IAS 32 and IAS 39 - ibr-ire.be · PDF fileIAS 32 and IAS 39 Accounting for Financial Instruments Advanced – IBR ... Hedge accounting criteria Exposure must be due to specific hedgeable

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IAS 32 and IAS 39IAS 32 and IAS 39

Accounting for Financial InstrumentsAccounting for Financial Instruments

Advanced – IBR – 3 december 2010Advanced – IBR – 3 december 2010

© 2010 KPMG Bedrijfsrevisoren/Réviseurs d’Entreprises, a Belgian civil CVBA/SCRL and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Printed in Belgium. IAS 32/39 - 1

DisclaimerDisclaimer

Th i f ti t i d h i i f l t d i tThe information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or

entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be

accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the

particular situation.

© 2010 KPMG Bedrijfsrevisoren/Réviseurs d’Entreprises, a Belgian civil CVBA/SCRL and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Printed in Belgium. 2

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AgendaAgenda

Definitions categories recognitionDefinitions categories recognitionDefinitions, categories, recognition and measurement

Hedge accounting

Presentation

Definitions, categories, recognition and measurement

Hedge accounting

Presentation


Definition of financial instrumentsDefinition of financial instruments

A financial instrument is a contract that gives rise to:• a financial asset of one entity and • a financial liability or equity instrument of another entity

Financialasset

CashEquity instrument of another entityContractual right to receive cash or another

Financialliability

Equity instrument

Contractual obligation to deliver cash or another financial asset or to ex-change financial asset or liabilities under potentially unfavourable conditions

Contract evidencing a residual interest in the assets of an entity after deducting all of its liabilities

a financial liability or equity instrument of another entity


financial asset or to exchange financial assets or liabilities under potentially favourable conditionsCertain contracts settled in the entity’s own equity

unfavourable conditionsCertain contracts settled in the entity’s own equity

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Categories of financial instrumentsCategories of financial instruments

4 categories of financial assets:

A financial asset at fair value through profit or loss

Held-to-maturity investments

Loans and receivables

Available-for-sale financial assets


Categories of financial instrumentsCategories of financial instruments

2 categories of financial liabilities:

A financial liability at fair value through profit or loss

Other financial liabilities


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Definition - DerivativeDefinition - Derivative

Three characteristics

No or little initial net investment

Settled at a future date

Fair value changes in response to the change in underlying

Interest rate,Security price, Commodity price


Commodity price, Foreign exchange rate, Credit rating, orOther index

RecognitionRecognition

All financial assets and financial liabilities, including derivatives,

should be recognised on the balance sheet when the entityshould be recognised on the balance sheet when the entity

becomes party to the contractual provisions of the instrument

Financial assets

@

Financial liabilities

@


“fair value of consideration

given”

“fair value of consideration

received”

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Subsequent measurement of financial instrumentsSubsequent measurement of financial instruments

Instrument Measurement Value changes

P&LFinancial assets at fair value through profit or loss Fair value

Not relevant(unless impaired)

P&L

Held-to-maturity investments

Amortised cost(effective interest rate)

Not relevant(unless impaired)

Amortised cost(effective interest rate)

Loans and receivables

Available-for-sale Fair value

g p

Financial liabilities at fair

Equity(unless impaired)


P&L

P&L

Derivatives Fair value

Financial liabilities at fair value through profit or loss Fair value

Other liabilities Not relevantAmortised cost

AgendaAgenda


Hedge accounting

Presentation


Hedge accounting

Presentation


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Introduction to hedge accountingIntroduction to hedge accounting

To hedge or not to hedge

i t th tiis not the question

Whether to apply hedge accounting

that is the issue


How are financial risk management and hedge accounting related?How are financial risk management and hedge accounting related?

Financial Risk Management

Accept risks Mitigate risks

Hedging

Typesof Financial

Risks

Risk objectsand

exposure

RM tacticsRM

Instruments

Risk identification Risk Management Strategy


Other

Hedge accounting

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Reasons for Special Hedge AccountingReasons for Special Hedge Accounting

Recognition mismatchesbetween hedged item

and hedging instruments

i.e.because the hedged item is not

yet recognised in the balance sheet

Measurement mismatchesbetween hedged item

and hedging instruments

i.e.because the hedged item is not

measured at fair value


recognised in the balance sheetor in the income statement

measured at fair value

Hedgeable risksHedgeable risks

Hedgeable risks on financial asset/liability:

Interest rate risk

Foreign currency risk

Credit risk

Equity price risk

Hedgeable risks on non-financial asset/non-


financial liability:

Entire risk

Foreign currency risk component

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Hedged itemHedged item

To qualify for designation the hedged item should create an exposure to risk that ultimately affects profit or loss

The following can be designated as hedged items:

A single or group of assets/liabilities

Firm commitments or highly probable forecast transactions

Non-financial assets/liabilities for foreign currency risk or the entire risk

A portion of the cash flows on any financial asset/liability


A portion of the cash flows on any financial asset/liability

Net investments in foreign operations

Net positions cannot be designated as hedged items

Hedging instrumentHedging instrument

The following can be designated as hedging instruments:

All derivatives with third parties

Non-derivatives for a hedge of foreign currency risk

Combination of two or more derivatives or non-derivatives, except for net written options

Portion of hedging instrument can be used as well (say 50% of the notional)


Hedging instrument cannot be designated for a portion of its life

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Types of hedgesTypes of hedges

Fair value hedges

Hedge of exposure to changes in fair value of:

Cash flow hedges

Hedge of exposure to variability in cash flows that is:attributable to a particular risk associated with a recognised asset or liability or a

a recognised asset or liability; an unrecognised firm commitment; or an identified portion of any of the above two;

that is attributable to a particular risk; and

could affect P&L


attributable to a particular risk associated with a recognised asset or liability or a highly probable forecast transaction (also an inter-company one); and

could affect P&L

Hedges of a net investment in a foreign operation

Fair value hedge accounting modelFair value hedge accounting model

Measurement of hedging instrument

Changes in fair value

Fair value

Measurement of hedged item

Fair value with

Profitor

loss


Fair value with respect to risk

being hedged (*)

(*) This applies even if a hedged item is otherwise measured at cost

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Cash flow hedge accounting modelCash flow hedge accounting model

Changesin fair valueMeasurement of

EffectiveEquity

(*)

hedging instrument

Fair value


Profitor loss

(*) Based on timing of earnings impact of hedged item (e.g. cost of sales, depreciation, interest)

Hedge accounting criteriaHedge accounting criteria

Exposure must be due to specific hedgeable risk that ultimately affects earnings

At inception, the hedge must be expected to be highly effective and effectiveness must be reliably measurable

The hedge must remain highly effective during the whole period of the hedge

The hedging relationship should be formally


The hedging relationship should be formally designated

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Hedge accounting criteria (continued)Hedge accounting criteria (continued)

Formal documentation is required at the inception of the hedge and must include:

Identification of the hedging instrument and the hedged item or transaction

The nature of the risk being hedged

The risk management objective and strategy for undertaking the hedge

How effectiveness will be assessed


How effectiveness will be assessed

The rules are strict, thus costs/benefits of hedge accounting should be considered

Assessment of hedge effectivenessAssessment of hedge effectiveness

Prospective assessmentAt inception and throughout the life of the hedge

Retrospective assessment At each reporting date and throughout the life of the hedgeg

Be highly effective in offsetting changesTesting methods (e.g. regression analysis, risk-reduction test, etc.) Hedging results within the range of 80-125%

g gTesting methods (e.g. dollar-offset, regression analysis, etc.)Hedging results within the range of 80-125%

Discontinue hedge accounting


Hedge accounting; ineffectiveness to profit or loss125%

100%

80%

Hedge accounting; ineffectiveness to profit or loss



Hedge accounting; ineffectiveness to profit or loss

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Hedge accounting - General guidelines Effectiveness – Assessment versus MeasurementHedge accounting - General guidelines Effectiveness – Assessment versus Measurement

Purpose

When

Assessment Measurement

At inception of the hedge

To provide a basis for the application of hedge accounting

N/A

At each reporting date

Ongoing assessment of the expected hedge effectiveness to provide a basis going forward

Measurement of the actual effectiveness for:

Decision on continued application of hedge accounting


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Recording of ineffective part of the hedge to be included in the income statement

Cash flow hedge Effectiveness TestCash flow hedge Effectiveness Test

On 1 January 2008 Dotcom enters into a qualifying cash flow hedgef ti i t d t ti t d t b t 1 Mof an anticipated transaction expected to occur on or about 1 May

2008. Every month Dotcom calculates the present value of theexpected cash flows of this anticipated transaction. CorporateTreasury of Dotcom reports the fair value of the forward used to

hedge the FX exposure.

31/1 28/2 31/3 30/4


Fair value derivative

-100 -150 -40 100

Fair Value forecasted Cash Flow

90 160 50 -90

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Question:Determine on a monthly basis whether the hedge is considered highly effective?

31/01 28/02 31/03 30/04

Cumulative result on forward contract

-100 -150 -40 100

Cumulative result on expected future cash flows

90 160 50 -90


expected future cash flows

Cumulative dollar offset 111% 94% 80% 111%


Question:Determine the ineffective portion of the hedge by month.

31/01 28/02 31/03 30/04

Cumulative effective portion -90 -150 -40 90

Actual change in value of forward

-100 -50 110 140


Change in effective portion -90 -60 110 130

Ineffective portion -10 10 0 10

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Cash Flow Hedge Accounting of Forecast Intragroup TransactionCash Flow Hedge Accounting of Forecast Intragroup Transaction

A highly probable forecasted internal transaction can be designated as the hedged item in consolidated financial statements if:

The transaction is denominated in a currency other than the functional currency of the entity entering into the transaction; and

It will affect the group P&L


Hedges of a net investmentHedges of a net investment

Must meet requirements for hedge accounting

Accounting treatment similar to that of a cash flow ghedge

Effective portion of gain or loss on hedging instrument recorded in the same manner as the foreign currency translation gain or loss i.e., in equity

Ineffective portion of gain or loss on hedging


Ineffective portion of gain or loss on hedging instrument recorded in P&L

Release to P&L when the net investment is sold

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IFRIC 16 Hedges of Net Investment in a Foreign OperationIFRIC 16 Hedges of Net Investment in a Foreign Operation

Scope

addresses hedge accounting for net investments in foreign operations

guidance in IFRIC 16 does not apply to other forms of hedge accounting

Effective for annual periods beginning on or after 1 October 2008

Where existing hedge of net investment does not


Where existing hedge of net investment does not meet the conditions in IFRIC 16, entity applies IAS 39 to discontinue the hedge prospectively

IFRIC 16 Hedges of Net Investment in a Foreign Operation (continued)IFRIC 16 Hedges of Net Investment in a Foreign Operation (continued)

IssuesIs the hedged risk the difference between the functional currency of the foreign operation andcurrency of the foreign operation and

the presentation currency of the group? the functional currency of the parent entity?

Amount of the hedged item

ConsensusApply hedge accounting to FX difference between functional currency (FC) of the foreign operation and FC of any parent


currency (FC) of the foreign operation and FC of any parent entity (immediate, intermediate or ultimate) of that foreign operationPresentation currency risk cannot be hedgedHedged item = net assets equal to or less than the carrying amount of net assets in the consolidated financial statements of the parent

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IssuesWhere within a group can the hedging instrument be held:

Can it only be held by the entity hedging the net investment?Can it only be held by the entity hedging the net investment?Can it be held by any entity within the group?

Does the nature of the hedging instrument or the method of consolidation affect effectiveness

ConsensusHedging instrument can be held by any entity within the group including the foreign operation being hedged*


group, including the foreign operation being hedged . Hedging instrument may be a derivative or non-derivative Assessment of effectiveness is not affected by the nature of the hedging instrument or by the method of consolidation


IssuesWhat amounts which should be reclassified from equity to profit or loss on disposal of the foreign operation.Whether the method of consolidation affects the amount which isWhether the method of consolidation affects the amount which is reclassified from equity to profit or loss.

ConsensusWhen the hedged foreign operation is disposed of, the cumulative gain or loss that was determined to be an effective hedge, is reclassified from the foreign currency translation reserve in the consolidated financial statements of the parent to profit or lossThe method of consolidation, i.e., step-by-step or direct, may affect the amount included in the group’s foreign currency translation

i t f th h d d t i t t


reserve in respect of the hedged net investmentUpon disposal of the net investment, the step-by-step method may result in reclassification to profit or loss of an amount different to that used to determine hedge effectivenessDifference may be eliminated by using instead the amount based on the direct method – accounting policy choice, which should be followed consistently for all net investments (hedged and unhedged)

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Illustrative Example Illustrative Example

Step by step

FCTR for B 77M euro loss

ParentEUR

Subsidiary BGBP

Subsidiary AJPY

100%

JPY 400B100%

GBP 500M

FCTR for C 69M euro gain

Net loss 8M euro

Direct method

FCTR for B 54M euro loss

FCTR for C 46M euro gain

Net loss 8M euro


Subsidiary CFunctional currency $

100%

USD 300M (GBP 151M)

1/1/09 31/12/09

EUR/USD 1:1.58 1:1.27

EUR/GBP 1:0.79 1:0.90

GBP/USD 1:1.99 1:1.41

Portfolio hedgingPortfolio hedging

To hedge a group of similar assets/liabilities:

Each individual item must share the hedged riskEach individual item must share the hedged risk exposure (e.g. interest, FX, price, credit rating etc.)

Changes in value due to the hedged risk must affect each item in a manner generally proportionate to the aggregate portfolio


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ExampleHedging a net positionExampleHedging a net position

Is it possible to apply ForwardIs it possible to apply hedge accounting?

Forecastpurchases

Forward contract

$20

Forecast sales

$100


$80

Forward

SolutionHedging a net positionSolutionHedging a net position

IAS 39 i h d d

Forecast sales

$100Forecast

purchases

Forward contract

$20

IAS 39 requires hedged item to be identified

Therefore cannot hedge a net position

BUT - can designate $20 of the forecast sales as the hedged item and achieve hedge accounting


$80Hedged sales

$20

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Discontinuation of hedge accountingDiscontinuation of hedge accounting

Fair value hedges Cash flow hedges

Future changes in fair value of hedging instr ment

Continue to be taken to profit or loss

Recognized immediately in profit or losshedging instrument profit or loss in profit or loss

Changes in fair value of hedged item

Treat as if not hedged

For hedges of interest bearing assets, adjustments to date is amortized to profit or loss over the period to maturity

N/A

Amounts recorded to date in a) Transferred to profit


equity:

a) hedged item still exist or still expected to occur

b) hedged item or transaction no longer expected to occur

N/A

or loss at the same time as the change in the hedged cash flows is recognized in profit or loss

b) Transferred to profit or loss immediately

AgendaAgenda


Hedge accounting

Presentation


Hedge accounting

Presentation


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Liability or equity? Liability or equity?

Is there a contractual obligation (for what?) that the issuer cannot avoid?

Assess at initial recognition Determine liability component

Yes

Liability

No

Equity

Part

Compound instrument


ssess at t a ecog t o

Classification continues until disposal

Determine liability component

fair value

include embedded derivatives

Equity is residual

No gain or loss on separation

IFRIC 2 Members’ Shares in Co-operative Entities and Similar InstrumentsIFRIC 2 Members’ Shares in Co-operative Entities and Similar Instruments

Members’ shares that would be classified as equity if members did not have the right to request redemption are equity if:

The entity has the unconditional right to refuse redemption of the members’ shares; or

Redemption is unconditionally prohibited by local law, regulation or the entity’s governing charter


regulation or the entity s governing charter

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Offsetting a financial asset and a financial liabilityOffsetting a financial asset and a financial liability

&A legally enforceable right to set off

An intention to settle net or to realise the asset and settle the liability

simultaneously

&Master netting agreements

Several instruments used to emulate a single instrument (synthetic instrument)


Items with the same risk, but different counterparties

Financial assets pledged as collateral for non-recourse liabilities

Assets set aside in a trust to discharge a liability that have not been accepted by the creditor (sinking fund arrangements)

Obligations as a result of losses recoverable via insurance

DisclosuresSignificance of Financial Instruments for Financial Position and Performance

DisclosuresSignificance of Financial Instruments for Financial Position and Performance

Hedge accountingDescription of each type of hedge, financial instruments designated as hedging instruments and nature of risks being hedgedF h fl h dFor cash flow hedges:

when cash flows are expected to occur and when they are expected to affect profit or loss;description of forecast transactions no longer expected to occur;amount recognised in other comprehensive income (‘OCI’);amount reclassified from OCI to profit or loss; andamount removed from OCI and included in initial cost of non-financial asset or non-financial liability

For fair value hedges:gains/losses on hedging instrument; and

© 2010 KPMG Bedrijfsrevisoren/Réviseurs d’Entreprises, a Belgian civil CVBA/SCRL and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Printed in Belgium. 42

gains/losses on hedging instrument; andgains/losses on hedged item attributable to hedged risk

Ineffectiveness recognised in profit or loss that arises from cash flow hedges and net investment hedges

Documents

IAS 32 and IAS 39 - ibr-ire.be · PDF fileIAS 32 and IAS 39 Accounting for Financial Instruments Advanced – IBR ... Hedge accounting criteria Exposure must be due to specific hedgeable