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Objective of hedge accounting

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Objective of hedge accounting provides the introduction a a few narratives to obtain an understanding of hedge accounting under IFRS 9. All hedge accounting narratives are listed here. Every entity is exposed to business risks from its daily operations. Many of those risks have an impact on the cash flows or the value of assets and liabilities, and therefore, ultimately affect profit or loss. In order to manage these risk exposures, companies often enter into derivative contracts (or, less commonly, other financial instruments) to hedge them.

Hedging can, therefore, be seen as a risk management activity in order to change an entity’s risk profile. Objective of hedge accounting

Applying the normal IFRS accounting requirements to those Read more

Hedged items General requirements

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Hedged items General requirements discusses the eligible hedged item and risk components in non-financial items. The general requirements of what qualifies as an eligible hedged item are unchanged compared to IAS 39. A hedged item can be: Hedged items General requirementsHedged items General requirements

  • A recognised asset or liability Hedged items General requirements
  • An unrecognised firm commitment Hedged items General requirements
  • A highly probable forecast transaction Hedged items General requirements

Or  Hedged items General requirements

All of above can either be a single item or a group of items, provided the specific requirements for a group of items are met (see ‘Groups of items‘).

Only assets, liabilities, Read more

Hedges of exposures affecting OCI

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Hedges of exposures affecting OCI is showing examples of exposures as hedged items recorded through other comprehensive income (OCI) and hedge accounting of Aggregated exposures.

Hedges of exposures affecting other comprehensive income

Only hedges of exposures that could affect profit or loss qualify for hedge accounting. The sole exception to this rule is when an entity is hedging an investment in equity instruments for which it has elected to present changes in fair value in OCI, as permitted by IFRS 9. Using that election, gains or losses on the equity investments will never be recognised in profit or loss.

For such a hedge, the fair value change of the hedging instrument is recognised in OCI. Ineffectiveness is Read more

Hedge Risk components General requirements

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Risk components General requirements is about hedging risk components be it financial or non-financial risks (new in IFRS 9).

Instead of hedging the total changes in fair values or cash flows, risk managers often enter into derivatives to only hedge specific risk components. Managing a specific risk component reflects that hedging all risks is often not economical and hence not desirable, or not possible (because of a lack of suitable hedging instruments). Risk components – General requirements

However, under IAS 39, a non-financial item can only be designated as the hedged item for its foreign currency risk or all its risks in their entirety. There is no such restriction for financial items, Risk components General requirementstherefore creating an inconsistency in Read more

Contractually specified risk components

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Contractually specified risk components – Under IFRS 9, risk components can be designated for non-financial hedged items, provided the component is separately identifiable and the changes in fair value or cash flows of the item attributable to the risk component are reliably measurable. This requirement could be met where the risk component is either explicitly stated in a contract (contractually specified) or implicit in the fair value or cash flows (non-contractually specified). Contractually specified risk components

Purchase or sales agreements sometimes contain clauses that link the contract price via a specified formula to a benchmark price of a commodity. Examples of contractually specified risk components are each of the price links and indexations Read more

Non-contractually specified risk components

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Non-contractually specified risk components – Under IFRS 9, risk components can be designated for non-financial hedged items, provided the component is separately identifiable and the changes in fair value or cash flows of the item attributable to the risk component are reliably measurable. This requirement could be met where the risk component is either explicitly stated in a contract (contractually specified) or implicit in the fair value or cash flows (non-contractually specified).

Not all contracts define the various pricing elements and, therefore, specify risk components. In fact, most risk components of financial and non-financial items are not to be contractually specified. While it is certainly easier to determine that a risk component is separately identifiable and Read more

IFRS 9 Inflation as a risk component

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Inflation as a risk component – Under IAS 39, inflation cannot be designated as a hedged risk component for financial instruments, unless the inflation risk component is contractually specified. For non-financial instruments, inflation risk cannot be designated under IAS 39 as a risk component at all. Inflation as a risk component

Highlight – For financial instruments, IFRS 9 opens the door for designating a non-contractually specified inflation component as a hedged risk component – but only in limited circumstances. For non-financial instruments, the inflation component will be eligible for designation as the hedged item in a hedging relationship provided that it is separately identifiable and reliably measurable.

For financial instruments, IFRS 9 introduces a rebuttable presumption that, Read more

The sub-LIBOR issue

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The sub-LIBOR issue  (see further below) related to contractually specified risk components: Purchase or sales agreements sometimes contain clauses that link the contract price via a specified formula to a benchmark price of a commodity. Examples of contractually specified risk components are each of the price links and indexations in the contracts below:

  • Price of natural gas contractually linked in part to a gas oil benchmark price and in part to a fuel oil benchmark price
  • Price of electricity contractually linked in part to a coal benchmark price and in part to transmission charges that include an inflation indexation
  • Price of wires contractually linked in part to a copper benchmark price and in part to a variable
Read more

Components of a nominal amount

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Definition Components of a nominal amount

Components of a nominal amount are specified part(s) of the amount of an item. This could be a proportion of an entire item (such as, EUR 60 million of a fixed rate loan of EUR 100 million) or a layer component (for example, the bottom EUR 60 million of a EUR 100 million fixed rate loan). Components of a nominal amount

Nominal components are frequently used in risk management activities in practice. Examples include: Components of a nominal amountNatural disasters - Hedge accounting

  • Part of a monetary transaction volume, e.g., the first USD1 million cash flows from sales to customers in a given period
  • Part of a physical volume, e.g., the 50 tonnes bottom layer
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Hedge accounting requirements

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Hedge accounting requirements – IFRS 9 now allows, for fair value hedges, the designation of layer components from a defined nominal amount or a defined, but open, population. IFRS 9 stillHedge accounting requirements includes some restrictions, in particular that a layer component that includes a prepayment option does not qualify as a hedged item in a fair value hedge if the fair value of the prepayment option is affected by changes in the hedged risk. Hedge accounting requirements

When an entity has an option to prepay a loan, at fair value, the fair value of the option is not affected by changes in the hedged risk. Consequently, an entity would be able to designate a hedge as described in Read more