FAR CPA Lessons 187-205 Flashcards
1
Q
Define business combination
A
a transaction or an event in which an acquirer obtains control of a business.
2
Q
Define transaction
A
when there is an exchange of consideration between two parties
3
Q
Define control
A
voting control and is essentially greater than 50% voting interest.
4
Q
Define Business
A
an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return
5
Q
FASB ASU 2017-01 - determination is a group of assets is not a business
A
“substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or group of similar assets, the set is not a business.”
This screening means that if the acquisition value is concentrated in only one type of asset, then the acquisition is an asset acquisition, not a business combination.
6
Q
3 legal forms of business combinations
A
merger, consolidation, and acquisition
7
Q
Explain a merger
A
One preexisting entity acquires either a group of assets that constitute a business or controlling equity interest of another preexisting entity and “collapses” the acquired assets or entity into the acquiring entity.
8
Q
Explain a Consolidation
A
A new entity consolidates the net assets or the equity interests of two (or more) preexisting entities.
9
Q
Explain an Acquisition
A
One preexisting entity acquires controlling equity interest of another preexisting entity, but both continue to exist and operate as separate legal entities.
10
Q
Legal Merger/Consolidation
A
All of the assets and liabilities of the acquiree are recorded on the acquirer’s general ledger. The acquiree will no longer exist. After this type of combination, only one entity exists, therefore there is no need to prepare Consolidated Financial Statements.
11
Q
legal acquisition
A
one entity (the acquirer) buys controlling interest (> 50%) of the voting stock of a target entity (the acquiree) and both entities (acquiring and acquired entities) continue as separate legal and accounting entities.
The acquirer records its ownership of the stock of the acquiree as a long-term investment.
The acquirer does not record (pick up) on its books the assets and liabilities of the acquiree.
an acquisition usually does require preparation of Consolidated Financial Statements, those of the acquirer together with those of the acquiree(s)
12
Q
Accounting at the date of combination
A
- Only the acquirer’s (acquiring firm’s) operating results (income/loss) up to the date of combination enter into determination of consolidated net income as of the date of the combination
- The acquiree’s operating results up to the date of the combination will be closed (or treated as closed) to its retained earnings.
- The acquiree’s retained earnings as of the date of the combination will be part of the acquiree’s equity eliminated against the acquirer’s investment account in the consolidating process. (The acquiree’s retained earnings as of the date of the combination is part of the equity “paid for” by the acquirer when it makes its investment.)
13
Q
Which of the 3 legal forms of business combinations are the asses & liabilities of an acquired entity record on the books of the acquiring entity?
A
Merger - Yes
Acquisition - No
Consolidation - Yes
14
Q
Which of the 3 legal forms of business combinations does at least one preexisting entity cease to exist?
A
Merger - Yes
Acquisition - Yes
Consolidation - No
15
Q
Which of the 3 legal forms of business combinations does more than one entity survive?
A
Merger - No
Acquisition - No
Consolidation - Yes
16
Q
Which of the 3 legal forms of business combinations are two or more entities combined into one new entity?
A
Merger - No
Acquisition - Yes
Consolidation - No
17
Q
Transactions that are exempt from applying the acquisition method of accounting
A
- The formation of a joint venture
- The acquisition of an asset or group of assets that does not constitute a business
- A combination between entities under common control
- A combination between not-for-profit organizations
- The acquisition of a for-profit entity by a not-for-profit organization
18
Q
Steps of applying the acquisition method
A
- Identifying the acquiring entity (the acquirer)
- Determining the acquisition date and measurement period
- Determining the cost of the acquisition
- Recognizing and measuring the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquired business (the acquiree)
- Recognizing and measuring goodwill or a gain from a bargain purchase, if any
19
Q
The acquirer of a variable interest entity
A
the primary beneficiary of the variable interest entity
20
Q
Measurements that must be identified and measured during the measurement period
A
- Identifiable assets, liabilities, and noncontrolling interest in the acquiree
- Consideration transferred to obtain the acquiree
- Any precombination interest held in the acquiree
- Any goodwill or bargain purchase gain
21
Q
How will additional identifiable assets or asset amounts effect goodwill?
A
Decrease in goodwill
22
Q
How will additional identifiable liabilities or liability amounts effect
A
Increase in goodwill
23
Q
The acquisition date of a business combination is generally what date?
A
The closing date
24
Q
The two ways an acquirer may obtain control of a business
A
- By transferring consideration to either another entity or its owner(s):
- To obtain a group of assets that constitute a business, or
- To gain control of another entity.
- Without transferring consideration.
25
Explain contingent consideration
Contingent consideration should be recognized on the acquisition date at fair value as part of the consideration transferred in exchange for the acquired business.
Two ways that an acquisition can be considered contingent:
A. An obligation of the acquirer to transfer additional assets or equity interest to the former owner(s) of the acquired business as part of the consideration if future events occur or conditions are met, or
B. A right of the acquirer to a return of previously transferred consideration if specific conditions are met.
26
Accounting for contingent consideration
Obligation to pay contingent consideration - Liability of equity
A right to the return of previously transferred consideration - Asset
27
Acquisition costs include
1. Finder's fees
2. Advising, legal, accounting, valuation (appraisal) and other professional and consulting fees
3. General administrative costs, including the cost of an internal acquisitions department
4. Cost of registering and issuing debt and equity securities in connection with an acquisition
28
Accounting for acquisition costs
Acquisition-related costs (except as noted in D, below) should be expensed in the period in which the costs are incurred and the services are received; these costs are not included as part of the cost of an acquired business.
29
The cost of an acquired business is the sum of:
1. Fair value of assets transferred by the acquirer
2. Fair value of liabilities incurred by the acquirer
3. Fair value of equity interest issued by the acquirer
4. Fair value of contingent consideration (net) obligations of the acquirer
5. Fair value of share-based payment awards for precombination services that the acquirer is obligated to provide
30
At the acquisition date, the acquirer must recognize:
(distinct from goodwill, if any) the identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree.
31
When can the acquirer recognize an intangible asset?
- It is capable of being separated from the acquiree and sold, transferred, leased, rented, or exchanged (e.g., customer lists); or
- It arises from contractual or other legal rights.
32
Exceptions to the general recognition and/or measurement principles at acquisition
1. Contingencies
2. Income Tax Issues
3. Employee Benefits
4. Indemnification Asset
5. Reacquired Rights
6. Share-Based Payment Awards
7. Assets Held for Sale
33
Exceptions to the general recognition and/or measurement principles at acquisition for Contingencies
- Contingencies related to existing contracts (contractual contingencies—e.g., warranty obligations) should be recognized and measured at fair value.
- Contingencies not related to existing contracts (noncontractual contingencies—e.g., lawsuits) should be recognized and measured at fair value only if it is more likely than not as of the acquisition date that the contingency will give rise to an asset or a liability, and the fair value is readily determinable.
34
Exceptions to the general recognition and/or measurement principles at acquisition for Income Tax Issues
- The acquirer will recognize and measure a deferred tax asset or liability related to assets acquired and liabilities assumed in a business combination
- The acquirer will account for the potential tax effects of temporary differences, carry forwards and income tax uncertainties of an acquiree at the acquisition date, or that will result from the acquisition
35
Exceptions to the general recognition and/or measurement principles at acquisition for Employee Benefits
The acquirer will recognize and measure a liability (or asset, if any) related to the acquiree's employee benefit arrangements in accordance with applicable GAAP.
36
Exceptions to the general recognition and/or measurement principles at acquisition for Indemnification Asset
The acquirer normally would recognize the indemnification benefit as an asset (indemnification asset) at the time and using the same measurement basis as the indemnified asset or liability.
37
What is an Indemnification Asset?
represents the promise by the seller to reimburse (indemnify) the acquirer if there are any adverse outcomes from a contingent liability. Typically in a business combination the indemnification would establish a seller's guarantee, which limits the acquirer's liability for the outcome of an uncertainty related to an identifiable asset or liability.
38
Exceptions to the general recognition and/or measurement principles at acquisition for Reacquired Rights
- If, as part of the business combination, the acquirer reacquires that right, it should be recognized by the acquirer as an intangible asset and measured on the basis of the remaining contractual term of the contract that granted the right.
- Subsequent to the business combination, the intangible asset “reacquired right” should be amortized over the remaining period of the contract that granted the right.
39
Exceptions to the general recognition and/or measurement principles at acquisition for Share-Based Payment Awards
The liability or equity recognized as a result of such awards should be measured in accordance with the provisions of ASC 718.
40
Exceptions to the general recognition and/or measurement principles at acquisition for Assets Held for Sale
Long-term assets acquired by the acquirer, which it classifies as held for sale at the acquisition date should be measured at fair value less cost to dispose
41
Accounting for precombination equity (For instance a 35% shareholder became an 80% shareholder - accounting for the 35%)
Any difference between the fair value of the acquirer's precombination equity interest in the acquiree and the carrying value of that interest on the acquirer's books would be recognized by the acquirer as a gain or loss in income of the period of the combination. Fair value less carrying value
42
Accounting for any Noncontrolling Interest at acquisition date
he noncontrolling interest and must be measured at fair value at the acquisition date - it is NOT valued as a proportional interest in the identifiable assets acquired, liabilities assumed and share of goodwill
43
The investment value is the sum of:
1. The fair value of Assets transferred
2. T he fair value of Liabilities incurred
3. The fair value of Equity interest issued
4. The fair value of Contingent consideration (at acquisition date)
5. The fair value of Required share-based payment awards to employees for precombination services
6. The fair value of Precombination equity of the acquiree held by the acquirer
7. The fair value of the noncontrolling interest in the acquiree (if any)
44
Goodwill results when
The investment value is greater than the net fair value of assets assumed and liabilities incurred at the date of the business combination
45
A bargain purchase results when
The investment value is less than the net fair value of assets assumed and liabilities incurred as of the date of the business combination
46
Accounting for goodwill
Goodwill is not amortized.
| Goodwill is assessed at least annually for impairment
47
Accounting for a bargain purchase
* Before recognizing a gain from a bargain purchase the acquirer must fully reassess whether all assets acquired and liabilities assumed have been identified and properly measured according to the provisions
- the amount of that bargain purchase shall be recognized as a gain in earnings as of the date of the business combination.
48
How does goodwill affect assets being tested for recoverability
goodwill arising from an acquisition business combination shall be allocated to the long-lived assets and identifiable intangible assets being tested for recoverability only if the asset group is or includes a reporting unit.
49
Accounting for Assets and Liabilities Arising from Contingencies Post Acquisition
- Until new information about the possible outcome of a contingency is received, the acquirer will continue to report the contingency at its fair value at the date of the combination.
Upon receiving new information -
- If the contingency is a liability, it will be measured and reported at the higher of:
1. Its acquisition-date fair value, or
2. The amount that would be recognized if the requirements of ASC 450 were followed.
- If the contingency is an asset, it will be measured and reported at the lower of:
1. Its acquisition-date fair value, or
2. The best estimate of its future settlement amount.
50
Accounting for Indemnification Assets Post Acquisition
An indemnification asset recognized in a business combination should be measured and reported on the same basis as the liability or asset that is indemnified, subject to any contractual limitations.
51
Accounting for Contingent Consideration Post Acquisition
Changes in the fair value of contingent consideration that results from events after the business combination (including reaching a specific share price, meeting an earnings target, etc.) are not measurement period adjustments and do not change the cost of the investment
- Contingent consideration classified as an asset or liability is remeasured at each reporting date and recognized in earnings
- Contingent consideration classified as equity is not remeasured and its subsequent settlement is accounted for within (by adjusting) equity;
52
Pushdown Accounting
The acquiree may elect to apply pushdown accounting each time there is a change in control. This is considered a change in accounting principle.
- it would revalue all of the assets and liabilities to acquisition date fair value as determined by the acquirer in its application of ASC 805.
- Adjustmendts to Paid in Capital - Not a gain on income statement
53
disclosure requirements for Pushdown Accounting
- If the acquiree applies pushdown accounting, it should disclose the effects of the pushdown accounting on its separate financial statements so that the financial statement user can evaluate the effects of pushdown accounting.
- If the acquiree does not elect to apply pushdown accounting, the entity should disclose that it has undergone a change in control event and that it elects to prepare its separate financial statements using its historical basis.
54
Which categories have the most differences between IFRS and GAAP when accounting for business combinations?
differences in the accounting for contingencies and goodwill
55
IFRS & GAAP differences in reporting for contingent assets & Liabilities
US GAAP - can be recognized if criteria are met
IFRS - Contingent assets cannot be recognzied
56
IFRS & GAAP differences in reporting for Goodwill
US GAAP - Goodwill is allocated to the reporting units
IFRS - Goodwill is allocated tot eh cash generated
57
IFRS & GAAP differences in reporting for Goodwill impairment testing
US GAAP - Goodwill impairment testing has a qualitative prestep and then, if needed, a 2 step approach
IFRS - Goodwill impairment testing is a 1 step approach
58
IFRS & GAAP differences in reporting for Pro Forma disclosures
US GAAP - Must disclose pro forma information for current and prior periods presented
IFRS - Must disclose pro form information only for current period
59
IFRS & GAAP differences in reporting for disclosures of assumptions
US GAAP - Not required to disclose assumptions related to acquired contingencies
IFRS - Required to disclose assumptions related to acquired contingencies
60
Financial assets
- Cash and cash equivalents
- Accounts receivable
- Investments in debt (notes, bonds, etc.) and equity securities (common and preferred stock, etc.)
- Interest in partnerships, limited liability entities, and joint ventures
- Option contracts (w/favorable terms)
- Futures and forward contracts (w/favorable terms)
- Swap contracts (w/favorable terms)
61
Financial liabilities
- Accounts payable
- Notes and bonds payable
- Option contracts (w/unfavorable terms)
- Futures and forward contracts (w/unfavorable terms)
- Swap contracts (w/unfavorable terms)
62
Accounting for transaction costs associated with financial instruments
- Cost related to fair value measurement are excluded from the cost of the financial instrument
- Usually the costs directly attributable to the financial item are expensed when incurred
- Costs associated with debt issuance are treated as deferred costs
63
Four possible purposes for which a derivative instrument is held
1. To speculate;
2. As a fair value hedge;
3. As a cash flow hedge; or
4. As a foreign currency hedge.
64
Legal merger
One preexisting entity (acquirer) acquires either a group of assets that constitutes a business or controlling interest in the stock of another preexisting entity (acquiree) and merges the acquired assets or other entity (assets and liabilities) into the acquirer entity.
65
Legal consolidation
A new entity is created to consolidate two or more preexisting entities.
-The preexisting entities cease to exist as legal entities.
66
Assets are Liabilities acquired by the acquirer are measured at fair value except:
1. Acquired income tax related items, including deferred tax assets or liabilities
2. Employee benefit liabilities or assets
3. Indemnification asset
4. Re-acquisition rights
5. Share-based employee payment awards
6. Assets held for sale
67
If investment value > fair value of net assets
goodwill is recognized
68
If fair value of net assets > investment value
a bargain purchase gain is recognized
69
In a business combination how are the retained earnings balances accounted from from the acquired firms?
These amounts will be eliminated when the firms are consolidated, not carried forward. As a newly formed entity, the new entity will have no retained earnings until after an operating period.
70
financial instrument
A financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity.
71
Financial asset
Any asset that is:
a. Cash;
b. An equity instrument of another entity (such as stock issuance);
c. A contractual right to receive cash or another financial asset from another entity; or
d. A contractual right to exchange financial instruments with another entity under conditions that are potentially favorable.
72
Financial liability
Any liability that is a contractual obligation to:
a. Deliver cash or another financial asset to another entity; or
b. Exchange financial instruments with another entity under conditions that are potentially unfavorable.
73
default classification category for financial assets
- Fair Value through Profit or Loss (FVTPL)
- This classification includes any financial assets held for trading and also derivatives, unless they are part of a properly designated hedging arrangement
- Changes in value are reported as gains or losses in profit or loss (net income) at each reporting date.
74
Business model test
The entity's objective is achieved by both holding financial assets to collect cash flows and by selling financial assets.
75
Cash flow characteristic test
The requirement is that the contractual cash flows collected on specified dates are solely payment of principal and interest (SPPI) on the principal amount outstanding. If this test is not met, the asset is measured at fair value.
76
Classification of equity securities
Fair Value through Other Comprehensive Income (FVTOCI) must be elected and is irrevocable
-Changes in value are reported in other comprehensive income at each reporting date; only dividend income is recognized in profit or loss.
77
is what circumstances can a debt instrument be reported at amortized cost?
Ff it meets the following two conditions:
1. Business model test—The entity's objective is to hold the financial asset to contractual maturity.
2. Cash flow characteristic test—The requirement is that the contractual cash flows collected on specified dates are solely payment of principal and interest (SPPI) on the principal amount outstanding.
78
Impairment requirements under IAS 9
1. A single impairment model is applied to debt instruments measured at amortized cost or FVOCI as well as loan commitments
2. requires an entity to recognize expected credit losses at all times and to update the expected credit losses at each reporting date. This model is forward-looking and eliminates the threshold of waiting for a trigger event to be identified first.
79
Performing instruments
(stage 1) have not deteriorated significantly in credit quality since initial recognition or have low credit risk.
- 12-month expected credit losses are recognized.
- Interest revenue is calculated on the gross carrying amount of the asset.
80
Underperforming
(stage 2) financial assets have deteriorated significantly in credit quality, and their credit risk has increased significantly since initial recognition. The instrument does not have objective evidence of a credit loss event.
- Lifetime expected credit losses are recognized.
- Interest revenue is calculated on the gross carrying amount of the asset.
81
Nonperforming
(stage 3) financial assets do have objective evidence of impairment at the reporting date.
- Lifetime expected credit losses are recognized.
- Interest revenue is calculated on the net carrying amount (reduced for expected credit losses).
82
Impairment Disclosures
- Basis for its expected credit loss calculations
- How it measures expected credit losses and assesses changes in credit risk.
- a reconciliation from the opening allowance balance for 12-month loss allowance
83
How are Financial liabilities held for trading measured
measured at fair value with changes in fair value through profit or loss (FVTPL).
84
How are All other financial liabilities measured?
measured at amortized cost using the effective interest rate method unless the fair value option is applied. Trade payables generally are not subject to discounting unless discounting is material.
85
Under IFRS how is an asset tested for impairment?
1. When there is objective evidence that a financial asset is impaired, its recoverable amount must be determined.
2. The difference between recoverable amount and carrying value is the impairment loss.
3. Impairment losses are recognized in income.
86
Practicable to Estimate
Means that fair value estimates can be made without incurring excessive costs; it is a cost/benefit assessment. If it is not practicable to estimate fair value, the following must be disclosed:
1. The reasons that it is not practicable to estimate fair value, and
2. Information pertinent to estimating fair value, such as carrying amount, effective interest rate, and maturity.
87
Disclosures about fair value are not required for the following financial items:
1. Employer's and plan's obligations for pension benefits, postretirement benefits, postemployment benefits, employee stock option and stock purchase plans, and other forms of deferred compensation arrangements
2. Substantially extinguished debt
3. Insurance contracts and certain investments made by insurance entities
4. Lease contracts
5.Warranty obligations and rights
6.Unconditional purchase contracts
7.Investments accounted for under the equity method
8. Noncontrolling interest in a consolidated subsidiary
9.Equity instruments issued and classified in shareholders' equity
10, trade accounts receivable or trade accounts payable when their carrying amounts approximate fair value
88
Define Credit Risk
he possibility of loss from the failure of another party (or parties) to perform according to the terms of a contract.
89
Define Concentrations of Credit Risk
occurs when an entity has contracts of material value with one or more parties in the same industry or region or having similar economic characteristics (e.g., receivables from a group of highly leveraged entities).
90
Disclosure requirements for Concentrations of Credit Risk
1. Information about the common activity, region, or economic characteristic that identifies the concentration;
2. The maximum amount of loss due to the credit risk
3. The entity's policy of requiring collateral or other security to support financial instruments subject to credit risk
4. The entity's policy of entering into master netting arrangements to reduce the credit risk associated with financial instruments
91
Define Market risk
the possibility of loss from changes in market value due to changes in economic circumstances, not necessarily due to the failure of another party.
92
SEC registrants are required to provide qualitative disclosures about:
1. Market risk
2. Interest rate risk
3. Foreign currency risk
4. Commodity price risk
5. Similar risks
Required to provide separate presentation in the balance sheet of financial instruments by class
GAAP does not require substantive qualitative disclosures about financial instruments.
93
derivative
a financial instrument (or other contract) with all three of the following elements:
1. It has one or more underlying and one or more notional amounts or payment provisions
2. Derivatives require little or no initial net investment.
3. Its terms require or permit a net settlement
94
Define an underlying
any financial or physical variable that has either observable changes or objectively verifiable changes.
95
Define notional
amounts are the “number of currency or other units” specified in the financial instrument or other contract.
96
Examples of derivative contracts
- Option contracts
- Future contracts (Made through a clearing house)
- Forward Contracts (Not made through a clearning house)
- Swap Contracts
97
Items that are NOT considered derivatives for accounting purpsoes
1. Normal purchases and sales contracts
2. Regular security trades
3. Traditional life insurance and property and casualty insurance contracts
4. Investments in life insurance
5. Contracts indexed to a company's own stock
6. Contracts issued in connection with stock-based compensation arrangements
7. Contracts to enter into a business combination at a future date.
98
Embedded Derivative
An embedded derivative exists when the host contract contains a term or component that behaves like a derivative.
99
hybrid instrument
The instrument containing both the host contract and the embedded derivative
100
Bifurcation
The process of separating an embedded derivative from its host contract.
101
value components of options
1. Call (right to buy)—A call is in-the-money when the strike price is less than the spot price.
2. Put (right to sell)—A put is in-the-money when the strike price is greater than the spot.
3. Assume—Stock with a $30 market value has an at-the-money option with a strike price of $30 (market = strike so the entire option value at the time of purchase is time value—this is an at-the-money option), and this option sells for $2 and is good for 60 days.
102
Option value =
intrinsic value + time value
103
Hedging
Hedging Is a Risk Management Strategy—Hedging involves using offsetting (or counter) transactions or positions so that a loss on one transaction or position would be offset (at least in part) by a gain on another transaction or position (and vice versa).
104
In the Money
the price of the underlying is greater than the strike or exercise price of the underlying, the call option is
105
At the Money
the price of the underlying is equal to the strike or exercise price.
106
Natural or economic hedges
both the underlying risk and the derivative instrument are marked-to-market value through earnings. The changes in the value of the hedged risk and derivative offset—to the extent these match, there is no impact on net income.
107
Criteria to Use Hedge Accounting
1. Formal designation and documentation at inception of the hedge including the hedging relationship, the entity's strategy and objective for undertaking the hedge, the nature of the risk being hedged, and the methods used to assess effectiveness.
2. Eligibility of hedged items and transactions
3. Eligibility of hedging instruments
4. Hedge effectiveness; the hedge should be expected to be highly effective throughout its life
108
Hedged Item
The recognized asset, recognized liability, commitment, or planned transaction that is at risk of loss; it is the possible loss on the hedged item that is hedged.
109
Hedging Instrument
The contract or derivative instrument that is entered into to mitigate or eliminate the risk of loss associated with the hedged item.
110
Options for accounting for hedge accounting
- Fair Value Hedge
- Cash Flow Hedge
- Foreign Currency Hedge
111
Fair Value Hedge:
- A hedge of the exposure to changes in the fair value of the following, because of a particular risk:
- A recognized asset or liability or
- An unrecognized firm commitment
112
Cash Flow Hedge:
- A hedge of the exposure to variability in the cash flows of the following, because of a particular risk:
- A recognized asset or liability or
- A forecasted transaction
113
Foreign Currency Hedge:
- A hedge of the foreign currency exposure of any of the following:
- An unrecognized firm commitment
- An available-for-sale security
- A forecasted transaction
- A net investment in a foreign operation or
- Foreign currency—denominated assets and liabilities
114
For financial assets and financial liabilities, the following risks can be hedged:
- Commodity price risk
- Interest rate risk
- Foreign exchange risk
- Credit risk (except not for investments in available-for-sale securities)
115
Items Not Eligible for Hedge Accounting
- An investment accounted for using the equity method of accounting
- A firm commitment to carry out a business combination
- A noncontrolling interest in a subsidiary
- Transactions between entities included in consolidated statements, except for foreign currency–denominated - forecasted intra-entity transactions
- Transactions with shareholders as shareholders (e.g., projected purchase of treasury stock or payment of dividends)
116
Instruments excluded from being used as a hedging instrument
- A nonderivative instrument (e.g., U.S. Treasury note), except as permitted in certain intracompany cases
- Components of a compound derivative instrument used for different risks.
- A hybrid financial instrument if:
- It is irrevocably elected to be measured in its entirety at fair value under the fair value option, or
- It has an embedded derivative that cannot be reliably identified and measured.
117
Interest rates that may be hedged
1. Direct U.S. Treasury obligations
2. London Interbank Offer Rate (LIBOR)
3. The securities industry swap rate
118
If the hedged item is the cash flow from a forecasted transaction, it cannot involve:
1. A business combination;
2. A parent's equity interest in a subsidiary; or
3. An entity's own equity instruments.
119
Foreign Currency Hedge
The hedge of an exposure to changes in the dollar value of assets or liabilities (including certain investments) and planned transactions that are denominated (to be settled) in a currency other than an entity's functional currency (i.e., a foreign currency).
120
Forecasted foreign-currency-denominated transactions
The risk being hedged is the risk that exchange rate changes will have on the cash flow from nonfirm but planned transactions to be settled in a foreign currency.
121
Unrecognized foreign-currency-denominated firm commitments
The risk being hedged is the risk that exchange rate changes will have on the fair value or cash flow of firm commitments for a future sale or purchase to be settled in a foreign currency.
122
Net investments in foreign operations
The risk being hedged is the risk that exchange rate changes will have on the fair (economic) value of financial statements converted from a foreign currency to the functional currency.
123
Required effectiveness percentage to be considered highly effective
between 80 and 125% in order for the hedge to qualify for hedge accounting.
124
Prospective Consideration Assessing Hedge Effectiveness
A forward-looking assessment of the entity's expectations that a planned hedging relationship will be highly effective over future periods in achieving offsetting changes in fair value or cash flows.
Generally, the prospective assessment involves a probability-weighted analysis of the possible changes in fair value and/or cash flows.
125
Retrospective Evaluation Assessing Hedge Effectiveness
When a relationship between an instrument and an item qualifies as a hedge for accounting purposes, the relationship must continue to be assessed for effectiveness whenever financial statements are reported, and at least every three months.
126
General disclosure requirements for Hedge Accounting
1. It's objective for holding the derivative and the context needed to understand the objective
2. Distinguish between instruments used for risk management (hedging) and those used for other purposes
3. Each instrument's underlying risk exposure
4. distinguish between instruments designated as fair value hedges, cash flow hedges, hedges of foreign currency exposure of net investments in foreign operations, and any other derivatives.
5. enable users to understand the volume of its derivative activities
6. Quantitative disclosures must be presented in tabular format.
7. If information on derivatives is disclosed in multiple footnotes, the derivative-related footnotes must be cross-referenced.
127
Balance Sheet–Related Disclosures for hedge accounting
The location (line item) and fair value amounts of derivative instruments
Fair value must be presented as the gross amount, shown separately as assets and liabilities and separately for each type of hedge
disclose the amounts reclassified from accumulated other comprehensive income to current income
128
Income Statement Related disclosures for hedge accounting
The location (line item) and amounts of gains/losses on derivative instruments.
Gains and losses must be presented separately for each type of hedge
disclose the amounts reclassified from accumulated other comprehensive income to current income
Disclose any amounts that no longer qualify for hedge accounting
129
Differences between GAAP and IFRS for hedge accounting
- IFRS definition does not include reference to notional concept or element.
- IFRS - embedded derivatives can only be assessed at the initiation of a contract
- IFRS - Normal purchase/sale is not considered a derivative and no formal documentation is necessary
- IFRS Embedded derivatives are separated a reported as multiple derivatives
- IFRS - hedging is allowed for business combinations with foreign risk
- IFRS - part-term hedging is allowed
- IFRS Nonderivative items can be used as hedging instruments
- IFRS - interest rate does not need to a benchmark rate
- IFRS - shortcut method is not permitted
