generating a profit from short-term fluctuations in price or dealer’s margin. In this
case, the fixed price contract may be designated as a cash flow hedge of the variability
of the consideration to be received on the sale of the asset (a future transaction) even
though the fixed price contract is the contract under which the asset will be sold.
[IAS 39.F.2.5].
Similarly, an entity may enter into a forward contract to purchase a debt instrument
(which will not be classified at fair value through profit or loss) that will be settled
by delivery of the debt instrument, but the forward contract is a derivative. This will
be the case if its term exceeds the regular way delivery period in the marketplace
(see Chapter 45 at 2.2). In this case the forward may be designated as a cash flow
hedge of the variability of the consideration to be paid to acquire the debt
instrument (a future transaction), even though the derivative is the contract under
which the debt instrument will be acquired. [IAS 39.F.2.5]. If the forecast debt
instrument was to be classified at fair value through profit or loss, the all-in-one
hedge strategy could not be applied as cash flow hedging of a forecast transactions
that will be accounted for at fair value through profit or loss on initial recognition is
precluded (see 2.6.2 above).
5.2.2
Hedges of firm commitments
A hedge of the foreign currency risk of a firm commitment may be accounted for as a cash
flow hedge or a fair value hedge (see 5.1.1 above). [IFRS 9.B6.5.3]. This is because foreign
currency risk affects both the cash flows and the fair value of the hedged item. Accordingly,
a foreign currency cash flow hedge of a forecast transaction need not be redesignated as a
fair value hedge when the forecast transaction becomes a firm commitment.
5.2.3
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. 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 7.2.3 below).
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5.3
Hedges of net investments in foreign operations
Many reporting entities have investments in foreign operations which may be
subsidiaries, associates, joint ventures or branches. As set out in Chapter 15 at 4, IAS 21
requires an entity to determine the functional currency of each of its foreign operations
as the currency of the primary economic environment of that operation. When
translating the results and financial position of its foreign operation into a presentation
currency, it should recognise foreign exchange differences in other comprehensive
income until disposal of the foreign operation. [IFRIC 16.1].
From the perspective of an investor (e.g. a parent) it is clear that an investment in a
foreign operation is likely to give rise to a degree of foreign currency exchange rate
risk and an entity with many foreign operations may be exposed to a number of
foreign currency risks. [IFRIC 16.4]. Whilst equity method investments and investments
in consolidated subsidiaries cannot be hedged items in a fair value hedge because
changes in the investments’ fair value are not recognised in profit or loss, they may be
designated in a net investment hedge relationship. A hedge of a net investment in a
foreign operation is said to be different because it is a hedge of the foreign currency
exposure, not a fair value hedge of the change in the value of the investment.
[IFRS 9.B6.3.2].
Conceptually, net investment hedging is somewhat unsatisfactory, as it mixes foreign
currency translation risk (largely an accounting exposure) with transactional risk
(much more an economic exposure). IFRIC 16 addresses the question of what does
and does not constitute a valid hedging relationship, a topic on which IFRS 9 provides
very little guidance.
IFRIC 16 applies to any entity that hedges the foreign currency risk arising from its net
investments in foreign operations and wishes to qualify for hedge accounting in
accordance with IFRS 9. [IFRIC 16.7]. It only applies to those hedges and should not be
applied by analogy to other types of hedge accounting. [IFRIC 16.8]. For the avoidance of
doubt, IFRIC 16 explains that such a hedge can be applied only when the net assets of
that foreign operation are included in the financial statements. This will be the case for
consolidated financial statements, financial statements in which investments such as
associates or joint ventures are accounted for using the equity method or those that
include a branch or a joint operation (as defined in IFRS 11 – Joint Arrangements).
[IFRIC 16.2]. For convenience, IFRIC 16 refers to such an entity as a parent entity and to
the financial statements in which the net assets of foreign operations are included as
consolidated financial statements and this section follows this convention.
Investments in foreign operations may be held directly by a parent entity or indirectly
by its subsidiary or subsidiaries (see 5.3.1 below). [IFRIC 16.12].
The requirements of IFRIC 16 are discussed in more detail at 5.3.1 to 5.3.4 below and, in
the case of accounting for such a hedge, at 7.3 below.
Financial instruments: Hedge accounting 4051
5.3.1
Nature of the hedged risk
Perhaps the most important decision made by the Interpretations Committee was that
hedge accounting may be applied only to the foreign exchange differences arising
between the functional currency of the foreign operation and the parent entity’s
functional currency. [IFRIC 16.10]. Furthermore, the hedged risk may be designated as the
foreign currency exposure arising between the functional currency of the foreign
operation and the functional currency of any parent entity (the immediate, intermediate
or ultimate parent entity) of that foreign operation. The fact that the net investment may
be held through an intermediate parent does not affect the nature of the economic risk
arising from the foreign currency exposure to the ultimate parent entity. [IFRIC 16.12]. This
principle is illustrated in the following example.
Example 49.46: Nature of the hedged risk in a net investment hedge
Company P is the ultimate parent entity of a group and presents its consolidated financial statements in its functional
currency of euro. It has two direct wholly owned subsidiaries, Company A whose functional currency is Japanese
yen and Company B whose functional currency is sterling. B has a wholly owned subsidiary, Company C, whose
functional currency is US dollars. P’s net investment in A is ¥400,000 million which includes A’s external
borrowings of US$300 million. P’s net investment in B is £500 million including the equivalent of £159 million
representing B’s net investment in C of US$300 million. This corporate structure is illustrated as follows:
P (€)
¥ 400,000 million
£500 million
A (¥)
B (£)
US$300 million
(£159 mil
lion equivalent)
C (US$)
P, in its consolidated financial statements, could hedge its net investment in each of A, B and C for the foreign
exchange risk between their functional currencies (Japanese yen, sterling and US dollars respectively) and
euro. P could, as an alternative to hedging P’s investment in C, hedge the foreign exchange risk between the
functional currencies of B (sterling) and C (US dollars).
In its consolidated financial statements, B could hedge its net investment in C for the foreign exchange risk
between C’s functional currency (US dollars) and its own (sterling). [IFRIC 16.AG1-AG3].
Where a non-derivative instrument is used as the hedging instrument, the designated
risk should be the spot foreign exchange risk; if the hedging instruments were forward
contracts, the forward or the spot foreign exchange risk could be designated as the
hedged risk (see 7.3.3 below). [IFRIC 16.AG2].
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5.3.2
Amount of the hedged item for which a hedging relationship may be
designated
The hedged item can be an amount of net assets equal to or less than the carrying
amount of the net assets of the foreign operation in the consolidated financial
statements of the parent entity. [IFRIC 16.11].
Example 49.47: Amount of hedged item in a net investment hedge
The facts are as in Example 49.46 above. If P wished to hedge the foreign exchange risk from its net
investment in C, it could use A’s external borrowing of US$300 million as a hedging instrument and the
hedged item could be an amount of net assets equal to or less than the US$300 million carrying amount of C
in P’s consolidated financial statements. [IFRIC 16.AG4].
The carrying amount of the net investment takes account of monetary items receivable
from or payable to a foreign operation for which settlement is neither planned nor likely
to occur in the future. Under IAS 21 these balances are considered to be, in substance,
part of the reporting entity’s net investment in the foreign operation. In the case of a
loan made to the foreign operation this will increase the amount that can be hedged; if
a loan is made by the foreign operation, the amount that can be hedged will be reduced.
[IFRIC 16.AG14].
In many cases the full economic value of a net investment will not be recognised in the
financial statements. The most common reason will be the existence of, say, goodwill
or intangible assets that are either not recognised or measured at an amount below their
current value. In these situations, if an investor hedges the entire economic value of its
net investment it will not be able to obtain hedge accounting for the proportion of the
hedging instrument that exceeds the recognised net assets.
A single hedging instrument can hedge the same designated risk only once.
Consequently, in Examples 49.46 and 49.47 above, P could not in its consolidated
financial statements designate A’s external borrowing in a hedge of both the €/US$ spot
foreign exchange risk and the £/US$ spot foreign exchange risk in respect of its net
investment in C. [IFRIC 16.AG6].
The carrying amount of the net assets of a foreign operation that may be designated as
the hedged item in the consolidated financial statements of a parent depends on
whether any lower level parent of the foreign operation has applied hedge accounting
for all or part of the net assets of that foreign operation and whether that accounting has
been maintained in the parent’s consolidated financial statements. [IFRIC 16.11]. An
exposure to foreign currency risk arising from a net investment in a foreign operation
may qualify for hedge accounting only once in the consolidated financial statements.
Therefore, if the same net assets of a foreign operation are hedged by more than one
parent entity within the group (for example, both a direct and an indirect parent entity)
for the same risk, only one hedging relationship will qualify for hedge accounting in the
consolidated financial statements of the ultimate parent. [IFRIC 16.13]. This is illustrated in
the following example.
Example 49.48: Amount of hedged item in a net investment hedge (different
hedged risks)
The facts are the same as in Examples 49.46 and 49.47 above except that P’s net assets include £500 million
and US$300 million of external borrowings. If P wished to hedge the foreign exchange risk in relation to its
Financial instruments: Hedge accounting 4053
net investments in B and C, the designations it could make in its consolidated financial statements include
the following: [IFRIC 16.AG10]
• US$300 million of the US dollar borrowings designated as a hedge of the net investment in C with the
risk being the spot foreign exchange exposure (€/US$) between P and C and up to £341 million of the
sterling borrowings designated as a hedge of the net investment in B with the risk being the spot foreign
exchange exposure (€/£) between P and B; or
• US$300 million of the US dollar borrowings as a hedge of the net investment in C with the risk being
the spot foreign exchange exposure (£/US$) between B and C and up to £500 million of the sterling
borrowings designated as a hedge of the net investment in B with the risk being the spot foreign exchange
exposure (€/£) between P and B.
The €/US$ risk from P’s net investment in C is a different risk from the €/£ risk from P’s net investment in B.
However, in the first case described above, P would have already fully hedged the €/US$ risk from its net
investment in C and if P also designated its £500 million of borrowings as a hedge of its net investment in B,
£159 million of that net investment, representing the sterling equivalent of its US dollar net investment in C,
would be hedged twice for £/€ risk in P’s consolidated financial statements. [IFRIC 16.AG11]. The £341 million
that may be designated is just £500 million less £159 million.
In the second case described above, because the designation of the US$/£ risk between B and C does not
include the £/€ risk, P is also able to designate up to £500 million of its net investment in B with the risk
being the spot foreign exchange exposure (£/€) between P and B. [IFRIC 16.AG12].
A hedging relationship designated by one parent entity in its consolidated financial
statements need not be maintained by another higher level parent entity. However, if it
is not maintained by the higher level parent entity, the hedge accounting applied by the
lower level parent must be reversed before the higher level parent’s hedge accounting
is recognised. [IFRIC 16.13]. This is illustrated in the following example.
Example 49.49: Hedge accounting applied by intermediate parent
The facts are the same as in Examples 49.46 and 49.47 above, except that P’s net assets include £500 million of
external borrowings and B’s net assets of £341 million include US$300 million of external borrowings which it
designates as a hedge of the £/US$ risk of its net investment in C in its own consolidated financial statements.
P could maintain B’s designation of that hedging instrument as a hedge of its net investment in C for the
£/US$ risk and P could designate its £500 million external borrowings as a hedge of its entire net investment
in B. The first hedge, designated by B, would be assessed
by reference to B’s functional currency (sterling)
and the second hedge, designated by P, would be assessed by reference to P’s functional currency (euro). In
this case, only the £/US$ risk from P’s net investment in C has been hedged in its consolidated financial
statements by B’s US dollar borrowings, not the entire €/US$ risk. Therefore, the entire €/£ risk from P’s net
investment in B may be hedged in P’s consolidated financial statements. [IFRIC 16.AG13].
Alternatively, P could reverse the hedging relationship designated by B. In this case, it could designate B’s
US$300 million external borrowing as a hedge of its net investment in C for the €/US$ risk and designate
£341 million of its borrowings as a hedge of part of the net investment in B. In this case the effectiveness of
both hedges would be computed by reference to P’s functional currency (euro). Consequently, both the US$/£
and £/€ changes in value of B’s US$300 million borrowing would be included in P’s foreign currency
translation reserve. Because P has already fully hedged the €/US$ risk from its net investment in C, it could
hedge only up to £341 million for the €/GBP risk of its net investment in B. [IFRIC 16.AG15].
5.3.3
Where the hedging instrument can be held
The hedging instrument(s) may be held by any entity or entities within the group,
including the foreign operation being hedged, provided the designation, documentation
and qualification criteria of IFRS 9 are satisfied. The hedging strategy of the group
should be clearly documented because of the possibility of different designations at
different levels of the group (see 5.3.2 above). [IFRIC 16.14, BC24A, BC24B].
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Where the entity holding the hedging instrument has a functional currency that is not
the same as the parent by which the hedged risk is defined, this could result in the
recognition of ineffectiveness in profit or loss – this is discussed further at 7.3.1 below.
Clearly the reporting entity (which, in the case of consolidated financial statements,
includes any subsidiary consolidated by the parent) must be a party to the hedging
instrument. In Examples 49.44 and 49.45 above, therefore, B could not apply hedge
accounting in its consolidated financial statements in respect of a hedge involving the
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 802
