As noted above, by default, the time value will be zero at expiry of an option contract. For
a time-period related hedged item, recognising the fair value changes of the time value in
OCI means that on expiry, the time value that existed at designation will have accumulated
in OCI. For time-period related hedged items, the standard does not prescribe what ‘on a
systematic and rational basis’ means in the context of amortising the time value from OCI
to profit or loss. We believe a straight-line amortisation to be appropriate in most cases.
Example 49.73: Hedging interest rate risk of a bond (time period related) (1)
An entity issues a seven-year floating rate bond and wishes to protect itself against increases in the interest
expense for the first two years. Therefore, the entity purchases an interest rate cap with a maturity of two years.
Financial instruments: Hedge accounting 4111
The terms of the option match all other terms of the floating rate bond. Only the intrinsic value of the cap is
designated as a hedging instrument in a cash flow hedge.
The time value on designation is CU 20, which is amortised to profit or loss on a straight-line basis over the
protection period (i.e. the first two years). The time value of the option amounts to CU 13 at the end of the
first year and zero at maturity.
Applying the IFRS 9 accounting requirements to the time value of the option results in the following
movement within other comprehensive income (OCI), specifically the reserve within equity for accumulating
amounts in relation to the time value of options associated with time-period related hedged items:
Year 1
Year 2
Reserve at beginning of year
–
3
Change in time value of option
(7)
(13)
Amortisation of time value at inception
10
10
Reserve at end of year
3
–
Effect on OCI for the year
3
(3)
Effect on profit or loss for the year
(10)
(10)
The standard is, however, not wholly prescriptive as to where in profit or loss the costs of
hedging accumulated in OCI should be recycled. The distinction between transaction
related hedged items and time-period related hedged items reflects that the accounting for
the time value of the option should follow general IFRS principles for how to account for
payments that are akin to insurance premiums (the ‘insurance premium view’ mentioned
above). So, in making the distinction, an entity needs to consider how the accounting for the
hedged item will eventually affect profit or loss. This would be an accounting policy choice
since the standard is not clear. However, when hedging forecast sales or purchases, one an
acceptable treatment would be presentation within the financial expense/income line item.
If hedge accounting is discontinued for a time-period related hedge relationship for which
the costs of hedging treatment has been applied to the time value of the hedging option,
the net amount (i.e. including cumulative amortisation) that has been accumulated in OCI
must be immediately reclassified to profit or loss. This appears to be the case whether or
not the hedged item is still expected to occur. [IFRS 9.6.5.15(c), BC6.399]. In contrast there is no
equivalent guidance for discontinuation of transaction related hedges when the
transaction is still expected to take place, and so there does not seem to be a need to
reclassify the net amount accumulated in OCI immediately to profit or loss in that
scenario, although this is an area of uncertainty given the standard as drafted.
The accounting for the time value of options would also apply to combinations of
options, for example, when hedging a highly probable forecast transaction with a zero-
cost collar. When designating the intrinsic value only, the volatility resulting from
changes in the time values of the two options would be recognised in other
comprehensive income. However, the amortisation (in the case of time-period related
hedged items) or the transaction costs deferred at the end of the life of the hedging
relationship (for transaction related hedged items) would be nil when using a zero-cost
collar, as the cumulative change in time value over the period would be nil. [IFRS 9.B6.5.31].
7.5.1.A
Aligned time value
Examples 49.72 and 49.73 above both assume that the critical terms of the option match
the hedged item. However, in practice, this is not always the case. The accounting
4112 Chapter 49
treatment described above applies only to the extent the time value relates to the
hedged item. An additional assessment has to be made if the critical terms of the option
do not match the hedged item. For that purpose, the actual time value has to be
compared with that of a hypothetical option that perfectly matches the critical terms of
the hedged item (in IFRS 9 referred to as the ‘aligned time value’). [IFRS 9.B6.5.32].
When the terms of the option are not aligned with the hedged item, the accounting for
the time value in situations in which the aligned time value exceeds the actual time value
is different to situations in which the actual time value exceeds the aligned time value.
[IFRS 9.B6.5.33].
If, at inception, the actual time value exceeds the aligned time value:
• the aligned time value at inception is treated in line with the general requirements
outlined in 7.5.1 above, depending on whether it is a time period or transaction
related hedged item;
• the change in the fair value of the aligned time value is recognised in OCI; and
• the remaining difference in change in fair value between the actual time value and
the aligned time value is recognised in profit or loss.
If, at inception, the aligned time value exceeds the actual time value:
• the actual time value at inception is treated in line with the general requirements
outlined in 7.5.1 above, depending on whether it is a time period or transaction
related hedged item;
• the lower of the cumulative change in the fair value of the actual time value and
the aligned time value is recognised in OCI; and
• the remaining difference in change in fair value between the actual time value and
the aligned time value, if any, is recognised in profit or loss. [IFRS 9.B6.5.33].
For the hedging strategy introduced in Example 49.73 above, this would change the
accounting as follows:
Example 49.74: Hedging interest rate risk of a bond (time period related) (2)
Scenario 1: Actual time value exceeds aligned time value
The actual time value at inception is CU 20. The aligned time value at inception is CU 15.
Year 1
Year 2
Change in actual time value of option
(7)
(13)
Change in aligned time value of option
(6)
(9)
Reserve in equity at beginning of year
–
1.5
Change in time value of option (based on aligned time value)
(6)
(9)
Amortisation of time value at inception (based on aligned time value)
7.5
7.5
Reserve in
equity at end of year
1.5
–
Effect on OCI for the year
1.5
(1.5)
Remaining change in (actual) time value recognised in profit or loss (difference
(1) (4)
between the change in aligned time value and the actual time value of the option)
Effect on profit or loss for the year
(8.5)
(11.5)
The above accounting treats the difference between the actual and the aligned time value, consistent with its
default classification, as a derivative at fair value through profit or loss.
Financial instruments: Hedge accounting 4113
Scenario 2: Actual time value is lower than aligned time value
The actual time value at inception is CU 20. The aligned time value at inception is CU 24.
Year 1
Year 2
Change in actual time value of option
(7)
(13)
Change in aligned time value of option
(14)
(10)
Reserve in equity at beginning of year
–
3
Change in time value of option (based on the lower of the cumulative change in
(7) (13)
aligned time value and actual time value)
Amortisation of time value at inception (based on actual time value)
10
10
Reserve in equity at end of year
3
–
Effect on OCI for the year
3
(3)
Remaining change in (actual) time value recognised in profit or loss (zero, because the
– –
aligned time value of the option exceeds the actual time value of the option at inception)
Effect on profit or loss for the year
(10)
(10)
The above ‘lower of test’ for the accounting of the time value ensures that the entity does not recognise more
expense in profit or loss than the entity actually incurs (based on the time value at inception). [IFRS 9.BC6.398].
In this scenario, over the life of the option the cumulative change in fair value of the actual time value will
always be lower than the cumulative change in fair value of the aligned time value, because the actual time
value was lower at inception of the hedge relationship.
IFRS 9 does not define the ‘aligned time value’ in much detail but it is clear that it is part
of the concept of ‘costs of hedging’. Therefore, regular pricing features, such as dealer
margins, are part of the aligned time value of an option, reflecting that they are part of
the fair value of the financial instrument whose intrinsic value is designated as the
hedging instrument. This is different from using a hypothetical derivative, which has the
purpose of measuring the hedged item. For that purpose, features that are only in the
hedging instrument but not the hedged item cannot be taken into account, whereas the
same rationale does not apply for the purpose of accounting for the costs of hedging.
This becomes clearer from the example of the foreign currency basis spread (see 7.5.3
below); it cannot be included as part of a hypothetical derivative to measure the hedged
item but it is a cost of hedging.
However, similar to the need to update a hypothetical derivative to reflect changes in
the timing of a forecast hedged item (see 7.4.4.A above), if expectations of the forecast
transaction are revised, the terms of the ‘aligned’ instrument will need to be updated to
reflect the change in timing. The updated aligned instrument should match all of the
critical terms of the forecast transaction, as if the amended terms were known at
inception of the hedge. A true up to the costs of hedging reserve and associated profit
or loss for the cumulative effect of the revised aligned time value will be required.
7.5.2
Forward element of forward contracts
Entities using foreign currency forward contracts in hedging relationships can designate
the instrument in its entirety or exclude the forward element by designating the spot
element only. Similar to the optional treatment for the accounting for time value of
options, when only the spot element is designated, an entity has a choice to apply costs
of hedging accounting to the excluded forward element. This is, however, not an
accounting policy choice, but an election for each designation. [IFRS 9.6.5.16]. If the costs
4114 Chapter 49
of hedging guidance is not applied, designating the spot element of a forward contract
results in the forward points (often also called the ‘forward element’) being accounted
for at fair value through profit or loss (see 3.6.5 above).
When designating the entire hedging instrument, it is usually desirable for the hedged
item also to be measured at the forward rate instead of the spot rate in order to enhance
effectiveness. For example, when hedging a highly probable forecast transaction, the
hedged item, once transacted, could be measured with respect to the forward rate if the
‘forward rate method’ is designated (see 7.4.5 above). However, IAS 21 requires
monetary financial assets and liabilities denominated in a foreign currency to be
measured at the spot rate. As a result, the forward rate method does not provide a similar
solution for hedges of such monetary items because of the IAS 21 requirement for such
assets and liabilities to be measured at the spot rate. [IFRS 9.BC6.422]. Some assistance is
provided in the implementation guidance of IAS 39 as to how the spot and forward
elements of a simple forward contract can be identified (see also Example 49.68
at 7.4.4.E above). [IAS 39.F.5.6]. This guidance remains relevant under IFRS 9.
When designating the spot element and applying the costs of hedging to the forward element,
the change in fair value of the forward element is recognised in other comprehensive income
(OCI) and accumulated in a separate component of equity. The accounting for the forward
element that exists at inception also follows the distinction between transaction related
hedged items and time-period related hedged items that is made when accounting for the
time value of an option (see at 7.5.1 above). This means, in the case of a transaction related
hedged item, that the change in the fair value of the forward element is deferred in OCI and
included, like transaction costs, in the measurement of the hedged item (or it is reclassified
to profit or loss when a hedged sale occurs). In case of a time-period related hedged item, the
forward element that exists at inception is amortised from the separate component of equity
to profit or loss on a rational basis. [IFRS 9.6.5.16, B6.5.34-36].
As a result of the above accounting, fluctuations in the fair value of the forward element
over time will affect other comprehensive income, and the amount accumulated in OCI
will be recognised in profit or loss when the hedged item affects profit or loss (in case
of a transaction related hedged item), or be amortised to profit or loss (in case of a time-
period related hedged item). The following example is designed to demonstrate the
accounting for the forward element of a hedging derivative, as a cost of hedging. The
fact pattern is intentionally simplified in order to isolate the costs of hedging accounting.
Example 49.75: Funding swaps – designating th
e spot risk only
A bank, having the Singapore Dollar (SGD) as its functional currency, borrows money by entering into a two-
year zero coupon loan denominated in Japanese Yen (JPY). The bank transfers the JPY funds into its functional
currency and lends the money as a SGD denominated two-year zero coupon loan. To hedge the SGD/JPY
exchange risk, the bank enters into a foreign exchange forward contract to buy JPY against SGD in two years’
time and designates it as a hedge of the spot JPY foreign exchange risk. The fair value of the forward element at
inception is SGD 20,000 and it is SGD 13,000 at the end of the first year and zero at maturity.
From an economic standpoint, the bank has now hedged the foreign exchange risk and locked in the interest
margin for the entire two-year period.
In economic theory, the forward points represent the difference in interest rates between the two currencies
involved. Hence, the forward element that exists at inception is seen as one element of the interest margin
(however, see also 7.5.3 below).
Financial instruments: Hedge accounting 4115
Applying the accounting for costs of hedging to the forward element of the forward contract results in the
following movement within other comprehensive income (OCI):
(All amounts in SGD thousands)
Year 1
Year 2
Reserve in equity at beginning of year
–
3
Change in fair value of forward element
(7)
(13)
Amortisation of forward element at inception
10
10
Reserve in equity at end of year
3
–
Effect on OCI for the year
3
(3)
Effect on profit or loss for the year
(10)
(10)
The bank could present the amortisation of the forward element in the income statement within the interest
margin, together with the interest income from the loan and the interest expense from the borrowing, showing
the economically fixed interest margin in SGD of the transaction.
The forward element costs of hedging treatment is not solely applicable for simple
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 815
