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Chapter 4 - Hedging Flashcards

1
Q

Explain IAS39, IFRS 7 and IFRS 9

A

IAS 39 - measurement and recognition of FI in the FS

IFRS 7 - disclosures of FI in the FS

IFRS 9 - will supersede IAS 39 on 1st Jan 18

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2
Q

IAS 39 states that a hedged item must be one of three things and the effect it will have is:

A
  1. Asset, Liability or firm commitment
  2. Highly probably forecast transaction
  3. Net investment in foriegn operation

Must expose the entity to the risk of changes in either

  • FV
  • Future CF’s
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3
Q

What are the 3 criteria needed to be classified as a Derivative?

A
  1. its value changes in response to a change in IR, FX, Commodity prices etc
  2. No or little inital investment
  3. Settled at a future date
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4
Q

Explain the recordings of derivatives

A

Derivatives are categorised as FV through the P&L (FVPL)

Each reporting period they are restated to the FV and recorded as an Asset or Liability and any gains/losses recorded through the P&L

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5
Q

What are the conditions needs for Hedge Accounting to be used:

A
  1. Must be highly effective (80-125%)
  2. Can be measured reliably
  3. Must be designated as hedge item at inception
    1. Formal documentation showing
      1. Hedged item
      2. Hedged Instrument
      3. Nature of risk hedged
      4. How entity will asses the hedging effectiveness
  4. Effectiviness assessement is done on ongoing basis
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6
Q

How is the effectivness of a hedge measured?

A

Comparing the movement of the hedged item and the movement of the hedged instrument

eg.

Item falls in value of 3.8m

Instrument gains in valie of 4.7m

3.8/4.7 = 80.85% or 4.7/3.8% = 123.68%

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7
Q

IFRS 7 Disclosures of Financial Instruments:

Explain what is meant by Qualatitive and Quantative disclousures:

A

Qualatitive:

  • MGMT objectives, policies and procedures for managing those risks
  • Risk exposures for each instrument
  • Changes from prior period

Quantative:

  • Provides information about the extent to which the entity is exposed to risk
  • Disclosuers about the 3 types of risk (Credit, Liquidity, Market)
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8
Q

What disclosuers must be made re the SOFP

A
  • Significance of Financial Instruments
  • Reclassifications or Derecognition of FI
  • Info about FI to be measured at FV
  • Rec between losses and breaches of loan agreements
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9
Q

What disclosuers must be made re the P&L

A
  • Income and expenses
  • Gains and losses
  • For FI no measured at FV through P&L, Interest Income and expense must be disclosed
  • Impairment losses on FI
  • Intertest income on imapaired assets
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10
Q

What ‘other’ disclosuers must be made re Financial Insturments

A
  • A/c policies for FI
  • Detailed info about Hedge Account (item/instrument)
  • CF Hedges: Expected time to hit P&L and any CF hedges that no longer occur
  • CF Hedges: Info of OCI recognised
  • FV Hedges: Any changes to item or instrument
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11
Q

Investment of £700m. Borrowings of £600m for this investment

Under IAS 39 what are the accounting treatment (in words)

A

G&L on designated hedging instruments (Borrowings) and Items (Net investment) are recorded in OCI

G&L on the unhedged element (100k) is recognised in the P&L

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12
Q

What are the entries (words and JNL) for a loss on a FWD contract in one years time if:

FWD Contract - Agreed to buy 400k P&M for $200 on 1/12/10

At YE Present Value of 400k = $180 on 30/06/10

Value at inception is Zero

A

As the value at inception is Zero this makes it a Cashflow Hedge.

The loss (You could have paid only $180 at year end prices) will be recorded in the OCI and carried FWD to match the future cashflow

DR OCI

CR Financial Liability

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13
Q

NOTE: Heding can be set up as part of a business overall Financial Strategy for the Long Term. But it always needs an end date

A
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14
Q

If an entity has a Net Foriegn investment and has used 80% Borrowing of net investment what are the entries if the FX rate changes between beginning and end of year

A

NFI is initally recorded at historic rate then translated at YE rate and Gain or Loss is in OCI

Borrowing is also initally recorded at historic rate and translated at YE rate and Gain or Loss in OCI

Gain or losses offset each other in OCI

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15
Q

What is the definition of Firm Commitment when looking at Hedged Item under IAS39

A

Binding agreement for the exhange of specific quantity on specific date at specific price

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16
Q

What are the steps on recognition of Derivative?

A
  1. FV on initial recognition which is usually Zero
  2. Restated at each reporting period to FV as FA or FL
  3. Gains or losses through P&L
17
Q

What are the main differences betwen Futures and Forwards

A

Futures have standard terms and are traded on financial markets

Forwards contracts are tailor made and are not exchanged

18
Q

What is a FV Hedge and where could it be used?

A

Changes in FV of

  • a recognised Asset or Liability
  • Unrecognised firm commitment
  • an identified portion of above

that is exposed to a particular risk that could affect the P&L

Hedge the risk in change in value of asset such as inventory

or

Interest rate swaps

19
Q

Explain what a Hedge of a net investment in a foreign operation

A

Used to eliminate the risk associated with changes in the value of the foreign investment due to FX movements

20
Q

Explain the movements of CF Hedges

A
  • The Gain or loss on the hedging instrument (or proportion that is deemed to be effective) is recognised in OCI
  • Then, when the underlying transaction affects the P&L (invoice or delivery date) the hedge stops and OCI entries are recycled into P&L
  • (NB. This is BEFORE the cashflow)
21
Q

Explain the transactions when looking at Net Investment Hedge Rules

A
  • Value is translated at Historic Rate and Closeing Rate
  • Any Gain or Losses matched against each other in OCI
  • Any remaining Gain or Loss in the ineffective part of hedge will be recognised in P&L
22
Q

What is the objective of IFRS 7

A

IFRS 7 = Disclosuers of Financial Instruments

  • Significance of FI for the entities Financial Position and Performance
  • Nature and extent of risks arising from FI and how they are managed
23
Q

Under IFRS 7 what are the categories of risk

A
  • Credit
  • Liquidity
  • Market
24
Q

Market Risk compromises of three types of risk. What are they?

A
  1. Currency risk
  2. Interest rate risk
  3. Other price risk
25
Q

Explain the treatment of a Interest Rate Swap

A

The Borrowing would be at FV in the SOFP with any gain or loss going to P&L

The Swap would be at FV in the SOFP with any gain or loss going to P&L

26
Q

Explain in words the treatment of Net Investment in Foregn operations

A

Gains or losses on the matched Investment and Hedging instrument are recorded in OCI

Gains or losses on the unmatched amount with goo direct to P&L

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