in IAS 39 or IFRS 9 until the project on accounting for macro hedging is finalised.24
Eventually, the IASB gave entities the following choices until the project on accounting
for macro hedging is completed:
• to apply the new hedge accounting requirements as set out in IFRS 9, in full;
• to apply the new hedge accounting requirements as set out in IFRS 9 to all
hedges except fair value hedges of the interest rate exposure of a portfolio of
financial assets or financial liabilities; in that case an entity must also apply the
paragraphs that were added to IAS 39 when that particular type of hedge was
introduced (IAS 39.81A, 89A and AG114-AG132) – i.e. an entity must apply all
the hedge accounting requirements of IAS 39 (including the 80%-125% bright
line effectiveness test as well) including the paragraphs that specifically address
fair value hedges of the interest rate exposure of a portfolio of financial assets
4150 Chapter 49
or financial liabilities); the choice to apply IAS 39 in these situations is the result
of the scope of the hedge accounting requirements of IFRS 9 and available on a
case-by-case basis (i.e. it is not an accounting policy choice); [IFRS 9.6.1.3] or
• to continue applying hedge accounting as set out in IAS 39 until the project on
accounting for macro hedging is completed, to all hedges; this is an accounting
policy choice. [IFRS 9.7.2.21]. Because it is an accounting policy choice, an entity
may later on change its policy and start applying the hedge accounting
requirements of IFRS 9 (subject to the transition requirements of IFRS 9 for
hedge accounting). However, even if an entity chooses to continue to apply the
hedge accounting requirements of IAS 39, the entity still has to provide the new
hedge accounting disclosures that were developed during the IFRS 9 project
because those disclosure requirements have become a part of IFRS 7 for which
no similar accounting policy choice to continue to apply the previous
requirements was provided. [IFRS 9.BC6.104]. Once an entity changes its accounting
policy and starts to apply the hedge accounting requirements of IFRS 9, it cannot
go back to applying IAS 39.
12
ALTERNATIVES TO HEDGE ACCOUNTING
12.1 Credit risk exposures
Many financial institutions hedge the credit risk arising from loans or loan commitments
using credit default swaps (CDS). This would often result in an accounting mismatch, as
loans and loan commitments are typically not accounted for at fair value through profit
or loss. The most natural approach to hedge accounting would be to designate the credit
risk as a risk component in a hedging relationship. However, the IASB noted that due to
the difficulty in isolating the credit risk as a separate risk it does not meet the eligibility
criteria for risk components (see 2.2.1 above). As a result, the accounting mismatch
creates profit or loss volatility. [IFRS 9.BC6.470]. The Exposure Draft leading up to IFRS 9
did not propose any changes in this area, however, the IASB asked its constituents to
comment on three alternative approaches, none of which were that credit risk could be
deemed an eligible risk component for hedge accounting. The feedback from
constituents showed that accounting for credit risk hedging strategies is a major concern
for many financial institutions. [IFRS 9.BC6.491].
In its redeliberations the Board reconfirmed its view that credit risk does not qualify as
a separate risk component. [IFRS 9.BC6.504]. However, the IASB decided that an entity
undertaking economic credit risk hedging may, at any time, elect to account for all or a
proportion of a debt instrument (such as a loan or a bond), a loan commitment or a
financial guarantee contract, to the extent that any of these instruments is managed for
changes in its credit risk, at fair value through profit or loss. This was one of the
alternative approaches set out in the Exposure Draft. This election can only be made if
the asset referenced by the credit derivative has the same issuer and subordination as
the hedged exposure (i.e. both the issuer’s name and seniority of the exposure match).
The accounting for the credit derivative would not change, i.e. it would continue to be
accounted at fair value through profit or loss. [IFRS 9.6.7.1].
Financial instruments: Hedge accounting 4151
If the election is made, the difference at that time between the carrying value (if any) and
the fair value of the financial instrument designated as at fair value through profit or loss
is immediately recognised in profit or loss; in case of a debt instrument accounted for as
at fair value through other comprehensive income the carrying amount (i.e. fair value)
does not change but instead the gain or loss that has been accumulated in the revaluation
reserve has to be reclassified to profit or loss. [IFRS 9.6.7.2]. This gain or loss would not only
reflect any change in credit risk, but also any change in other risks such as interest rate
risk. Also different to a fair value hedge, once elected, the financial instruments hedged
for credit risk are measured at their full fair value instead of just being adjusted for changes
in the risk actually hedged. As a result, by economically hedging the credit risk exposure
and applying the fair value option consistent with the guidance in paragraph 6.7.1 of
IFRS 9, the entity also has to revalue the financial instrument for the general effect of
interest rate risk, which may result in profit or loss volatility.
An entity has to discontinue the specific accounting for credit risk hedges in line with
its actual risk management. This would be the case when the credit risk either no longer
exists or if the credit risk is no longer managed using credit derivatives (irrespective of
whether the credit derivative still exists or is sold, terminated or settled). [IFRS 9.6.7.3].
On discontinuation, the accounting for the financial instrument reverts to the same
measurement category that had applied before the designation as at fair value through
profit or loss. However, the fair value of the financial instrument on the date of
discontinuing the accounting at fair value through profit or loss becomes the new carrying
amount on that date. [IFRS 9.6.7.4]. For example, the fair value of a loan at the time of
discontinuation becomes its new deemed amortised cost which is the basis to determine
its new effective interest rate. This applies also to a debt instrument that reverts to
accounting at fair value through other comprehensive income because it is required to
affect profit or loss in the same way as a financial instrument at amortised cost. [IFRS 9.5.7.11].
This means the revaluation reserve only includes the gains and losses that arise after the
date on which the accounting at fair value through profit or loss ceased.
For a loan commitment or a financial guarantee contract the fair value at the date on
which the accounting at fair value through profit or loss ceased is amortised over the
remaining life of the instrument in accordance with the principles of IFRS 15 – Revenue
from Contracts with Customers – unless the impairment requirements of IFRS 9 would
require a higher amount than the remaining unamortised balance (see Chapter 46 at 2.8).
In contrast to the fair
value option under IFRS 9 (see Chapter 44 at 7), the possibility to
elect to measure at fair value through profit or loss those financial instruments whose
credit risk is managed using credit derivatives, has the following advantages:
• the election can be made after initial recognition of the financial instrument;
• the election is available for a proportion of the instrument (instead of only the
whole instrument); and
• the fair value through profit or loss accounting can be discontinued if credit risk
hedging no longer occurs.
Consequently, even though it is not an equivalent to fair value hedge accounting, this
accounting does address several, but not all, concerns of entities that use CDSs for
hedging credit exposures.
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12.2 Own use contracts
Contracts accounted for in accordance with IFRS 9 include those contracts to buy or sell
non-financial items that can be settled net in cash, as if they were financial instruments
(i.e. they are in substance similar to financial derivatives). Many commodity purchase and
sale contracts meet the criteria for net settlement in cash because the commodities are
readily convertible to cash. However, such contracts are excluded from the scope of
IFRS 9 if they were entered into and continue to be held for the purpose of the receipt or
delivery of a non-financial item in accordance with the entity’s expected purchase, sale
or usage requirements. [IFRS 9.2.4]. This is commonly referred to as the ‘own use’ scope
exception. Own use contracts are further discussed in Chapter 41 at 4.2.
Own use contracts are accounted for as normal sales or purchase contracts (i.e. executory
contracts), with the idea that any fair value change of the contract is not relevant given the
contract is used for the entity’s own use. However, some entities in certain industries enter
into contracts for own use and similar financial derivatives for risk management purposes
and manage all these contracts together. In such a situation, own use accounting leads to
an accounting mismatch as the fair value change of the derivative positions used for risk
management purposes cannot be offset against fair value changes of the own use contracts.
To eliminate the accounting mismatch, an entity could apply hedge accounting by
designating an own use contract as the hedged item in a fair value hedging relationship.
However, hedge accounting in these circumstances is administratively burdensome.
Furthermore, entities often enter into large volumes of commodity contracts and, within
the large volume of contracts, some positions may offset each other. An entity would
therefore typically hedge on a net basis.
To address this issue, IFRS 9 includes a fair value option for own use contracts. At inception
of a contract, an entity may make an irrevocable designation to measure an own use contract
at fair value through profit or loss (the ‘fair value option’). However, such designation is only
allowed if it eliminates or significantly reduces an accounting mismatch. [IFRS 9.2.5].
Example 49.88: Processing and brokerage of soybeans and sunflowers
An entity is in the business of procuring, transporting, storing, processing and merchandising soybeans and
sunflower seeds. The inputs and the outputs are agricultural commodities which are traded in liquid markets.
The entity has both a broker business and a processing business, which are operationally distinct. However,
the entity analyses and monitors its net commodity risk position, comprising inventories, physically settled
forward purchase and sales contracts and exchange traded futures and options. The target is to keep the net
fair value risk position close to nil.
Applying the guidance in IFRS 9 paragraph 2.4, the physically settled forward contracts from the processing
business have to be accounted for as own use contracts, whereas all other contracts are accounted for at fair
value through profit or loss. The resulting accounting mismatch does not reflect how the entity is managing
the overall fair value risk of those contracts.
If the entity applied the fair value option to the physically settled contracts, this would eliminate the
accounting mismatch.
Some entities, especially in the power and utilities sector, enter into long-term own use
contracts, sometimes for as long as 15 years. The business model of those entities would often
be to manage those contracts together with other contracts on a fair value basis. However,
there are often no derivatives available with such long maturities, while fair values for longer
dated contracts may be difficult to determine. Hence, for risk management purposes a fair
Financial instruments: Hedge accounting 4153
value based approach might only be used for the time horizon in which derivatives are
available, i.e. sometime after inception of the contract. The fair value option is, however, only
available on inception of the own use contract. As risk management of longer term own use
contracts on a fair value basis usually occurs sometime after inception of the contract, the fair
value option will mainly be useful for shorter-term own use contracts.
13
EFFECTIVE DATE AND TRANSITION
13.1 Effective
date
The version of IFRS 9 issued in July 2014 had a mandatory effective date of annual
periods beginning on or after 1 January 2018. Early application was permitted.
[IFRS 9.7.1.1]. Early application can only start from the beginning of a reporting period,
which is the date of initial application and must be after the date IFRS 9 was issued, i.e.
after 24 July 2014. [IFRS 9.7.2.2]. Although not explicit in the standard, we believe that
reporting period can be an annual reporting period or an interim reporting period.
This version of IFRS 9 supersedes the three earlier versions of IFRS 9 (issued in 2009,
2010 and 2013). However, the IASB provided a ‘grace period’ that allowed an entity to
adopt those earlier versions of IFRS 9 but only if it did so by choosing a date of initial
application before 1 February 2015. [IFRS 9.7.3.2].
Taken together, this means an entity that has early applied one of the earlier versions
of IFRS 9 (when that option was still available) could continue to apply that version until
the version issued in July 2014 became mandatorily effective in 2018.
As stated at 1.3 above, an entity has the accounting policy choice to continue applying
hedge accounting as set out in IAS 39 to all hedges until the project on accounting for
macro hedging is completed, instead of the requirements of Chapter 6 of IFRS 9.
[IFRS 9.7.2.21]. We believe that an entity can chose to adopt the IFRS 9 hedge accounting
requirements subsequent to the initial adoption of IFRS 9, as there is nothing in the
transition guidance that indicates that an entity must continue to apply the accounting
policy choice until the macro hedging project is finished. [IFRS 9.BC6.104]. However, it is
not possible to switch back to the hedge accounting provisions of IAS 39 once Chapter 6
of IFRS 9 has been applied. It should also be noted that on subsequent adoption of
IFRS 9 hedge accounting, comparatives will need to be restated for any retrospective
application (see 13.3 below). Furthermore, for first time adopters of IFRS, the transition
guidance in IFR
S 9 is not relevant, and hence the accounting policy choice to apply the
hedge accounting requirements of IAS 39 is not available.
The accounting policy choice to continue to apply the hedge accounting requirements
of IAS 39, effectively defers all of the Chapter 6 of IFRS 9, (although not the IFRS 7
disclosure requirements on hedge accounting introduced by IFRS 9). As the guidance
on designating credit exposures at fair value through profit or loss is included within
Chapter 6 of IFRS 9, we believe it cannot be applied if an entity chooses to remain on
IAS 39 for hedge accounting. See 12.1 above for more details on designating credit
exposures at fair value through profit or loss.
Furthermore, if an entity has an equity instrument classified at fair value through other
comprehensive income as permitted by paragraph 5.7.5 of IFRS 9, and has chosen to
4154 Chapter 49
continue to apply the IAS 39 hedge accounting requirements; we believe that such an
equity instrument is not an eligible hedged item as it will not impact profit or loss.
[IAS 39.86]. This is because the specific guidance in paragraph 6.5.8 of IFRS 9 which
permits designation of an equity instrument for which an entity has elected to present
changes in fair value in other comprehensive income in a fair value hedges is not
applicable if the entity remains on IAS 39 hedge accounting.
13.2 Prospective application in general
A hedging relationship can only be designated on a prospective basis, in order to avoid the
use of hindsight. The same concern about using hindsight would also apply if the new
hedge accounting requirements were to be applied retrospectively. Consequently, the
IASB decided that hedge accounting in accordance with IFRS 9 has to be applied
prospectively, with some limited exceptions. [IFRS 9.7.2.22]. Because the date of initial
application can only be the beginning of a reporting period, an entity can only start applying
the new hedge accounting requirements of IFRS 9 prospectively from the beginning of a
reporting period, and only if all qualifying criteria – including the hedge accounting
documentation that conforms to IFRS 9 – are met on that date. [IFRS 9.7.2.23, 7.2.2].
Many preparers will already be applying hedge accounting under IAS 39 before
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 823
