International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

Home > Other > International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards > Page 824
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 824

by International GAAP 2019 (pdf)


  transitioning to IFRS 9. For such entities, the standard clarifies that hedging relationships

  under IAS 39 which also qualify for hedge accounting under IFRS 9, are treated as

  continuing hedging relationships. [IFRS 9.7.2.24]. Hedge accounting under IAS 39 ceases in

  the very same second as hedge accounting under IFRS 9 starts, therefore resulting in no

  accounting entries on transition. However, entities might have to rebalance their hedges

  on transition to fulfil the new effectiveness requirements under IFRS 9 in which case any

  resulting gain or loss must be recognised in profit or loss. [IFRS 9.7.2.25].

  Entities that are already applying IAS 39 hedge accounting will need to ensure the

  existing IAS 39 hedge documentation is updated to meet the requirements of IFRS 9 on

  the date of initial application. As a minimum this would include the following:

  • reconsideration of the documented risk management strategy and objective;

  • the approach and rationale for concluding the eligibility criteria are met,

  specifically an explanation of the economic relationship, the effect of credit risk,

  and the hedge ratio;

  • identification of all major sources of ineffectiveness;

  • justification for designation of any risk components;

  • deletion of retrospective effectiveness assessment; and

  • the approach to costs of hedging (if applicable).

  13.3 Limited retrospective application

  The exceptions from prospective application of the new standard are for the accounting

  treatment for the time value of options, when only the intrinsic value is designated; and,

  at the option of the entity, for the forward element of forward contracts, when only the

  spot element is designated, and the foreign currency basis spread of financial instruments

  (see 7.5 above). However, retrospective application shall not be applied to items that have

  already been derecognised at the date of application. [IFRS 9.7.2.1]. Comparative periods

  Financial instruments: Hedge accounting 4155

  need not be restated for any retrospective application of IFRS 9 when the classification

  and measurement requirements are first applied (see Chapter 50 at 8.1). However, if the

  IFRS 9 hedge accounting requirements are adopted sometime after the initial date of

  application of the IFRS 9 classification and measurement requirements, restatement

  would be required. [IFRS 9.7.2.15].

  13.3.1

  Accounting for the time value of options

  Entities have to apply the new accounting treatment for the time value of options

  retrospectively, if in accordance with IAS 39, only the hedging option’s intrinsic value

  was designated as part of the hedge relationship (see 14 below). However, retrospective

  treatment is only applied to hedging relationships that existed at the beginning of the

  earliest comparative period and hedging relationships designated thereafter.

  [IFRS 9.7.2.26(a)]. There is also the restriction that IFRS 9 shall only be applied to items that

  have not been derecognised by the date of application, which would preclude any

  retrospective application to hedge relationships for which either of the hedging

  instrument or hedged item have been derecognised prior to that date. [IFRS 9.7.2.1].

  If the entity decides to restate its comparative information on the initial adoption of

  IFRS 9, it will need to adjust the comparative information for this retrospective change

  (see 13.3 above). For those foreign entities registered with and reporting to the United

  States Securities and Exchange Commission and required to present two comparative

  years of income statements, this means they would have a longer period to adjust for

  the retrospective application of the new requirements.

  Applying the new accounting requirement retrospectively may have a much wider

  impact on comparative periods than is at first apparent. Depending on the type of

  hedging relationship, many line items in the primary statements and many disclosures

  in the notes may be affected.

  Example 49.89: Retrospective application of accounting for time value of option

  An entity applies the IFRS 9 hedge accounting requirements for its accounting period beginning

  1 September 2018 and 1 September 2017 is the beginning of its earliest comparative period presented. The

  entity has chosen to restate the comparative period.

  As of 1 September 2017, the entity had a hedging relationship in place in which the intrinsic value of an

  option was designated as the hedging instrument of a highly probable forecast purchase of a machine on

  30 November 2018. For the purposes of this example, there is an assumption that no sources of ineffectiveness

  exist. When preparing the September 2019 financial statements, the entity would have to:

  • determine the change in the time value of that option as of 1 September 2017 and restate accumulated

  other comprehensive income (OCI) against retained earnings as of that date;

  • determine the change in time value of that option from 1 September 2017 to 31 August 2018 and restate

  accumulated OCI against retained earnings as of that date;

  • reflect the restatement in the statement of profit or loss and other comprehensive income and the

  statement of changes in equity for the comparative period; and

  • reflect the restatement in the notes disclosures.

  13.3.2

  Accounting for the forward element of forward contracts

  Different to the accounting for the time value of options, entities have a choice of whether

  to apply retrospectively the new accounting for the forward element of forward contracts

  or not (see at 7.5.2 above. This is exclusively relevant for hedge relationships where, in

  4156 Chapter 49

  accordance with IAS 39, only changes in the spot element of a hedging forward contract

  were designated within the hedge relationship. The choice applies on an all or nothing

  basis (i.e. if an entity elects to apply the accounting retrospectively, it has to be applied to

  all hedging relationships that qualify for the election). The retrospective application would

  also only apply to those hedging relationships that ‘existed’ at the beginning of the earliest

  comparative period or that were designated thereafter. [IFRS 9.7.2.26(b), BC7.49]. We believe

  that in order for a hedge relationship to ‘exist’ as at the beginning of the earliest

  comparative period, it must have met all the hedge accounting conditions in paragraph 88

  of IAS 39 on that date, including demonstration of effectiveness (see 14 below). Assets and

  liabilities cannot be adjusted to reflect hedges that had already finished at the start of the

  comparative period. Furthermore, if under IAS 39 a forward designation was made, yet

  on application of IFRS 9 a spot designation is deemed preferable, we believe that such a

  change to the designation should be treated as discontinuation of the original relationship

  and the re-designation of a new relationship, hence this retrospective application will not

  apply in that case, see 13.3.4 below.

  13.3.3

  Accounting for foreign currency basis spread

  Similar to the retrospective transition guidance for the accounting for the forward element

  of forward contracts, it is also possible to apply retrospectively the accounting for foreign

  currency basis spreads (see at 7.5.3 above) on transition to IFRS 9. Howeve
r, in contrast to

  the transition requirements for the forward element of forward contracts, the decision to

  apply retrospectively the costs of hedging guidance on foreign currency basis spreads can

  be made on a hedge by hedge basis, without a requirement that foreign currency basis had

  been excluded from the designation under IAS 39. This is owing to the differences in

  circumstances: IAS 39 did not have an exception for excluding a foreign currency basis

  spread from the designation of a financial instrument as a hedging instrument. The hedge

  by hedge choice can be made for those hedging relationships that ‘existed’ at the beginning

  of the earliest comparative period or that were designated thereafter. [IFRS 9.7.2.26(b), BC7.49].

  13.3.4

  Re-designation of hedge relationships for non-financial risk components

  IFRS 9 permits the designation of eligible risk components in non-financial hedged items

  (see 2.2 above). Such a designation was not possible under IAS 39. This means, even if

  entities were economically hedging a risk component, they were obliged to designate the

  change in the entire hedged item as the hedged risk in order to achieve hedge accounting.

  Such a designation was likely to result in the recognition of ineffectiveness in profit or loss

  and in some cases failure of the effectiveness requirements.

  On transition to IFRS 9, entities may wish to amend hedge accounting relationships such

  that the hedged risk is an eligible risk component for non-financial hedged items. The

  question is whether that change in the documented hedged risk must result in the

  discontinuation of the original hedge relationship and the start of a new hedge relationship,

  or whether it can be treated as an amendment to the original designation such that the

  original hedge relationship continues. This question is particularly relevant for cash flow

  hedges, as on re-designation the non-zero fair value of the hedging instrument can result

  in subsequent ineffectiveness recorded in profit or loss (see 7.4.4.B above).

  Financial instruments: Hedge accounting 4157

  We believe that such a change in the documented hedged risk should be treated as a

  discontinuation of the original hedge relationship and the re-designation of a new hedge

  relationship because it can be seen as either a change in the hedged item or a change in

  the documented risk management objective which both require discontinuation of a

  hedging relationship. [IFRS 9.B6.5.26(a)].

  The IASB was nervous of permitting any retrospective application of the IFRS 9 hedge

  accounting requirements, as such an application could involve the use of hindsight, for

  example as to whether it is beneficial or not to change the hedged risk to be an eligible

  risk component. The specific scenarios where retrospective application is permitted are

  those that either do not involve the use of hindsight as IFRS 9 application relied on

  particular choices that had already been made under IAS 39 (e.g. the designation of the

  intrinsic value of an option or the spot element of a forward) or where retrospective

  application was already permitted in IAS 39 (novation of a derivative through a central

  counterparty). [IFRS 9.BC7.44-51]. Due to the absence of a specific respective transition

  relief, it follows that a hedge relationship cannot continue if an eligible risk component

  under IFRS 9 is introduced into an existing IAS 39 hedge relationship.

  The question has been asked as to whether this transition issue could be resolved by

  ‘dual-designating’ the hedge relationship, at the inception of the hedge, under n both

  IAS 39 and IFRS 9. The IAS 39 designation would be for the full price risk, while the

  IFRS 9 designation would be of just the eligible risk component. Unfortunately this does

  not work, because the switch from the IAS 39 hedge designation to the IFRS 9 hedge

  designation would reflect a change in risk management objective, which would result in

  discontinuation of the first hedge relationship (see 8.3 above).

  The logical follow-on question is whether an entity can continue with the original

  IAS 39 designation although it does not exactly represent the entity’s risk management

  objective. We note that although the objective of hedge accounting under IFRS 9 is to

  represent an entity’s risk management activities, [IFRS 9.6.1.1], it does not require that it is

  an exact match. The Basis for Conclusions notes that, in some circumstances, the

  designation for hedge accounting purposes is inevitably not the same as an entity’s risk

  management view of its hedging, but that the designation reflects risk management in

  that it relates to the same type of risk that is being managed and the instruments used

  for this purpose. The IASB refer to this situation as ‘proxy hedging’, which is an eligible

  way of designating the hedged item under IFRS 9 as long as that still reflects risk

  management (see 6.2.1 above). One example of proxy hedging mentioned is those

  instances where the risk management objective is to hedge a risk component but the

  accounting hedge designation is for the full price risk. Where there is a choice of

  accounting hedge designation, there is no requirement for an entity to select the

  designation that most closely matches the risk management view of hedging as long as

  the chosen approach still reflects risk management. [IFRS 9.BC6.97, BC6.98, BC6.100(b)].

  Consequently, we believe that it is permitted, on transition, to continue with an

  accounting designation of the full price risk even if the management objective was

  always to hedge a component of risk.

  4158 Chapter 49

  Both questions above were debated by the IFRS Interpretations Committee in

  September 2015 and January 2016. The final agenda decision reached by the Interpretations

  Committee is consistent with the analysis presented above.25

  13.3.5

  Designation of own use contracts at fair value through profit or loss

  On introduction of this fair value option for own use contracts (see 12.2 above), the IASB

  considered the need for specific transition requirements. As a result, the IASB allowed

  that on transition to IFRS 9, entities can apply the fair value option on an ‘all-or-nothing’

  basis for similar types of (already existing) own use contracts. The change in the net

  assets resulting from such a designation shall be recognised in retained earnings at the

  date of initial application. [IFRS 9.7.2.14A].

  14

  MAIN DIFFERENCES BETWEEN IFRS 9 AND IAS 39 HEDGE

  ACCOUNTING REQUIREMENTS

  Most of the basics of hedge accounting are the same under both IFRS 9 and IAS 39,

  however there are some significant differences. We discuss the main differences

  between IFRS 9 and IAS 39 hedge accounting below.

  IAS 39 includes some specific guidance originally designed with portfolio fair value

  hedges of interest rate risk. Equivalent guidance does not appear in IFRS 9 – see 11

  above for further details.

  IAS 39 includes extensive Implementation Guidance on the application of hedge

  accounting. In developing IFRS 9, the IASB decided not to carry forward any of the

  hedge accounting related Implementation Guidance that accompanied IAS 39.

  However the IASB emphasised that not carrying forward the implementation guidance

  did not mean that it had rej
ected the guidance for the application of IFRS 9.

  [IFRS 9.BC6.93-95]. Much, but not all, of the Implementation Guidance in IAS 39 therefore

  remains relevant on application of IFRS 9 (see 1.3 above).

  14.1 The objective of hedge accounting

  The objective of IFRS 9 hedge accounting is to represent in the financial statements, the

  effect of an entity’s risk management activities that use instruments to manage

  exposures arising from particular risks that could affect profit or loss (or OCI in the case

  of equity investment designated at FVOCI). This approach aims to convey the context

  of hedging instruments for which hedge accounting is applied in order to provide insight

  into their purpose and effect. [IFRS 9.6.1.1]. There is no such objective within IAS 39.

  The perceived purpose of hedge accounting under IAS 39 is to reduce the accounting

  mismatches caused by risk management activity, but it has no conceptual objective.

  Consequently it is a more rules-based standard, which is particularly evident in the

  80-125% quantitative threshold for the hedge effectiveness assessment (see 14.4 below).

  Similar to IFRS 9, IAS 39 includes a requirement to document the risk management

  strategy and risk management objective for undertaking the hedge (see 6.2 above).

  [IAS 39.88(a)]. However, whereas, under IFRS 9, the risk management objective is rooted

  in risk management practice and determines whether the hedge relationship can be or

  should be discontinued, under IAS 39 it is just part of the accounting designation.

  Financial instruments: Hedge accounting 4159

  14.2 Eligible hedged items

  The hedge accounting guidance under IAS 39 has a number of additional restriction on

  the eligibility of hedged items that do not appear within the IFRS 9 guidance. Most

  importantly is the preclusion of designating any risk components in non-financial hedged

  items, other than foreign exchange risk. The rationale at the time was the difficulty of

  isolating and measuring the appropriate portion of cash flows or fair value changes

  attributable to specific risks (other than foreign currency risks) in a non-financial asset or

  liability. [IAS 39.82, AG100]. This preclusion has been removed in IFRS 9 (see 2.2 above).

  The ability to designate an aggregated exposure, which includes a derivative as the hedged

 

‹ Prev