of cost
and net realisable value may also be the subject of a fair value hedge because their fair
value will affect profit or loss when they are sold or written down. For example, a
copper forward may be used as the hedging instrument in a hedge of the copper price
associated with copper inventory. [IAS 39.F.3.6].
An equity method investment cannot be a hedged item in a fair value hedge because the
equity method recognises in profit or loss the investor’s share of the associate’s profit
or loss, rather than changes in the investment’s fair value. For a similar reason, an
investment in a consolidated subsidiary cannot be a hedged item in a fair value hedge in
the consolidated financial statements of a parent because consolidation recognises in
profit or loss the subsidiary’s profit or loss, rather than changes in the investment’s fair
value. [IFRS 9.B6.3.2]. However, assuming the investment is held at cost or fair value
through other comprehensive income, it would in our view be possible to designate the
foreign exchange risk in the carrying value of a foreign currency denominated
investment in the parent entity’s separate financial statements. Further, we believe it
would be possible to hedge the change in the entire fair value of the investment even if
the fair value is not reflected in the parent entity’s separate financial statements. This
hedge relationship would most likely be treated as a fair value hedge and would require
an adjustment to be made to the carrying value of the investment.
The ongoing accounting for fair value hedges is described at 7.1 below.
5.1.1
Hedges of firm commitments
A hedge of a firm commitment (e.g. a hedge of the change in fuel price relating to an
unrecognised contractual commitment by an electricity utility to purchase fuel at a fixed
price) is considered a hedge of an exposure to a change in fair value. Accordingly, such
a hedge is a fair value hedge. However, a hedge of the foreign currency risk of a firm
commitment may be accounted for as either a fair value hedge or a cash flow hedge (this
is discussed further at 5.2.2 below). [IFRS 9.B6.5.3].
5.1.2
Hedges of foreign currency monetary items
A foreign currency monetary asset or liability that is hedged using a forward exchange
contract may be treated as a fair value hedge because its fair value will change as foreign
exchange rates change (see 7.1 below). Alternatively, it may be treated as a cash flow hedge
because changes in exchange rates will affect the amount of cash required to settle the
item (as measured by reference to the entity’s functional currency) (see 7.2 below).
4048 Chapter 49
5.2 Cash
flow
hedges
The purpose of a cash flow hedge is to defer the gain or loss on the hedging instrument
to a period or periods in which the hedged expected future cash flows affect profit or
loss. An example of a cash flow hedge is the use of an interest rate swap to change
floating rate debt (whether measured at amortised cost or fair value) to fixed rate debt,
i.e. a hedge of a future transaction where the future cash flows being hedged are the
future interest payments. [IFRS 9.B6.5.2].
As noted at 5.1 above, a hedge of the exposure to changes in the fair value of a fixed rate
debt instrument as a result of changes in interest rates could be treated as a fair value
hedge. This could not be a cash flow hedge because changes in interest rates will not
affect the cash flows on the hedged item, only its fair value.
It is also noted at 7.1 below that a copper forward, say, may be used in a fair value hedge
of copper inventory. Alternatively, the same hedging instrument may qualify as a cash
flow hedge of the highly probable future sale of the inventory. [IAS 39.F.3.6].
The following example from the IAS 39 implementation guidance explains how a
company might lock in current interest rates by way of a cash flow hedge of the
anticipated issuance of fixed rate debt.
Example 49.45: Hedge of anticipated issuance of fixed rate debt
Company R periodically issues new bonds to refinance maturing bonds, provide working capital, and for
various other purposes. When R decides it will be issuing bonds, it sometimes hedges the risk of changes in
long-term interest rates to the date the bonds are issued. If long-term interest rates go up (down), the bond
will be issued either at a higher (lower) rate, with a higher (smaller) discount or with a smaller (higher)
premium than was originally expected. The higher (lower) rate being paid or decrease (increase) in proceeds
is normally offset by the gain (loss) on the hedge.
In August 2019 R decides it will issue £2m seven-year bonds in January 2020. Historical correlation studies
suggest that a seven-year UK treasury bond adequately correlates to the bonds R expects to issue, assuming
a hedge ratio of 0.93 future contracts to one debt unit. Therefore, it hedges the anticipated issuance of the
bonds by selling (‘shorting’) £1.86m worth of futures on seven-year treasury bonds.
From August 2019 to January 2020 interest rates increase and the short futures positions are closed on the
date the bonds are issued. This results in a £120,000 gain, which offsets the increased interest payments on
t
he bonds and, therefore, will affect profit or loss over the life of the bonds. The hedge may qualify as a cash
flow hedge of the interest rate risk on the forecast debt issuance (assuming all other conditions for hedge
accounting are met). [IAS 39.F.2.2].
Similarly, the forecast reinvestment of interest cash flows from a fixed rate asset can be
the subject of a cash flow hedge using, say, a forward rate agreement to lock in the
interest rate that will be received on that reinvestment.
The ongoing accounting for cash flow hedges is described at 7.2 below.
5.2.1 All-in-one
hedges
The implementation guidance of IAS 39 made specific reference to an ‘all in one hedge’,
although none of the IAS 39 implementation guidance on hedge accounting was carried
forward into IFRS 9, much of it remains relevant under IFRS 9 (see 1.3 above).
[IFRS 9.BC6.94-97]. Accordingly the IAS 39 guidance on an ‘all in one hedge’ is discussed
below with respect to application within IFRS 9.
Financial instruments: Hedge accounting 4049
There are situations where an instrument that is accounted for as a derivative is
expected to be settled gross by delivery of the underlying asset in exchange for the
payment of a fixed price. The IAS 39 implementation guidance states that such an
instrument can be designated as the hedging instrument in a cash flow hedge of the
variability of the consideration to be paid or received in the future transaction that
will occur on gross settlement of the derivative contract itself. It is explained that this
is acceptable because there would be an exposure to variability in the purchase or sale
price without the derivative. It is important to note that, in order to qualify for a hedge
of a highly probable forecast transaction, the hedging entity must have the intention
(and the ability) to gross settle the derivative. For example, consider an entity that
enters into a fixed price contract to sell a commodity and that contract is accounted
for as a derivative under IFRS 9 (see Chapter 41 at 4). This might be because the entity
has a practice of settling such contracts net in cash or of taking delivery of the
underlying and selling it within a short period after delivery for the purpose of
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