To record the settlement of the forward contract at its fair value.
€
€
Machine 950
Cash 950
To record the settlement of the firm commitment at the contracted price of US$1,000 at the spot rate of US$1:€0.95.
€
€
Other comprehensive income
50
Machine 50
To remove the gain recognised in other comprehensive income and adjust the carrying amount of the machine
that results from the hedged transaction by this amount.
In summary, the result of these accounting entries is as follows:
€
€
Machine 900
Cash 900
which again reflects the starting presumption, i.e. that X had effectively fixed the purchase price of its
machine at €900.
Financial instruments: Hedge accounting 4079
In applying treatment (b) above to hedged items that are not forecast transactions that
subsequently result in the recognition of a non-financial asset or liability, or a hedged
forecast transaction for a non-financial asset or liability becomes a firm commitment for
which fair value hedge accounting is applied, an appropriate reclassification method
must be applied. When instruments such as conventional interest rate swaps are used
as a hedging instrument in a cash flow hedge, it is common for entities to recognise net
interest income or expense on the hedging instrument directly in profit or loss on an
accruals basis. Other changes in fair value of the hedging instrument (i.e. the ‘clean value’
– excluding accrued interest) are recognised in other comprehensive income, subject
to the ‘lower of’ requirements (see 7.2.1 above). Such an approach avoids the need to
reclassify from cash flow hedge reserve to profit or loss the net interest as the hedged
item impacts profit or loss. However, care must be taken to ensure the portion of the
gain or loss on the hedging instrument that is recognised in the cash flow hedge reserve
appropriately excludes ineffectiveness, which should be recognised in profit or loss.
The hedging derivative would still be recognised in the statement of financial position
at the full fair value.
Although not clearly evident from the standard, we believe the reclassification from
cash flow hedge reserve to profit or loss should be recognised in the same line item in
profit or loss as the hedged transaction to reflect the offsetting effect of hedge
accounting (see Chapter 50 at 7.1.3).
If a hedge of a foreign currency forecast intragroup transaction qualifies for hedge
accounting (see 4.3.2 above), any gain or loss that is recognised in other comprehensive
income should be reclassified from cash flow hedge reserve to profit or loss in the same
period(s) during which the foreign currency risk of the hedged transaction affects
consolidated profit or loss. [IFRS 9.6.3.6].
7.2.3
Recycling for a hedge of foreign currency monetary items
It was stated at 5.2.3 above that using a forward exchange contract to hedge a foreign
currency payable or receivable could be treated either as a fair value hedge, or a cash flow
hedge. In a fair value hedge, the gain or loss on remeasurement of both the forward
contract and the hedged item are recognised immediately in profit or loss. Even if the
forward foreign currency risk was the designated hedged risk, then ineffectiveness would
arise from changes in the forward points, as the retranslation of the foreign currency
payable or receivable is restricted to the IAS 21 spot revaluation (see 7.4.5 below).
However, in a cash flow hedge of the forward foreign currency risk, the cumulative gain
or loss on remeasuring the forward contract is recognised in the cash flow hedge reserve
(assuming no sources of ineffectiveness) and reclassified from the cash flow hedge
reserve to profit or loss when the payable or receivable affects profit or loss (see 7.2.2
above). Because the payable or receivable is remeasured continuously in respect of
changes in foreign exchange rates per IAS 21, there is a requirement for the gain or loss
on the forward contract to be reclassified from the cash flow hedge reserve to profit or
loss as the payable or receivable is remeasured, not when the payment occurs. There is
variation in practice as to the method used to facilitate the reclassification over the
period the payable or receivable affects profit or loss.
4080 Chapter 49
The forward element of a forward contract may be excluded from the designated hedge
relationship (designation of the spot exchange risk only – see 3.6.5 above). In that case
any fair value changes attributable to the forward element would be recognised in other
comprehensive income (see 7.5.2 below). [IFRS 9.B6.5.36].
Designating the forward exchange rate or the spot exchange rate as the hedged risk
could result in different results as illustrated in Example 49.68 at 7.4.4.E below.
7.2.4
Cash flow hedges within subsidiaries on acquisition or disposal
Where a reporting entity acquires a subsidiary that is applying cash flow hedge
accounting, additional considerations arise. In applying the purchase method of
accounting in its consolidated financial statements, the reporting entity does not inherit
the subsidiary’s existing cash flow hedge reserve, since this clearly represents
cumulative pre-acquisition gains and losses.9 This has implications for the assessment
of hedge effectiveness and the measurement of ineffectiveness because, so far as the
group is concerned, it has effectively started a new hedge relationship with a hedging
instrument that is likely to have a non-zero fair value (see 6.3.1 above and 7.4.4.B below).
The standard does not address the situation when a subsidiary is disposed of. In November
2016, the Interpretations Committee discussed the issue of whether a group should
discontinue hedge accounting in the consolidated financial statements where the group
applies cash flow hedge accounting to forecast transactions that are anticipated in a
subsidiary after the expected date of disposal of that subsidiary. The Interpretations
Committee were of the tentative view that the assessment of a qualifying hedging
relationship should be performed from the group’s perspective based on whether the
transaction is highly probable and could affect the group’s profit or loss. Given that the
forecast transactions are expected to occur only after the expected date of disposal of the
subsidiary, these transactions are no longer expected to occur from the group’s perspective
as soon as the subsidiary is classified as held for sale. According to the Interpretation
Committee’s tentative view the forecast transactions would no longer be eligible hedged
items and the group would discontinue hedge accounting from the date the subsidiary is
classified as held for sale.10 The Interpretations Committee suggested that outreach would
be helpful to understand if diverse accounting is currently applied in practice. If the
Interpretation Committee’s view is confirmed, existing accounting policies may need to be
changed retrospectively, although this has still not happened at the time of writing.
7.3
Accounting for hedges of a net investment in a foreign operation
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Hedges of a net investment in a foreign operation (see 5.3 above), including a hedge of
a monetary item that is accounted for as part of the net investment (see Chapter 15
at 6.3.1), shall be accounted for similarly to cash flow hedges:
• the portion of the gain or loss on the hedging instrument that is determined to be an
effective hedge should be recognised in other comprehensive income and (as clarified
by IFRIC 16) included with the foreign exchange differences arising on translation of
the results and financial position of the foreign operation; [IFRIC 16.3] and
• the ineffective portion should be recognised in profit or loss. [IFRS 9.6.5.13].
The cumulative gain or loss on the hedging instrument relating to the effective portion
of the hedge that has been accumulated in the foreign currency translation reserve shall
Financial instruments: Hedge accounting 4081
be reclassified from equity to profit or loss as a reclassification adjustment on disposal
or, in certain circumstances, partial disposal of the foreign operation in accordance with
IAS 21 (see Chapter 15 at 6.6). [IFRS 9.6.5.14].
The meaning of ‘similarly to cash flow hedges’ is not immediately clear, and has been the
subject of some debate. It is readily understood that the portion of the gain or loss on the
hedging derivative that is determined to be an effective hedge should be recognised in
other comprehensive income (as it would for a cash flow hedge). However, the wording
in the standard also seems to indicate that ineffectiveness should be measured in the same
way as for cash flow hedges, i.e. no ineffectiveness is recognised in profit or loss if the gain
or loss on the hedging instrument is less, in absolute terms, than the gain or loss on the
hedged item, (see 7.2.1 above). This is despite the fact that there appears to be no good
reason why ineffectiveness should not also be recognised in profit or loss if the gain or
loss on the hedging instrument is less, in absolute terms, than the gain or loss on the hedged
item. This is different to the accounting for net investment hedges under US GAAP,11 for
which it is clear that ineffectiveness should be recognised in profit or loss for under-
hedges as well as over-hedges.
In its March 2016 meeting, the Interpretations Committee discussed this issue. The
Interpretations Committee concluded that the guidance in IFRS 9 is sufficiently clear
and would require an entity to apply the lower of test for net investment hedges. One
of the arguments put forward was that the application of the lower of test in determining
the effective portion of the gains or losses arising from the hedging instrument when
accounting for net investment hedges, avoids the recycling of exchange differences
arising from the hedged item that have been recognised in other comprehensive income
before the disposal of the foreign operation. Such an outcome would be consistent with
the requirements of IAS 21.12
Whilst the above accounting may appear relatively straight forward at first
consideration, a number of additional complexities arise in the accounting for net
investment hedges. The complexity is largely driven by the requirement to apply
guidance written for a cash flow hedge to a situation where no cash flow arises, and the
accounting for net investments in foreign operations within complex groups. These are
further considered in the following sections.
7.3.1
Identifying the effective portion in a net investment hedge
In accounting for a hedge of a net investment, IFRS 9 requires that the portion of the gain
or loss on the hedging instrument that is determined to be an effective hedge should be
recognised in other comprehensive income. [IFRS 9.6.5.13]. IFRIC 16 provides some helpful
guidance in calculating the effective portion of the gain or loss on the hedging instrument.
As set out at 3.3.1 above, IFRIC 16 explains that the hedged risk in a net investment
hedge is defined by reference to the functional currency of a parent of the foreign
operation that is the subject of the hedge. The cumulative gain or loss on the hedging
instrument that is determined to be effective is the change in value of the hedging
instrument in respect of foreign exchange risk, this should be computed by reference to
the functional currency of this parent entity. [IFRIC 16.15, 16].
Depending on where the hedging instrument is held, in the absence of hedge
accounting the total change in its value might be recognised in profit or loss, in other
4082 Chapter 49
comprehensive income, or both. The interpretation states that the calculation of the
effective portion should not be affected by where the change in value of the hedging
instrument would be recognised. In applying hedge accounting, the total effective
portion of the change should be included in other comprehensive income.
[IFRIC 16.15, 16].
Example 49.63: Identification of the effective portion in a net investment hedge (1)
Consider the situation outlined in Example 49.46 above (see 5.3.1 above). In addition, A’s borrowings were
designated in a hedge of the €/US$ spot risk associated with P’s net investment in C. In the absence of hedge
accounting, the total US$/€ foreign exchange difference on A’s US$300 million external borrowing would
be recognised in P’s consolidated financial statements as follows: [IFRIC 16.AG5]
• US$/¥ spot foreign exchange rate change, translated to euro, in profit or loss; and
• ¥/€ spot foreign exchange rate change in other comprehensive income.
The fact that gain or loss on the hedging instrument is split between profit or loss and OCI does not affect the
calculation of the effective portion in applying paragraph 6.5.13 of IFRS 9.
The cumulative gain or loss on the hedging instrument that is determined to be effective is computed by
reference to the functional currency of P, the hedging parent, which is euro. [IFRIC 16.15, 16]. Hence all of the
€/US$ foreign exchange difference on A’s US$300 million external borrowing would, after the application
of hedge accounting, be recognised in other comprehensive income and be included in the foreign currency
translation reserve relating to C.
The guidance says this is because the change in value of both the hedging instrument and the hedged item are
computed by reference to the functional currency of P (euro) against the functional currency of C (US dollars).
[IFRIC 16.AG4, AG7].
Example 49.64: Identification of the effective portion in a net investment hedge (2)
Using the same fact pattern as in Example 49.63 above, but if A’s US$300 million external borrowing was
designated as a hedge of the £/US$ spot foreign exchange risk between C and B, the guidance states that the
total US$/€ foreign exchange difference on A’s borrowing would instead be recognised in P’s consolidated
financial statements as follows:
• the £/US$ spot foreign exchange rate change (the effective portion of the hedging instrument) in
the foreign currency translation reserve relating to C;
• £/¥ spot foreign exchange rate change, translated to euro, in profit or loss; and
• ¥/€ spot foreign exchange rate change in other comprehensive income. [IFRIC 16.AG5].
Finally, the interpretation states that if P held the US$ denominated borrowings and designated them in a
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hedge of the spot foreign exchange exposure (£/US$) between B and C, only the £/US$ part of the change in
the value of the borrowings (the effective portion of the hedging instrument) would be included in P’s foreign
currency translation reserve relating to C. The remainder of the change (equivalent to the £/€ change on
£159 million) would be included in P’s consolidated profit or loss. [IFRIC 16.AG12].
The calculation of the effective portion is not affected by whether the hedging
instrument is a derivative or a non-derivative instrument or by the method of
consolidation. [IFRIC 16.15, AG7].
7.3.2 Non-derivative
liabilities
hedging a net investment
A foreign currency denominated non-derivative financial liability, such as a borrowing,
can be used as the hedging instrument in a hedge of a net investment in a foreign
operation (see 3.3.1 above). [IFRIC 16.14]. This can be seen as purely an ‘accounting’ hedge,
i.e. the retranslation gain or loss on the borrowing (an accounting entry representing a
part of its change in fair value that is accounted for on a continuous basis) can offset the
Financial instruments: Hedge accounting 4083
retranslation gain or loss on the net investment (another accounting entry). In fact, if the
liability is:
• denominated in the same currency as the functional currency of the hedged net
investment;
• held by an entity with the same functional currency as the parent by which the
hedged risk is defined;
• has an amortised cost that is lower than the net investment in the foreign operation; and
• is designated appropriately,
the hedge is likely to be perfectly effective in terms of the offsetting retranslation gains
and losses on the liability and the hedged proportion of the net investment.
If a borrowing or similar liability is denominated in a different currency to the functional
currency of the net investment, it may still be possible to designate it as the hedging
instrument. However, it will need to be demonstrated that the two currencies are
sufficiently correlated so that the hedging instrument is expected to result in offsetting
gains and losses over the period that the hedge is designated. This might be the case if the
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