Hedge Accounting Flashcards
1
Q
What is the objective of hedge accounting?
A
- Simultaneous and identical presentation of hedged item and hedging instrument
- Elimination of impact on profit or loss
2
Q
What accounting Choice applies to hedge accounting?
A
- # IFRS9_7_2_21 –> one time only chance
- continuing applying IAS39
- apply IFRS 9
- cannot go back to IAS39 after
3
Q
What hedged items are defined in IFRS9
A
IFRS9_78
- Assets
- Liabilities
- Firm commitments
- already contract: deliver 1k christmas trees in December signed in july
- Highly probable forecast transactions (without legal obligations, like future purchases or sales)
- in april 21 enter hedging contract in april 22 for FX Risk
- Net investment in a foreign operation
- Group of above
4
Q
What are Hedging instruments?
A
- Derivatives #IAS39_72
- FX Risk –> non derivative Asset or liability
- written options generally no #IAS39_73, #IAS39_AG94
5
Q
What hedging strategies are allowed under IAS39
A
- Transaction based hedging ( #IAS39_78) (single risk, single hedging instrument)
- more than one risk, single hedging instrument ( #IAS39_76) (e.g. currency and interest rate risk)
- single risk, combination of hedging instruments ( #IAS39_77)
- Hedging of portions of risks of a financial instrument ( #IAS39_81)
6
Q
What hedging strategies do not qualify?
A
- Macro hedges
- exception: portfolio hedges of interest rate risk ( #IAS39_84 , #IAS39_78)
- Hedging internal transactions ( #IAS39_80)
- Hedging of groups of assets, liabilities, firm commitments or highly probable forecast transactions with unequal risk exposure ( #IAS39_78)
7
Q
What Accounting Models exist?
A
IAS39_86
Fair Value Hedge
- Asset/liability hedge against Market Risk
- main intent: debt instruments with fixed interest rate
### Cash Flow Hedge
- Hedge against future against CF risk
- main intent: debt instrument with variable interest rate
8
Q
What documentations are needed for hedges?
A
- Designation of relationship –> documentation ( #IAS39_88a)
- Hedging relationship
- Hedging objectives and
- Hedging strategies
- Documentation = identification ( #IAS39_88a)
- Hedging instrument
- Hedged item or underlying transaction
- Risk to be hedged
- If forecast transaction to be hedged, evidence of high probability and of related variations in cash flows ( #IAS39_88b )
9
Q
How is hedging effectiveness assessed?
A
- Measurability of hedge effectiveness ( #IAS39_88d)
- Expectation: high effectiveness at inception ( #IAS39_88b, #IAS39_AG105-113)
- Assessment of effectiveness during (range of 80% to 125%) ( #IAS39_88d #IAS39_AG105)
- Continuous assessment (at least quarterly) ( #IAS39_88e , #IAS39_AG106)
10
Q
What is the Methods for assessing Hedge Accounting?
A
- No method specified ( #IAS39_AG107)
- has to be
- appropriate
- used consistently for similar hedges
- documented
- Effectiveness measured between external hedging instrument and hedged item
- Evidence of effectiveness provided on period-by-period / cumulative basis over full term of hedging relationship
11
Q
What is the short cut method of Hedge Accounting?
A
- If critical terms of hedged item and hedging instrument match exactly, then prospective hedge effectiveness can be assumed
- notional and principal amount
- terms
- repricing dates
- dates of interest and principal receipts and payments
- basis of measuring interest rates
- No exception from requirement to demonstrate retrospective effectiveness (no short cut method) und IFRS
- USGAAP explicitly permitted
12
Q
When is hedge accounting discontinued?
A
- # IAS39_91, #IAS39_101
- no longer meets criteria
- instrument expires or is sold, terminated or exercised
- forecast transaction no longer expected
- Impact:
- seperate measurement of hedged item and hedging instrument
- hedged item according to rules for relevant category
- hedging instrument in profit or loss
- seperate measurement of hedged item and hedging instrument
13
Q
What is Fair Value Hedge?
A
- Hedging line items against possible FV changes with effect on profit or loss resulting from a specific risk – examples
- Hedging fixed interest rate loans against risk resulting from change of market interest rate
- Hedging future obligations to deliver resources against change in resource prices (price changing risk)
- According to the name Fair Value Hedge
- Hedging of changes of the fair value of a hedged item
- Example – fixed interest rate bond
- Market value of the bond fluctuates in respond to interest rate changes of the market (not restricted to intervention of central banks)
14
Q
What is the normal accounting treatment for the Fair Value hedged item?
A
- Adjustment of carrying amount by fair value changes attributable to hedged risk (hedge adjustment)
- Immediate recognition of these fair value changes in profit or loss
→ Deviation from general accounting principles for hedged items
15
Q
What is the normal accounting treatment for Fair Value Hedging instrument?
A
- Immediate recognition of fair value changes in profit or loss
→ In accordance with general accounting principles for derivatives
16
Q
What is the definition for a cashflow Hedge?
A
- Hedging cash flows against variability in cash flows that could affect profit or loss and result from a specific risk – examples
- Swap to convert a variable interest-bearing financial asset or a variable interest-bearing financial liability to a fixed interest rate financial asset or fixed interest rate financial liability
- Hedging of foreign currency risk of a highly probable purchase commitment with a fixed price in foreign currency
- According to the name Cash Flow Hedge
- Hedging of changes of variable cash flows of a hedged item
- Example – variable interest rate bond
- Cash flows of the bond fluctuates in respond to interest rate at the point in time of payments due to changes of the market day by day meanwhile
17
Q
What are special requirements for forecast requirements?
A
- High probability of occurrence ( #IAS39_78)
- No hedged item if forecast transaction cannot be sufficiently specified
- Possible changes in timing of forecast transaction do not affect hedging relationship if effectiveness does not change ( #IAS39_IG_F_5_4)
- In assessing likelihood that a transaction will occur to be considered ( #IAS39_IG_F_3_7)
- Frequency of similar past transactions
- Financial/operational situation which may prevent the transaction
- Substantial commitments of resources to a particular activity
- Extent of loss/disruption of operations if transaction does not occur
- Alternatives with different characteristics to achieve business purpose
- Entity’s business plan
18
Q
What is the accounting treatment in normal cases for Cashflow Hedged item?
A
- No adjustment of carrying amounts/recognition of adjustments of financial assets classified at FVtEquity (no hedge adjustment)
→ In accordance with general accounting principles for hedged items
19
Q
What is the accounting treatment in normal cases for cashflow hedging instrument?
A
- All changes attributable to effective portion of hedge to be recognised directly in revaluation reserve (OCI)
- Reclassification of gains and losses recognised directly in equity (OCI) into profit or loss in period in which hedged transaction affects profit or loss (at latest upon termination of hedging relationship)
→ Deviation from general accounting principles for derivatives
20
Q
What accounting treatment in special cases of forecast transactions for hedged item?
A
- Forecast transaction that results in assets or liabilities – gains or losses attributable to hedging instrument (derivative) that were recognised directly in equity to be treated as follows (subsequent treatment)
- Financial assets or financial liabilities: Reclassification into p/l in same period in which hedged item affects profit or loss ( #IAS39_97)
- Non financial assets or non financial liabilities: Same treatment as for financial assets/liabilities or inclusion in initial carrying amount of non financial asset or non financial liability ( #IAS39_98-99)
21
Q
What are the accounting treatments for special case of forecast transactions in case of early termination?
A
- Forecast transaction occurs: Accumulated gains or loss on hedging instrument remain separately in equity until forecast transaction occurs
- Forecast transaction does not occur: If forecast transaction is no longer expected to occur accumulated gain or loss on hedging instrument to be recognised in profit or loss immediately
- forecast transaction happens: subsequent treatment to differentiate further between kind of asset (financial or non financial)
- Treatment makes sure that hedge effect due to the hedging period remains valid after early termination
- In cases where no forecast transaction occurs economically hedging was not existent – accounting illustrates that effect as early as possible
22
Q
What are presentation on Balance Sheet of Hedged items and hedging instruments?
A
- Hedged item – no adjustments
- Hedging instrument (derivative) – resented as derivatives in hedge relationship (both as an asset or a liability)
23
Q
What are the presentation on income statements of hedged items and hedging instruments?
A
- Separate line item income/expense from hedge relationships for ineffective part
- Separate line item in equity (OCI) cash flow hedge reserve for effective part
24
Q
What are objective of hedge accounting in IFRS9?
A
- Reflect in financial statements the effect of an entity’s risk management activities
- Introduce a more principlebased approach
- Align hedge accounting more closely with risk management
-> Advantages more corporate than bank related
25
What are changes in micro hedge accounting?
- Qualifying hedged items ( #IFRS9_6_2_1 – #IFRS9_6_2_3)
- Combination of an exposure and a derivative, a component or percentage of a nominal amount, and ‘one-sided‘ risks
- Risk components as part of either a financial or non-financial item if separately identifiable and reliably measurable
- Kupferblöcke --> Durchschnittlicher Kupfergehalt wird berechnet und Anteil wird kupfergehedged
- Kaffe -> Kaffeepreis und USD als Risiko --> beides separat absicherbar
- Non-derivative financial instruments eligible for designation as a hedging instrument ( #IFRS_9_6_2_2)
- Hedge accounting for investments in equity instruments designated as at fair value through OCI allowed ( #IFRS_9_6_1_1)
- völliger Quark weil nichts bringt weil kein Transfer in GuV
- Hedge effectiveness assessment based on risk management strategy and only prospectively ( #IFRS9_6_1_1)
- Elimination of 80-125% range when determining hedge effectiveness
- Rebalancing of a hedge ratio to still meet risk management objective
- Consideration of new hedge accounting requirements only in context of closed portfolios
- No voluntary discontinuation of hedge accounting if hedging relationship still meets risk management objective
- Continue application of IAS 39 for portfolio hedge of interest rate risk ( #IFRS_9_6_1_3)
- Macro hedge accounting (hedge of open portfolios) not addressed (separate Discussion Paper in April 2014)
26
What are qualifying Hedged Items new in IFRS9?
- Risk components of non-financial items
- Aggregated exposure
- groups (restrictions removed)
- Net positions (with some restrictions)
27
What are non-qualifying hedged items?
- entity’s own equity instruments
- Most intragroup items
- Firm commitment to acquire a business in a business combination (except for FX risk)
- Fair value hedge of investments where at equity method used
- Risks that have no impact on P/L
28
How is hedge effectiveness defined in IFRS9?
#IFRS9_6_4_1
- Extent to which changes in fair value or cash flows of the hedging instrument offset changes in fair value or cash flows of hedged item
29
What criteria is for qualification of Hedge Effectiveness?
#IFRS9_6_3_4_1c
- Economic relationship between hedged item and hedging instrument and opposite movements in value
- Effect of credit risk does not dominate value changes
- Same hedge ratio as the one used in entity’s risk management provided no imbalance inconsistent with objective of hedge accounting
30
What is the derivative method regarding hedge effectiveness?
- Measurement method of changes in fair values on hedged item
- Hedge ineffectiveness:
- Change in FV of contracted derivative vs.
- Change in FV of hypothetical derivative
- Hypothetical derivative iteself – derivative with terms exactly matching the critical terms of the hedged item
31
What are sources of FV Hedge ineffectiveness?
- Credit risk (counterparty and entity’s own – CVA/DVA)
- Floating component of an interest rate swap in a FVH of the interest rate risk component of a fixed rate debt
- Designation of a debt instrument that includes a prepayment option hedged with a plain vanilla interest rate swap
- Hedging with options and time value not aligned
32
What are sources of CF Hedge inefectiveness?
- Credit risk (counterparty + own credit risk on derivatives)
- Basis risk (example – debt indexed on Euribor 6 month versus an interest rate swap indexed on Euribor 3 month)
- Interest rate resets (example – CFH of a floating debt indexed on Euribor 3 month resets in January, April, July, October with an interest rate swap resets in March, June, September, December)
- Forecast transaction occurs in an earlier (or later) period than originally anticipated
- Hedging with options and time value not aligend
33
What is the definition of rebalancing?
- Changes in quantities of the hedged items or hedging instruments ( #IFRS_9_B6_5_7)
- Allows continuation of a hedging relationship by adjusting hedge ratio
34
When is rebalancing required?
- changes in an economic relationship between hedged item and hedging instrument but without change in risk management objective ( #IFRS9_6_5_14b)
- Mandatory
35
How is rebalancing done?
- Continuation for the entire relationship – but ( #IFRS9_B6_5_8)
- Ineffectiveness in P/L just before rebalancing
- Accounting treatment depends on whether the change in hedge ratio is achieved by adjusting the hedged item or the hedging instrument
- Update formal documentation of the hedging relationship
36
What changes when volume of hedged item increases?
Hedged item
- Previously designated amount unchanged
- Additional volume is included from date of rebalancing
Hedging instrument unchanged
37
What changes when volume of hedged item decreases?
Hedged item
- Reduced volume unchanged
- Decrease in volume is discontinued from date of rebalancing
Hedging instrument unchanged
38
What changes when volume of hedging instruments increases?
Hedged Items unchanged
Hedging instruments
- Previously designated volume unchanged
- Additional volume is included from date of rebalancing
39
What changes when volume of hedging instruments decreases?
Hedged Items unchanged
Hedging instruments
- Reduced volume unchanged
- Decrease in volume is measured at FVTPL from date of rebalancing
40
When is hedge accounting discontinued obligatory?
- #IFRS9_6_5_10, #IFRS9_6_5_12
### When
- Qualifying criteria no longer met
- Hedging instrument expires or is sold, terminated or exercised
- Hedging effectiveness requirements no longer met (after rebalancing)
- Forecast transaction is no longer highly probable
### Impact
- CFH –amounts deferred in CFH to be recycled if forecast transaction no longer expected to occur
- (FVH – amortisation to begin when hedge accounting ceases)
- Option to designate hedged item and/ or hedging instrument in a new hedge relationship – prospective effect
- Specific treatment for elements excluded from designation
