IFRS 9 Hedge Accounting
The objective of hedge accounting is to present an entity’s risk management activities that use financial instruments to be reflected in the entity’s financial statements.
Hedging instruments & hedge items
An entity can designate a derivative carried at profit or losses (except some written options) as a hedging instrument. An entity can also designate a non-derivative financial asset or liability carried at FVTPL as a hedging instrument except for non-derivative financial liability whose fair value changes arising from credit risk are reflected in OCI.
An instrument must be designated in its entirety except where it meets the requirement for certain allowed exceptions, such as segregation of intrinsic value and time value of an option.
A hedged item can be a recognized asset or liability, an unrecognized firm commitment, a forecast transaction, or a net investment in foreign operations. It can be a single item or a group of items, in its entirety or a component thereof, mainly entered into with external parties. Further, it must be reliability measurable and (in case of a forecast transaction) highly probable.
Qualifying criteria for hedge accounting
A hedging relationship qualifies for hedge accounting only if:
- It consists of eligible hedging instrument and hedged instrument,
- The hedge relationship is designated and documented at inception, and
- The hedge is effective in that (i) economic relationship exists between the hedging item and hedged item, (ii) the effect of credit risk does not dominate the value changes, and (iii) the hedge ratio is the same as that arising from quantity of hedged instrument to the quantity of hedging instrument.
Accounting for qualifying hedging relationships
Hedging relationships include fair value hedge, cash flow hedge and hedge of a net investment position in a foreign operation. Fair value hedge is a hedge of the exposure to a change in fair value resulting exposure to a particular risk. Cash flow hedge is a hedge of the variability of cash flows arising from exposure to a particular risk.
If a hedging relationship does not meet the hedge ratio requirement of hedge effectiveness, an entity must rebalance (adjust) the hedge ratio such that it meets the requirement.
An entity shall discontinue hedge accounting only if the hedge is ineffective (even after the rebalancing). It shall be discontinued on expiry of the hedging instrument. However, a rollover of the hedging instrument would not trigger such discontinuation if it is a normal party of the documented risk management strategy.
Fair value hedge
As long as a fair value hedge meets the qualifying criteria, any gain or loss on the hedging instrument shall be recognized in profit or loss (or in OCI if it hedges an equity instrument designated at FVOCI). Any hedging gain or loss (on a financial asset or unrecognized firm commitment) shall adjust the carrying amount of the hedged instrument and be recognized in profit or loss except for an equity instrument designated at FVOCI in which case the changes are presented in OCI.
Cash flow hedge
As long as a cash flow hedge meets the qualifying criteria, the cash flow hedge reserve (in other comprehensive income) is adjusted to the lower (in absolute terms) of cumulative gain on the hedging instrument (since inception) or the cumulative change in fair value of the hedged item since inception. A portion of gain or loss on the hedging instrument which is effective (i.e. which is offset by the change in the cash flow hedge reserve) is recognized in other comprehensive income, and the residual amount is recognized in profit or loss.
The amounts included in cash flow hedge are either included in the carrying amount of an asset or liability which result from the hedged transaction or reclassified to profit and loss in the period in which the hedged expected cash flows affect profit or loss. However, if the amount is a loss which is not expected to be recovered, it is charged to profit and loss.
Hedges of a net investment in a foreign operation
Hedges of a net investment in a foreign operation are accounted for similarly to cash flow hedges, i.e. (a) the effective portion of the gain or loss on the hedging instrument is recognized in OCI, and (b) the ineffective part is recognized in profit or loss. The cumulative gain or loss on the hedging instrument related to the effective portion accumulated in foreign currency translation reserve shall be reclassified from equity to profit or loss as a reclassification adjustment on disposal or partial disposal of the foreign operation.
Accounting for the time value of options
If an entity separates the intrinsic value and time value of an option and designates only the intrinsic value to the hedging instrument, the accounting for the time value of the option depends on whether the option hedges a transaction-related hedged item or a time-period related hedged item as explained in IFRS188.8.131.52. The same requirements may be applied when forward and spot element of a forward contract are separated.
Hedges of a group of items
A group of items is an eligible hedged item only if (a) all items individually are eligible hedged items, (b) the items are managed together for risk management purposes, and (c) in case of a cash flow hedge of a group of items whose variability is not approximately proportional to variability of the group, the hedge is foreign currency risk and at the time of initial designation it specifies the period in which the forecast transactions are expected to affect profit or loss.
A component which is a proportion of an eligible group of items is an eligible hedged item provided it is consistent with the entity’s overall risk management objective. Similar, a layer component is also eligible for hedge accounting if certain criteria are met.
For a hedge of a group of items with offsetting risk positions, any hedging gains or losses shall be presented separately from the item related to the hedged item.
If certain criteria as given in IFRS184.108.40.206 are met, a net nil position may be designated as a hedging relationship with no hedging instrument.
Option to designate credit exposure as measured at FVTPL
If an entity uses a credit derivative measured at FVTPL to manage credit risk of a financial instrument, it can designate the financial instrument to be measured at FVTPL to the extent it is so managed, provided (a) the name of the credit exposure matches the reference entity of the credit derivatives, and (c) the seniority of the financial instrument matches that of the instruments than can be delivered in accordance with the credit derivative. Such a designation can be made at any time before derecognition provided it is documented. Upon such designation, any difference between its carrying amount and fair value is recognized in profit or loss. If the financial instrument is measured at FVOCI, the gain or loss is reclassified to profit or loss.
The accounting treatment outlined above shall cease if the qualifying criteria are no longer met or whether the financial instrument giving rise to the credit risk is not otherwise required to be measured at profit or loss. On such discontinuation, the fair value at the date of discontinuation becomes the new carrying amount.