IFRS 9 Hedging Notes PDF

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1. Introduction:  

Foreign Currency Txs or Foreign Operations – exposes entity to ∆ exchange rates = Foreign Currency Risk Entity can protect itself using Hedging (trying to make foreign exchange difference as small as possible): o Internal Hedging Pay foreign creditor sooner :. avoiding negative impact due to deterioration of exchange rates o



External Hedging Use a financial instrument (hedging instrument) to eliminate/minimize negative impact through offsetting of foreign exchange differences – FORWARD EXCHANGE CONTRACT (FEC)

Forward Exchange Contract (FEC): o Entity enters agreement with bank to purchase  Specific amt of foreign currency  On specified future date (maturity date of FEC)  At specified exchange rate (regardless of spot exchange rate on that date) = forward rate (usually at a premium or discount to current spot exch. rate) o DERIVATIVE financial instrument :  Value changes based on exchange rates (underlying)  No initial investment  Settled at future date

2. Hedge Accounting:   

Voluntary accounting model (applied if qualifying criteria met) Accounting mismatch occurs bet. hedged item & hedging instrument :. apply hedge accounting to offset changes in FairV or CF Hedging = policy to manage certain risks ; Hedge Accounting = accounting model applied

2.1 Hedged Items (3) Gives rise to the risk. 1



Can be one of the following (or a component thereof): o Recognised Asset/Liability o Unrecognised Firm Commitment o Forecast Tx



Recognised Asset or Liability: o A or L recognised in FS e.g. Foreign Creditor or Foreign Debtor



Unrecognised Firm Commitment o Binding agreement for exchange of specified quantity of resources @ specified price on specified date(s) in future e.g. non-cancellable purchase order



Forecast Transaction o Anticipate future tx entity is not commited to e.g. cancellable purchase order o Must be highly probable before hedge accounting applied



Item must be reliably measurable before it can be a hedged item: o Recog. A or L usually meets req. o Unrecog. Firm Commitment / Forecast Tx – entity uses judgment



Can designate item in entirety or component as hedged item: o Entirety – all changes in CFs or FairVs o Component – less than total CF or FairV changes  Types:  Changes attributable to a specific risk (only Foreign Currency Risk for FRK 300)  One/more selected contractual CFs

2.2 Hedging Instruments Financial Instrument entity uses to manage risk caused by hedged item.  

Derivative Financial Instrument - @ fair value through P or L e.g. FEC Designated in entirety

2.3 Qualifying Criteria for Hedge Accounting Hedging relationship qualifies for hedge accounting if all following criteria met: 1. Comprises: 2

a. Eligible hedging instrument b. Eligible hedged item 2. At inception, there is formal designation + documentation of hedging relationship & entity’s risk management policy + strategy for undertaking hedge. Docs include: a. ID of hedging instrument & hedged item b. Nature of risks c. How entity det. if hedging relationship meets effectiveness req. 3. Hedging relationship meets all hedge effectiveness criteria: (not FRK 300)

2.4 Discontinuation of Hedge Accounting 



Discontinued prospectively when ceases to meet qualifying criteria o Hedging instrument expires, is sold, terminated or exercised o Replacement or rollover is part of documented risk management objective ≠ expiration or termination of hedging instrument Entity cannot discontinue when it has chosen to apply hedge accounting & hedging relationship still meets all of hedging criteria

3. Types of Hedges: 3 types of hedging relationships:   

Fair Value Hedge Cash Flow Hedge Hedge of net investment in a foreign operation (not FRK 300)

3.1 Fair Value Hedge 

Hedge of exposure to ∆ fair value of: o Recognised A or L o Unrecognised Firm Commitment o Component of any of the above

3.2 Cash Flow Hedge 

Hedge of exposure to ∆ cash flows of: 3

o o o 

Recognised A or L Highly Probable Forecast Tx Component of any of above

If foreign currency risk being hedged - firm commitment can be accounted for either as a FairV or a CF hedge (Q will specify)

4. Fair Value Hedge Accounting:  

Gain/Loss on hedging instrument (FEC) → profit or loss [Foreign Exchange Difference] Gain/Loss on hedged item (Firm Commitment; Recog. A or L) → o Adjusts CA of hedged item (if applicable) o Recognised in profit or loss [Forex Difference]

Purchase inventory from a foreign creditor & take out an FEC on Firm Commitment date. Dr

Cr

Date of Firm Commitment & entered FEC No journal entries! Reporting Date Hedging Instrument FEC (SFP) Foreign Exchange Difference (P/L)

xxx xxx

Hedged Item (Firm Commitment)

Gain (FEC to FEC)

R10 – R5

Foreign Exchange Difference (P/L) Firm Commitment (SFP)

Loss

xxx xxx

to FEC)

xxx

Gain

(FEC

Transaction Date (FOB/CIF) Hedging Instrument FEC (SFP) Forex Difference (P/L)

xxx (FEC

to FEC)

Hedged Item (Firm Commitment)

R13 – R10

Forex Difference (P/L) Firm Commitment (SFP)

xxx xxx

4

Loss to FEC)

(FEC

Recognise Tx Inventories (SFP) Foreign Creditor (SFP)

xxx xxx

Spot Rate on tx date

Eliminate Firm Commitment (from before Tx Date) against Asset Firm Commitment (SFP) Inventories (SFP)

xxx xxx

Balance on Firm Commitment

Settlement Date & FEC matures Hedging Instrument FEC (SFP) Forex Difference (P/L)

xxx

Gain xxx

Hedged Item (Foreign Creditor)

(Spot – FEC)

R14 – R13

xxx

Forex Difference (P/L) Foreign Creditor (SFP)

xxx

Loss (Spot to Spot)

Settle Creditor & FEC matures xxx

Foreign Creditor (SFP) FEC (SFP) Bank (SFP)

xxx xxx



Spot rate on date



Original forward rate

5. Cash Flow Hedge Accounting: 

Gain/Loss on hedging instrument (effective hedge) in OCI [Cash Flow Hedge Reserve]

 

Remaining gain/loss (ineffective hedge) in Profit or Loss CFHR: o Hedged Forecast Tx/Firm Commitment results in recognition of non-fin asset or liability – remove balance of CFHR & include directly in initial cost/CA of A or L (Inventories; PPE)  Not a reclassification adjustment :. no effect on OCI → directly affects Equity o Other CF hedges  Reclassified from CFHR to P/L as a reclassification adjustment

5

Purchase inventory from a foreign creditor & take out an FEC on Firm Commitment date. Dr

Cr

Date of Firm Commitment & entered FEC No journal entries! Reporting Date Hedging Instrument FEC (SFP) Cash Flow Hedge Reserve [CFHR] (OCI)

Gain

xxx xxx

(FEC to FEC)

R10 – R5

Hedged Item (Firm Commitment) No journal entry! Transaction Date (FOB/CIF) Hedging Instrument FEC (SFP) CFHR (OCI)

xxx xxx

Hedged Item (Firm Commitment)

Gain (FEC to FEC)

R13 – R10

No journal entry!

Recognise Tx Inventories (SFP) →non fin asset Foreign Creditor (SFP)

xxx xxx

Spot Rate on tx date

xxx

Balance on CFHR

Eliminate CFHR bal (from before Tx Date) against Asset CFHR (Equity) →not a reclassification Inventories (SFP)

xxx

Settlement Date & FEC matures Hedging Instrument FEC (SFP) CFHR (OCI)

Gain

xxx

(Spot – FEC)

xxx R14 – R13

6

Hedged Item (Foreign Creditor) xxx

Loss

Forex Difference (P/L) →not offset in P/L due to CFHR Foreign Creditor (SFP)

(Spot to Spot)

xxx

Reclassify CFHR CFHR (OCI) Forex Difference (P/L) Settle Creditor & FEC matures xxx

Foreign Creditor (SFP) FEC (SFP) Bank (SFP)

xxx xxx

SPLOCI OCI: Items that will not be reclassified to profit or loss: CFHR: Gain/(Loss) recognised in current year Items that will be reclassified to profit or loss: CFHR: - Gain/(Loss) recognised in current year + - Recognised in profit or loss in “Other Expenses” line item (-)



Spot rate on date



Original forward rate

20x15

20x14

Amt before/on tx date

Amt before/on tx date

Amt after tx date

Amt after tx date

Cash Flow Hedge Reserve

SCE

20x15

20x14

Balance @ beginning of yr TCI - PFY - OCI (per SPLOCI)

Amt after tx date

Amt after tx date

CFHR included in intial cost of asset

( xxx

)

TCI Both will & will not be reclassified to P or L

7

Sell inventory to a foreign debtor & take out an FEC on Firm Commitment date. Dr

Cr

Date of Firm Commitment & entered FEC No journal entries! Reporting Date Hedging Instrument Loss CFHR (OCI) FEC (SFP)

(FEC to FEC)

xxx xxx

R10 – R5 Forward rate ↑ed :. Bank would’ve paid us more

Hedged Item (Firm Commitment) No journal entry! Transaction Date (FOB/CIF) Hedging Instrument CFHR (OCI) FEC (SFP)

xxx xxx

Hedged Item (Firm Commitment)

Loss (FEC to FEC)

R13 – R10

No journal entry!

Recognise Tx Foreign Debtor (SFP) Revenue (P/L)

xxx

Cost of Sales (P/L) Inventories (SFP)

xxx

xxx

Spot Rate on tx date

xxx

Reclassify CFHR bal (from before Tx Date) xxx

Revenue (P/L) CFHR (OCI)

xxx

Balance on CFHR

Settlement Date & FEC matures Hedging Instrument Loss CFHR (OCI) FEC (SFP)

xxx

(Spot – FEC)

xxx 8

R14 – R13

Hedged Item (Foreign Debtor) Gain

xxx Foreign Debtor (SFP) Forex Difference (P/L)

xxx

(Spot to Spot)

Reclassify CFHR Forex Difference (P/L) CFHR (OCI) [balance on CFHR] Debtor Pays & FEC matures Bank (SFP) FEC (SFP) Foreign Debtor (SFP)

xxx xxx



xxx

SPLOCI

20x15

OCI: Items that will not be reclassified to profit or loss: CFHR: Gain/(Loss) recognised in current year



Original forward rate Spot rate on settlem ent date

20x14 No recognition of nonfinancial asset :. reclassify all CFHR movements

-

straight away

Items that will be reclassified to profit or loss: CFHR: - Gain/(Loss) recognised in current year + - Recognised in profit or loss in “Revenue” line item + - Recognised in profit or loss in “Other Income” line item +

Amt to date of tx

Amt to date of tx

Amt after tx date

Amt after tx date

SCE

Cash Flow Hedge Reserve

20x15 Balance @ beginning of yr TCI - PFY - OCI TCI 9

20x14

5.1 Effective & Ineffective Portions of CF Hedge  



 

Hedge effectiveness = extent to which changes in FairVs or CFs of a hedging instrument are offset by changes in FairVs or CFs of a hedged item Different to hedge effectiveness criteria o Criteria used to det. whether hedge accounting can be applied to hedging relationship o Relationship does not have to be 100% effective before hedge accounting can be applied CFHR adjusted to lower of following amts: o Cumulative P/L on hedging instrument since commencement date o Cumulative change in FairV of hedged item from commencement date Gain/Loss on hedging instrument < Gain/Loss on hedged item = under-hedging Gain/Loss on hedging instrument > Gain/Loss on hedged item = over-hedging (excess in P/L)

5.2 Highly Probable Forecast Tx  



Included in description of CF Hedge (not FV Hedge) :. only CF Hedge accounting can be applied to highly probable forecast tx (HPFT) Can result in firm commitment and/or recog. A or L o ONLY CF Hedge Accounting applied to HPFT o CF or FV Hedge Accounting applied to Firm Commitment & Recognised A or L Change ≠ change in accounting policy

Combination of CF & FV Hedge Accounting When adjusting initial CA of Asset

Dr

Equipment (SFP) CFHR (Equity) [Balance] Firm Commitment (SFP) [Balance]

xxx xxx

Cr

xxx

5.3 Discontinuation of CF Hedge Accounting 

When discontinued, amt accumulated in CFHR dealt with as follows: o If future CFs still expected to occur – amt in CFHR left there until CFs occur o Not expected to occur – amt in CFHR reclassified immediately to profit or loss

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6. Renewal of the Forward Cover: 

 

Entity may need forward cover for period longer than originally anticipated o Renew/roll forward cover by taking out another forward cover contract o When original one matures Not seen as termination of original hedging relationship o Provided renewal/roll forward was part of document risk management objective Steps: o Original FEC matures o Entity acquires foreign currency o Entity immediately sells currency back to bank @ spot rate o Forward rate @ which purchased different to spot rate sold to bank = difference o Gain/Loss from diff.  FairV Hedge – profit or loss  CF Hedge – CFHR in OCI  Hedge accounting NA – profit or loss

When original FEC matures First FEC matures

Dr

Bank (SFP) FEC 1 (SFP) [Balance on FEC]

xxx

Cr

xxx

PLEASE NOTE! The journals provided in these notes will not be the same for every question. Debits and Credits will change depending on the change in rates provided. Use the above journals to grasp the principle 

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