of a new hedging relationship. Alternatively, the entity may be able to designate the base rate swap as hedging
the aggregated exposure of the base rate floating rate loan and pay LIBOR interest rate swap (see 2.7 above).
Fact pattern 3
An entity with US dollars as its functional currency designated a fix rate loan denominated in EUR and a US
dollars /Euro forward exchange contract in a cash flow hedge. Subsequently, the borrower suffers significant
financial difficulties and the entity only expects to receive 90% of the contractual cash flows on the loan.
The entity cannot apply rebalancing because the changes in the cash flows of the hedged item are not caused
by basis risk but by credit risk. Instead, the entity is required to assess whether credit risk dominates the fair
value changes of the hedged item in which case the hedging relationship needs to be discontinued (see 8.1
above). The entity might, however, simply adjust the amount of the hedging instrument to reflect the reduced
volume of the hedged risk and treat this as a partial dedesignation (see 8.3 below).
Fact pattern 4
An airline with a functional currency of Swiss francs enters into a firm commitment to purchase ten new wide-
bodied airplanes in two years’ time. The contract to purchase those airplanes is denominated in US dollars and
the airline enters into a forward exchange contract to hedge the foreign currency exposure. There is no embedded
foreign currency derivative to bifurcate, as sales of wide-bodied aircrafts appear to be routinely denominated in
US dollars around the world (see Chapter 42 at 5.2.1.B). The airline designates the firm commitment and the
derivative in a fair value hedge. Six months into the contract, the aircraft manufacturer informs the airline that it
has suffered significant delays in production and that the aircrafts will not be delivered in two years as originally
planned but in three years. Payment is due when the airplanes are delivered.
The delay in payment may result in some ineffectiveness as the forward exchange and discounting rates for
two years and three years are likely to be different. However, the airline could not avoid this ineffectiveness
by rebalancing, because the ineffectiveness is caused by the timing difference and not basis risk that was
present in the original designation.
8.2.2
Requirement to rebalance
Whether an entity is required to rebalance a hedging relationship is first and foremost a
matter of fact, which is, whether the hedge ratio has changed for risk management
purposes. An entity has to rebalance a hedging relationship if that relationship has an
unchanged risk management objective but no longer meets the hedge effectiveness
requirements regarding the hedge ratio. This will, in effect, be the case if the hedge ratio
is no longer the one that is actually used for risk management (see 6.4.3 above).
[IFRS 9.6.5.5].
However, consistent with initial designation, the hedge ratio used for hedge accounting
purposes may have to differ from the hedge ratio used for risk management if the latter
would result in ineffectiveness that could result in an accounting outcome that would
be inconsistent with the purpose of hedge accounting (see 6.4.3 above). [IFRS 9.B6.5.14].
The guidance in IFRS 9 clarifies that an accounting outcome that would be inconsistent
with the purpose of hedge accounting as the result of failing to adjust the hedge ratio for
risk management purposes, would not meet the qualifying criteria for hedge accounting.
4126 Chapter 49
This simply means that the qualifying criteria treat inappropriate hedge ratios in the
same way, irrespective of whether they were achieved by acting (inappropriate
designation) or failure to act (by not adjusting a designation that has become
inappropriate). [IFRS 9.B6.5.13].
IFRS 9 also clarifies that not every change in the extent of offset between the hedging
instrument and the hedged item constitutes a change in the relationship that requires
rebalancing. For example, hedge ineffectiveness arising from a fluctuation around an
otherwise valid hedge ratio cannot be reduced by adjusting the hedge ratio.
[IFRS 9.B6.5.11, B6.5.12]. A trend in the amount of ineffectiveness on the other hand might suggest
that retaining the hedge ratio would result in increased ineffectiveness going forward.
Accordingly, in order to continue to apply hedge accounting, an entity must rebalance the
hedge ratio if required for accounting purposes as part of the prospective effectiveness
assessment. IFRS 9 acknowledges that such an assessment is usually inherent in effective
risk management monitoring, and so in many cases existing risk management process may
be sufficient to determine whether accounting rebalancing is required or not. [IFRS 9.BC6.301].
IFRS 9 does not specify the nature of the assessment to determine if rebalancing is
required. Therefore, the nature of the assessment requires judgement based on the facts
and circumstances of the hedge relationship. For example, a hedge involving two
underlyings with correlation that has been historically volatile would likely require
more robust analysis than two underlyings that have shown consistent correlation over
many years. As another example, a relationship that has been under-hedging for four
consecutive quarters would likely require more robust analysis than a relationship
constantly moving to and from an over- and under-hedge position.
Regardless of the chosen assessment methodology, it is clear that rebalancing is not a
mathematical optimization exercise. Accordingly hedges are not required to be
perfectly effective, but judgement will be required to determine if rebalancing is
necessary or not. [IFRS 9.BC6.310]. Therefore at each reporting date entities should
document the work performed to determine whether rebalancing is necessary or not,
and any judgements made.
8.2.3 Mechanics
of
rebalancing
Rebalancing is accounted for as a continuation of the hedging relationship. On
rebalancing, any hedge ineffectiveness arising from the hedging relationship is determined
and recognised immediately before adjusting the hedging relationship. [IFRS 9.B6.5.8].
Once any hedge ineffectiveness has been recognised, rebalancing can be achieved by:
• increasing the volume of the hedged item;
• increasing the volume of the hedging instrument;
• decreasing the volume of the hedged item; or
• decreasing the volume of the hedging instrument. [IFRS 9.B6.5.16].
Decreasing the volume of the hedging instrument or hedged item does not mean that
the respective transactions or items no longer exist or are no longer expected to occur.
As demonstrated in Examples 49.78 and 49.79 below, rebalancing only changes what is
designated in the particular hedging relationship.
Financial instruments: Hedge accounting 4127
Example 49.79: Rebalancing the hedge ratio by decreasing the volume of the
hedging instrument
1 January
An entity expects to purchase 1m barrels of West Texas Intermediate (WTI) crude oil in 12 months. The
entity designates a futures contract of 1.05m barrels of Brent crude oil in a cash flow hedge to hedge the
highly probable forecast purchase of 1m barrels of WTI crude oil (hedge ratio of 1.05:1). This hedge ratio is
/> consistent with risk management, and is not designed to result in an accounting outcome that would be
inconsistent with the purpose of hedge accounting.
30 June
At 30 June, the cumulative change in the value of the hedged item is CU 200, while the cumulative change
in the fair value of the hedging instrument is CU 229.
The entity would account for the hedging relationship as follows:
CU
CU
Hedging gain/loss – other
200
comprehensive income
Hedge ineffectiveness
29
Derivatives – hedging instruments
229
The treasurer of the entity is very sensitive to ineffectiveness and therefore considers rebalancing the hedging
relationship.
The analysis of the treasurer shows that the sensitivity of Brent crude oil to WTI crude oil prices was not as
expected. Going forward, the treasurer expects a different relationship between the two benchmark prices and
decides to reset the hedge ratio to 0.98:1.
Rebalancing on 30 June
The treasurer can either designate more WTI exposure or de-designate part of the hedging instrument. The entity
decides to do the latter, that is, discontinue hedge accounting for 0.07m barrels of Brent crude oil derivatives.
Of the total of 1.05m barrels of Brent derivative, 0.07m are no longer part of the hedging relationship.
Therefore, the entity needs to reclassify 7/105 (or 6.7%) of the hedging instrument in the statement of
financial position to a held for trading derivative, measured at fair value through profit or loss. The hedge
documentation is updated accordingly.
The entity accounts for the rebalancing as follows:
CU
CU
Derivatives – hedging instruments
15
Derivatives – trading
15
To reflect that a part of the derivative is no longer part of a hedging relationship.
In Example 49.78 above, the entity no longer needs to hold this portion of the derivative
any longer for hedging purposes and could, therefore, close it out. If the entity chooses
to keep that portion of the derivative it will of course continue to result in volatility in
the profit or loss, although it would no longer be presented as hedge ineffectiveness. As
mentioned, the entity could have also rebalanced by designating more WTI exposure
(assuming that the higher level of exposure is highly probable of occurring). In that case,
there would not be any immediate accounting entries; the entity would simply designate
more WTI exposure. However, the ongoing accounting can be more complex, which is
discussed in more detail below. The same would be true when rebalancing by increasing
the volume of hedging instrument, in which case the entity would simply designate more
of the same hedging instruments within the hedge relationship. This could be achieved
4128 Chapter 49
either by entering into additional hedging instruments via a market transaction, or
designating existing derivatives that are not currently designated within a hedge
relationship. [IFRS 9.B6.5.16-20].
Example 49.80: Rebalancing the hedge ratio by decreasing the volume of hedged
item
1 April
An entity has highly probable forecast purchases of diesel over the next 12 months. The entity expects to
get monthly deliveries of 10,000 metric tonnes at the local market price. The entity designates a futures
contract referenced to the Platts Diesel D2 price with a nominal amount of 9,500 metric tonnes in a cash
flow hedge, to hedge 10,000 metric tonnes of highly probable diesel purchases in September (giving a
hedge ratio of 1:0.95).
30 June
At 30 June, the cumulative change in the value of hedged item is CU 820, while the cumulative change in the
fair value of hedging instrument is CU 650.
The entity would account for the hedging relationship as follows:
CU
CU
Hedging reserve – other comprehensive
650
income
Derivatives – hedging instruments
650
To account for the fair value change of the hedging instrument.
Despite the hedge only being 79% effective, no hedging ineffectiveness is recorded as a result of the ‘lower
of test’ in the standard. [IFRS 9.6.5.11(a)]. As per that paragraph, the amount accumulated in other
comprehensive income has to be the lower of:
i)
the cumulative gain or loss on the hedging instrument; and
ii) the cumulative change in fair value of the hedged item, with any remaining gain or loss on the hedging
instrument being recorded in profit or loss (see 7.2 above).
Based on an analysis, the entity now believes that the appropriate hedge ratio going forward is 1:1.05.
Consequently, the entity can either increase the volume of hedging instrument or decrease the volume of
hedged item. Based on a cost-benefit analysis the entity decides to reduce the volume of hedged item by 952
metric tonnes.
Rebalancing on 30 June
Rebalancing a hedge ratio by decreasing the volume of hedged item is considered a partial discontinuation
of the hedging relationship. [IFRS 9.B6.5.27]. The entity is discontinuing 952 (10,000 – (9,500/1.05) = 952)
metric tonnes of diesel purchases while 9,048 metric tonnes of forecast purchases remain in the hedging
relationship. The hedge documentation is updated accordingly. No accounting entry is required (however,
the entity would have to retain the information that 952 metric tonnes of diesel were the hedged item for
some part of the total life of the hedging relationship and which amount in the cash flow hedge reserve
relates to this quantity of diesel).
Even though the standard allows adjusting either the quantity of hedging instrument or
the quantity of the hedged item, when rebalancing, entities should consider that
adjusting the hedged item will be operationally more complex than adjusting the
hedging instrument because of the need to track the history of different quantities that
were designated during the term of the hedging relationship. For example, if a quantity
of 10 tonnes of a hedged item were added to increase the quantity of hedged item and
later deducted to decrease it, those 10 tonnes would have been part of the hedged item
for only a part of the life of the hedging relationship. However, any cash flow hedge
Financial instruments: Hedge accounting 4129
adjustment would still, in part, relate to that quantity, even though it is not currently part
of a cash flow hedge. Therefore ongoing tracking of the 10 tonnes is required to ensure
appropriate recycling of the amounts previously taken to the cash flow hedge reserve.
This can get more complex in situations in which the hedging relationship needs
frequent rebalancing, if not all hedged transactions occur at the same time, or in
conjunction with the cost formulas used for the measurement of the cost of inventory
(for example a first in first out formula) (see Chapter 22 at 3.2). In addition, risk
management would normally adjust the quantity of the designated hedging instruments
when rebalancing, since the hedged exposure is normally the ‘given’ and drives what
hedges are needed.
When rebalancing a hedging relationship, an entity must update its analysis of the
sources of ineffectiveness in the hedge documentation. [IFRS 9.B6.5.21].
8.3 Discontinuation
An entity has to discontinue hedge accounting prospectively if any one of the
following occurs:
• the hedging relationship ceases to meet the qualifying criteria (after taking into
account any rebalancing of the hedging relationship, if applicable) (see 8.1 and 8.2
above); or
• the hedging instrument expires or is sold, terminated, or exercised.
For the purpose of the second of these two occurrences, the replacement or a rollover
of a hedging instrument into another hedging instrument is not an expiration or
termination if that is part of and consistent with a documented rollover hedging strategy
(see 7.7 above).
There is a further exception, introduced when regulators began to mandate the clearing
of over the counter derivatives through a central clearing house (see 8.3.2.A below).
These are the only circumstances when discontinuation occurs, as voluntary
discontinuation is not permitted under IFRS 9.
Discontinuing hedging accounting can either affect a hedging relationship in its entirety
or only a part of it (in which case hedge accounting continues for the remainder of the
hedging relationship). [IFRS 9.6.5.6].
The table below summarises the main scenarios resulting in either full or partial
discontinuation:
Scenario
Discontinuation
The risk management objective has changed
Full or partial
There is no longer an economic relationship between the hedged item and the hedging instrument
Full
The effect of credit risk dominates the value changes of the hedging relationship
Full
As part of rebalancing, the volume of the hedged item or the hedging instrument is reduced
Partial
The hedging instrument expires
Full
The hedging instrument is (in full or in part) sold, terminated or exercised
Full or partial
The hedged item (or part of it) no longer exists or is no longer highly probable
Full or partial
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 818
