HEDGE ACCOUNTING (Part 2)

ACCA P2 考試：HEDGE ACCOUNTING (Part 2)

BASIC PRINCIPLES HEDGE ACCOUNTING AND EFFECTIVENESS

In essence the principle of hedge accounting is that it seeks to reflect the substance of why the hedging instrument (the derivative) has been entered into. To that end hedge accounting is trying to match any loss (or gain) on the hedged item with the gain (or loss) on the hedging instrument. In a perfect world hedging would work so that no net gain or loss arose. For example if the hedged item created a loss of say $500m it would then be matched by a gain on the hedging instrument of $500m. This would be a perfect hedge, a hedge with 100% effectiveness. However we do not live in a perfect world so a 100% effective hedge is highly unlikely. So if the hedged item created a loss of $500m and the hedging instrument a gain of $450m then the hedge would said to be 90% effective (450/500 = 90%).

IAS 39 - THE CURRENT REGULATION

IAS 39 regulates what can be designated a hedged item, a hedging instrument, when a hedging relationship exists and also how to account for the gains and losses on certain types of hedging relationships.

IAS 39 regulates that a hedged item can be:

·a group of assets, liabilities, firm commitments, or highly probable forecast transactions

·an investment for foreign currency or credit risk (but not for interest risk or prepayment risk)

·a portion of the cash flows or fair value of a financial asset or financial liability

·a non-financial item for foreign currency risk only for all risks of the entire item

·a portfolio hedge of interest rate risk (Macro Hedge) only

·a portion of the portfolio of financial assets or financial liabilities that share the risk being hedged.

IAS 39 regulates that hedging instruments can be derivative contracts with an external counterparty, except for some written options. However a non-derivative financial asset or liability may not be designated as a hedging instrument except as a hedge of foreign currency risk. (This is quite a rule-based approach!)

IAS 39 permits hedge accounting under certain circumstances provided that the hedging relationship is:

·formally designated and documented at inception, including the entity's risk management objective and strategy for undertaking the hedge, identification of the hedging instrument, the hedged item, the nature of the risk being hedged, and how the entity will assess the hedging instrument's effectiveness, and

·expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk as designated and documented, and effectiveness can be reliably measured, and

·assessed on an ongoing basis and determined to have been highly effective.

Effectiveness is the extent to which the instrument offsets changes in fair value or cash flows attributable to the hedged risk. A hedge is highly effective if that offset falls within a 80-125% window. Hedge effectiveness has to be assessed both prospectively and retrospectively. All hedge ineffectiveness is recognised immediately in the statement of profit or loss (including ineffectiveness within the 80% to 125% window).

While IAS 39 recognises three categories of hedge, only two are examinable in Paper P2, Corporate Reporting. These are fair value hedges and cash flow hedges.