HEDGE ACCOUNTING (Part 3)

ACCA P2 考試：HEDGE ACCOUNTING (Part 3)

FAIR VALUE HEDGE

A fair value hedge is defined as a hedge of the exposure to changes in fair value of a recognised asset or liability. For example, if a company has an asset that it is concerned will fall in value it can designate this as a hedged item and enter into a derivative that is designed to match any change in the fair value of the asset, and this derivative is then designated as a hedging instrument.

The accounting for a fair value hedge is that the gain (or loss) from the change in fair value of the hedging instrument is recognised immediately in the statement of profit or loss. At the same time the carrying amount of the hedged item is adjusted for the corresponding loss (or gain) with respect to the hedged risk, which is also recognised immediately in the statement of profit or loss. This is instant hedge accounting as the gains and losses offset in the statement of profit or loss. A fair value hedge is taken to the statement of profit or loss.

EXAMPLE OF A FAIR VALUE HEDGE

For example a company has an asset with a current fair value of $200m that it is concerned will fall in value, so designates this to be a hedged item and enters into a derivative designated as a hedging instrument. This is a fair value hedge. Let us suppose at the next reporting date the fair value of the hedged item has fallen to $160m thus creating a loss of $40m. However, because it is a hedged item the hedging instrument (the derivative) should create a gain. If the gain on the hedging instrument is $45m, then the hedge is assessed as being 112.5% effective (45/40 = 112.5%). This is within the permitted band of 80% – 125%. As a result of applying fair value hedge accounting and matching the loss on the hedged item with the gain on the hedging instrument, the loss of $40m and the gain of $45m will offset to report a net gain of $5m in the statement of profit or loss.

CASH FLOW HEDGE

A cash flow hedge is defined as a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with a recognised asset or liability (such as all or some future interest payments on variable rate debt) or a highly probable forecast transaction and could affect profit or loss. For example, if a company is concerned that the price it will have to pay for next year's raw materials will rise it can designate this as a hedged item and enter into a derivative (eg a futures contract designed to cover any price rise) which it designates as a hedging instrument. Similarly, if a company is concerned that interest rates will rise on its debt finance, then it could designate this as a hedged item and enter into a derivative (eg an interest rate swap) which it designates as a hedging instrument.

The portion of the gain or loss on the hedging instrument that is determined to be an effective cash flow hedge is recognised in other comprehensive income and creates a reserve in equity. If a hedge of a forecast transaction subsequently results in the recognition of a financial asset or a financial liability, any gain or loss on the hedging instrument that was previously recognised directly in equity is recycled from reserves into the statement of profit or loss in the same period(s) in which the financial asset or liability affects profit or loss.

If a hedge of a forecast transaction subsequently results in the recognition of a non-financial asset, then the entity has an accounting policy option that must be applied to all such hedges of forecast transactions. One policy is to apply the same accounting as for recognition of a financial asset or financial liability, in that any gain or loss on the hedging instrument that was previously recognised in other comprehensive income is recycled from reserves into the statement of profit or loss in the same period(s) in which the non-financial asset or liability affects profit or loss. The other policy is to make an adjustment on the acquired non-financial asset so that the gain or loss on the hedging instrument that was previously recognised in other comprehensive income is removed from reserves and is included in the initial measurement of the acquired non-financial asset.

EXAMPLE OF A CASH FLOW HEDGE

For example during year 1, a company is planning to buy an asset in the next accounting period at a an estimated cost of $100m but it is concerned that the cost of buying the asset will rise. The company can designate the risk of the future cash out flows rising as a hedged item and enter into a derivative, the hedging instrument to cover this risk. This is a cash flow hedge. Let us suppose at the year 1 reporting date the estimated cost of the asset had risen to $120m and the hedging instrument was reporting a gain of $19m then the hedge is 95% effective (19/20 = 95%) and so within the 80%–125% rule. The gain of $19m that has arisen in respect of the derivative has to be recognised, and as it is the hedging instrument of a cash flow hedge, it is recognised in other comprehensive income and creates a reserve (often called other components of equity). The gain (or loss) on a derivative that is designated as a cash flow hedge is in effect carried forward and is delayed being recognised in the statement of profit of loss. There can be no offset in the current accounting period as the potential extra cost of $20m of buying the assets is a notional number and not one that is yet recognised in the financial statements, as after all the asset has yet to be bought.