HEDGE ACCOUNTING UNDER IAS 39

Download this PPT as PDF File

OBJECTIVE Hedge Accounting seeks to ELIMINATE these Accounting Mismatch.

CORE PRINCIPLE It recognises the OFFSETTING EFFECTS on P & L of Changes in Fair Value of the Hedging Instrument and the Hedged Item.

KEY TERMS DEFINED

Hedged Item	an Asset, Liability, Firm Commitment, Highly probable forecast transaction or Net Investment in Foreign Operation THAT: (a) Exposes the entity to RISK of changes in Fair Value or Cash Flows and (b) is DESIGNATED as being hedged.
Hedging Instrument	is DESIGNATED (a) a Derivative or (b) a Non-Derivative FA or FL (for a hedge of risk of changes in foreign currency rates only) – whose Fair Value or Cash Flows are expected to offset changes in Fair Value or Cash Flows of a Designated Hedged Item.
Hedge Effectiveness	the DEGREE to which changes in Fair Value or Cash Flows of the Designated Hedged Item Attributable to Hedged Risk are to offset by changes in Fair Value or Cash Flows of a Designated Hedged Instrument.
Firm Commitment	Binding Agreement – to Exchange – Specified Resource – Specified Price – Specified Future Date(s).
Forecast Transaction	An uncommitted but Anticipated Future transaction.

Examples of Hedging Instrument – Purchased Options; An HTM Investment for Foreign Currency Risk

Not a Hedging Instrument – Written Options; Entity’s own equity instruments; AFS Investment in Unquoted Equity Share not carried at Fair Value; Stock Index

Examples of Hedged Item – An Exposure to a risk that affects the Income Statement; An AFS Security; A Loan / Receivable; Foreign currency monetary item

Not a Hedged Item – A HTM Investment for interest rate risk; An Investment in Associate or Subsidiary; Non financial asset or Liability; A general business Risk; Derivative

Types of Risk which can be Hedged

• Forex
• Credit
• Equity
• Interest
• Commodity

Exposure to these Risk can arise from changes in

• Fair Value
• Cash Flows
• Probable Future Cash Flows

IAS 39 recognises 3 types of Hedge Relationship

I.    Fair Value Hedge

• Fair value hedges
  
  • Hedge of exposure to changes in fair value of 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
  • would affect P&L.

II.    Cash Flow Hedge

• 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 highly probable forecast transaction (also an inter-company one); and
• would affect P&L.

III.    Hedge of Net Investment in Foreign Operation

• Hedge of a Net Investment in Foreign Operation
  
  • The Net Investment in Foreign Operation is the amount of a reporting entity’s interest in the net assets of that operation.

CONDITIONS FOR HEDGE ACCOUNTING

• Formal Documentation at Inception
  • Entity’s Risk Management Objective and Strategy
  • Formal Designation of Hedging Relationship by Identification of
    • Hedging Instrument
    • Related Hedged Item or Transaction
    • Nature of Risk being Hedged
    • How the Entity will assess the Hedging Instrument’s EFFECTIVENESS.
• Hedge Effectiveness –

  The Hedge should be expected to be Highly Effective in achieving Offsetting Changes in Fair Value or Cash Flow attributable to the Hedged Risk – At Inception and subsequent periods.
  
  

• Hedge Effectiveness – can be Reliably measured.

HEDGE ACCOUNTING – FAIR VALUE HEDGE

*     MEASUREMENT MISMATCH

• Fair value hedges
  

Hedge of exposure to changes in fair value of 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
• would affect P&L.

  		Measurement of Hedged Item	Measurement of Hedging Instrument
  Without Hedge Accounting		At Amortised Cost Or At Fair Value through Equity (OCI)	At Fair Value through P & L.
  With Hedge Accounting		Adjust the Carrying Amount to Fair Value through P & L.	At Fair Value through P & L.

  

  
  

MECHANICS OF FAIR VALUE HEDGE

HEDGE ACCOUNTING – CASH FLOW HEDGE

*     RECOGNITION MISMATCH

Hedge of exposure to variability in cash flows that is:

• attributable to a particular risk associated with a recognised asset or liability or a highly probable forecast transaction (also an inter-company one); and
• would affect P&L.

MECHANICS

MECHANICS

DISCONTINUATION OF HEDGE ACCOUNTING

• Prospective Discontinuation IF::
  • Hedging Instrument expires, is sold, terminated or exercised.
  • Hedge no longer meets the criteria for Hedge Accounting.
  • The entity revokes the Designation.
• On Discontinuation

  

FAIR VALUE OF SECURITY DEPOSIT UNDER IAS 39

IAS 39 defines a Loans and receivable as ”non-derivative financial assets with fixed or determinable payments that are not quoted in an active market”

Security Deposits without Fixed Maturity such as Deposit with Regulatory Authorities such as Taxation – Indirect, as well as Public Utility Services such as providers of Telephone, Mobile, Electricity, Gas, etc would be comprised in the category – Loans and Receivable – they are

• non-derivative,
• have fixed or determinable payments,
• are not quoted in active market, &
• generally have no fixed maturity.

If Security Deposits have a fixed maturity (defined refund period) then they would normally be classified as HTM (Held To Maturity) Investments subject to meeting condition of Management Intent and Ability.

Security Deposits paid to Public Utility Service providers or any private party are definitely ‘Contractual Rights / Obligations’. though I cannot commit myself on this point so far as Deposit with regulatory authorities are concerned.

In case of a Security Deposit – cash is generally refunded after termination of the contract, therefore, it is a contractual right to receive cash and therefore it is a Financial Asset

Therefore, Security Deposits paid to Public Utility Services should be definitely categorised as “Loans & Receivables“.

Initial Recognition of Financial Assets is at Fair Value of Consideration given or paid + Transaction Costs

Subsequent Measurement of Loans and receivable is at Amortised Cost using the Effective Interest Method.

Amortised Cost = Initial Recognition Amount – (Principal Repayments) ‘+/-’ (Difference in Initial Recognition and Maturity Value) – Impairment Reduction.

Suppose, Security deposit is Rs. 5000/-, transaction costs is Rs. 50/- and maturity is also Rs. 5000/-

Fair Value at initial recognition is Rs. 5000/- + 50/- = 5050/-

then Amortised cost = 5050 – Nil – (5050-5000) or (50) – Nil

= 5050 – Nil – 50 – Nil

= 5000

therefore, effectively Security Deposits for contractual obligations will stand in the Balance Sheet at the amount receivable on the termination of the contract and which will generally be equal to the amount paid.

IFRS 8 OPERATING SEGMENTS

IFRS 8 Operating Segments [Download this PPT as PDF File]

THE CORE PRINCIPLE

An entity shall DISCLOSE information to enable users of its financial statements  to EVALUATE The nature and financial effects of the BUSINESS ACTIVITIES in which it engages & the ECONOMIC ENVIRONMENT in which it operates.

IFRS 8 – APPLICATION SUMMARY

•1 •Identify the CODM

•2 •Identify the Operating Segments

•3 •Determine the Reportable Segments

•4 •Disclose the Required Information

IDENTIFY The Chief Operating Decision Maker (CODM)

CODM is a FUNCTION, not a DESIGNATION. CODM can be an INDIVIDUAL or a GROUP of Individuals. CODM FUNCTION is to Allocates the Resources of the Entity  and Assess the performance of the Operating Segments of the Entity.

Operating Segments is a Component of an Entity.

•From which it MAY EARN REVENUES and INCUR EXPENSES (including Intra-Group Revenue and Expenses)

•Whose operating results are REVIEWED regularly by the Entity’s CODM – to assess performance and decide about resource allocation.

•For which DISCRETE Financial Information is available

Specific Example

Yes – Startup Operations – before Earning Revenues

No – Corporate HQ’s and Functional Departments (say Internal Audit) not earning Revenues  & Post-Employment Benefits Plans

Determining Reportable Segments

AGGREGATION CRITERIA

Ø Aggregation is consistent with the Core Principle

Ø Segments have similar economic characteristics

Ø Segments similar on each of the Five Specified Criteria

1. Nature of Products and Services

2. Nature of the Production Processes

3. Customer type or class

4. Distribution Methods

5. Nature of Regulatory Environment

Quantitative Thresholds

A Segment is REPORTABLE if MAJORITY of its REVENUE is from Sales to External Customers.

• Segment Revenue > 10% of Revenue from all Segments (Revenue = External + Internal)

• Segment Results > 10% of the Combined Results

• Segments Assets > 10% of the Total assets of all Segments

Determining Reportable Segments

•Identify each Operating Segment that exceed the Quantitative Threshold

•Aggregate

•any operating segments that meet all aggregation criteria

•Remaining operating segments below Quantitative threshold with each other if the majority of aggregation criteria met

•If Reportable Segments are less than 75% of Revenue, add more reportable segments.

SEGMENTS NOT MEETING THE QUANTITATIVE THRESHOLD
Management BELIEVEs that the Information is Useful for the Users	Can be disclosed
in Current Year but was disclosed in Preceding Period	Can be disclosed if the Management judges that the Information is of Continuing Significance
SEGMENTS MEETING THE QUANTITATIVE THRESHOLD
in Current Year but was Not disclosed in Preceding Period	Disclose Restate prior period information (unless the necessary information is not available and cost to develop it would be excessive)

DISCLOSURE

An entity shall DISCLOSE information to enable users of its financial statements  to EVALUATE The nature and financial effects of the BUSINESS ACTIVITIES in which it engages & the ECONOMIC ENVIRONMENT in which it operates.

What is This Information ?

An Entity shall disclose the following for each period for which a Statement of Comprehensive Income is presented: a. General Information b. Information about Segment Revenues, Segment Profit or Loss and Segment Assets and Liabilities and basis of Measurement. c. Reconciliation Statement

Disclosure – general information a. Factors used to IDENTIFY the Entity’s Reportable Segments (viz., Nature of Products & Services, Nature of Production & Distribution Processes, Geographical Areas, Regulatory Environment, or a Combination of these Factors). b. The Types of Products and Services from which each Reportable Segment derives its Revenue.

Disclosure – information about Segment (revenues, p & l and assets & liabilities) For each Reporting Segment, Entity shall report :

Ø Segment Profit or Loss

Ø Total Segment Assets

Ø Segment Liabilities (if reviewed by CODM)

For each Reporting Segment, Entity shall report (if reviewed by CODM or otherwise Information is provided to CODM, even if not included in measure of P & L)  :

Ø Revenues from External Customers

Ø Revenue from Intra-Group Transactions with Other Operating Segments

Ø Interest Revenue & Interest Expenses (separately)

Ø Depreciation and Amortisation

Ø Material Items of Income and Expenses

Ø Entity’s interest in P&L of Associates / JV accounted for under the Equity Method

ØIncome tax expense

Ø Material non-cash items other than Depreciation & Amortisation.

Disclosure – Reconciliation

Total of Reportable Segments

^ Revenues to Entity’s Revenue

^ P & L to Entity’s P & L

^ Assets to Entity’s Assets

^ Liabilities to Entity’s Liabilities (if Reported)

^ Amounts for Every Material Item of Information disclosed to corresponding amount for the entity.

Entity Wide Disclosures

All entities subject to this IFRS including Entities that have a single reporting segment shall provide Information about ::

* Products and Services

* Geographical Areas

* Major Customers

The amounts reported shall be based on the financial information that is used to produce the entity’s financial statements. If Any Information is Not Available and Cost to develop it would be excessive, the fact should be disclosed.

Information About Products & Services

Revenues from External Customers for each product & services (or group of products and services).

Information About Geographical Areas

* Revenues from External Customers &

* Non-current Assets (other than Financial Instruments, Deferred Tax Assets and Rights under Insurance Contracts)

i.     Attributed to the Entity’s country of Domicile

ii.     Attributed to the all Foreign Countries from which the Entity derives Revenue or holds Assets. If revenues from External Customers or Assets attributed to an Individual Foreign Country are Material, the same shall be disclosed separately.

Information About Major Customers

# Extent of its Reliance on Major Customers

# If Revenues from transaction with single external customer amount to 10% or more of the Entity’s Revenue, the Entity shall Disclose:

Ø the Fact;

Ø the total amount of Revenues from each such Customer;

Ø the Identity of the Segment(s) reporting such Revenue

Ø Need NOT Disclose – Identity of the Customer A group of Entities known to the Reporting Entity to be under common control shall be considered a single customer.

Government (and entities known to the Reporting Entity to be under the control of that Government shall be considered a single customer.

IAS 23 BORROWING COSTS

Download this Post in PDF Format

1.     STATUS         Mandatory

2.     OBJECTIVE         Prescribe the Accounting Treatment for BORROWING COSTS.

3.     NOT APPLICABLE     Does not deal with ACTUAL or IMPUTED Cost of Equity including Preferred Capital not classified as Equity.

4.     KEY TERMS         BORROWING COSTS (BC)         are INTEREST + OTHER COSTS incurred by an entity in connection with the borrowing of funds.

QUALIFYING ASSETS (QA)         is an asset that NECESSARILY takes a SUBSTANTIAL period of time to get ready for intended use or sale.

BENCHMARK TREATMENT

5.     RECOGNITION OF BC     BC shall be recognised as an Expense in the period in which they are incurred. (~ regardless of how they are incurred. )

6.     DISCLOSURE         Accounting Policy adopted for Borrowing Costs.

 

ALLOWED ALTERNATIVE TREATMENT

5.     RECOGNITION OF BC         BC shall be recognised as an Expense in the period in which they are incurred. EXCEPT to the extent they are CAPITALISED.

CAPITALISATION OF BC     BC DIRECTLY attributable to the Acquisition, Construction or Production of QA shall be CAPITALISED as part of the cost of the asset.

AMOUNT OF BC ELIGIBLE FOR CAPITALISATION

Funds are borrowed SPECIFICALLY for the purpose of obtaining a QA		Funds are borrowed GENERALLY and used for the purpose of obtaining a QA
ACTUAL BC incurred on that borrowing during the period LESS any income on temporary investment of those borrowings		BC shall be determined using a CAPITALISATION RATE to the expenditure on that asset.
		Capitalisation Rate is the WEIGHTED AVERAGE of the BC of the entity that are outstanding during the period – OTHER than Borrowings made SPECIFICALLY for the purpose of obtaining a QA.
Amount of BC Capitalised during a period shall NOT EXCEED the ACTUAL amount of BC incurred during the year.

 

IMPAIRMENT     If the Carrying Amount or Expected ultimate cost of QA EXCEEDS its Recoverable Amount of Net Realisable Value (NRV) – THEN Carrying Amount is WRITTEN DOWN- as per IAS on Impairment of Assets.

 

COMMENCEMENT, SUSPENSION AND CESSATION OF CAPITALISATION

COMMENCEMENT		SUSPENSION	CESSATION
(a)  Expenditure for the asset are being incurred; (b)  BC are incurred; (c)  Active Development i.e., activities that are necessary to prepare the asset for its intended use or sale are in progress.		During Extended periods in which Active Development is INTERRUPTED. Read ABNORMAL DELAYS.	Substantially all the activities necessary to prepare the asset for its intended use or sale are in progress.

 

DISCLOSURE             The Financial Statements shall disclose:

(a)      the Accounting Policy adopted for Borrowing Costs;

(b)      the amount of Borrowing Costs capitalised during the period;

(c)      Capitalisation Rate.

IAS 21 THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES

OBJECTIVE	To prescribe ◦      How to include Foreign Currency Transactions and Foreign Operations in the Financial Statements of the entity and ◦      How to Translate Financial Statements into a presentation currency.
SCOPE	Foreign Currency Transactions Accounting for Transactions and Balances in Foreign Currencies. Exception: Derivative Transactions and Balances (including Hedge Accounting) within the Scope of IAS 39 Foreign Operations Translating the Financial Statements of FOREIGN OPERATIONS included in the FS of entity by Consolidation, Proportionate Consolidation or the Equity Method. Presentation of FS in Foreign Currency Translating an Entity’s FS into a Presentation Currency
FUNCTIONAL CURRENCY	Currency of the ‘Primary Economic Environment’ in which the Entity operates. Primary Economic Environment is normally the one in which the Entity PRIMARILY GENERATES AND EXPENDS CASH. —  PRIMARY INDICATORS ◦      The Currency that determines the Sales prices of its goods and services and Operating Costs. —  SECONDARY INDICATORS ◦      Currency of Generation of Funds from Financing Activities – Issue of Debt and Equity Instruments. ◦      Currency of Retention of Receipts from Operating Activities —  ADDITIONAL INDICATORS (Only for Foreign Operations) ◦      Autonomy – Activities of Foreign Operation are Extension of the Reporting Entity or carried with a Significant Degree of Autonomy. ◦      Volume of Transactions with the Reporting Entity ◦      Impact of Cash Flows of Foreign Operation on the Reporting Entity. ◦      Ability to service Debt Obligations without resort to Reporting Entity. When Indicators are mixed and Functional Currency is not obvious, MANAGEMENT uses its JUDGEMENT.
CHANGE IN FUNCTIONAL CURRENCY	—  Used CONSISTENTLY —  is not changed unless there is a Change in Underlying Transactions,  Events and Conditions (PRIMARY ECONOMIC ENVIRONMENT) —  Change is accounted for PROSPECTIVELY.
FOREIGN CURRENCY	Currency other than ‘functional currency’.
INITIAL RECOGNITION (REMEASUREMENT OF FOREIGN CURRENCY TRANSACTIONS INTO FUNCTIONAL CURRENCY)	Of FOREIGN CURRENCY TRANSACTION In FUNCTIONAL CURRENCY By applying SPOT EXCHANGE RATE (b/w Functional Currency & Foreign Currency) At the Date of Transaction v   Average Rate is permitted, if the exchange rates don’t fluctuate significantly.
SUBSEQUENT MEASUREMENT OF FOREIGN CURRENCY TRANSACTIONS AND TRANSLATION OF FOREIGN OPERATIONS WITH DIFFERENT FUNCTIONAL CURRENCY	Items	Translation Rate		Recognition of Exchange Differences on Settlement or Translation
	Monetary Items	Closing Rate on Balance Sheet Date		To Profit or Loss #
	Non-Monetary Items at Historical Cost	Rate as at Date of Transaction		Equity : If Gain or Loss is recognized in Equity. PL : If Gain or Loss is recognized in PL.
	Non-Monetary Items at Fair Value	Rate as at Date of Fair Value Determination
	# Exchange differences arising on monetary items that form part of a reporting entity’s net investment in foreign operation shall be recognized, in consolidated financial statements initially as a separate component of equity and recognized in profit or loss on Disposal of the net investment.
TRANSLATION TO PRESENTATION CURRENCY * (*Except that of an entity whose functional currency is the currency of a hyperinflationary economy.)	Items		Translation Rate	Recognition of Exchange Difference
	Assets and Liabilities (including Comparatives)		Closing Rate on Balance Sheet Date	As a Separate Component of Equity.
	Income and Expenses (including Comparatives)		Exchange Rate at the date of the transaction #
	Equity (including Comparatives)		Historic Rate or Closing Rate (Management Policy)
	#          Average Rate is permitted, if the exchange rates don’t fluctuate significantly.
SUMMARY	Determine Functional Currency Re-measurement of Foreign Currency Items into Functional Currency. Translation of Functional Currency to Presentation Currency.