International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

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  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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