By Christin Kauten
The Hedge Accounting Project is the third phase of IFRS 9: Financial Instruments, a replacement of IAS 39 Financial Instruments: Recognition and Measurement. In August 2011 the IASB provided an update which focused on summarizing the outcome of the re-deliberation process after comments were received on the Exposure Draft (“ED”).
Changes to Exposure Draft
Bifurcation of Risk
Note: Great news, there are no changes from the ED.
Time Value Treatment
Forward Points The ED did not propose any change to accounting for forward points however, in the outreach activities this issue came up repeatedly. As a result it was included in the re-deliberations. It was proposed that for companies that chose to exclude forward points from special hedge accounting treatment they could be recognized into the P&L over time on a rational basis since its value was essentially locked in at the inception of the hedge. Effective spot rate changes would continue to be recognized in OCI as per the original guidance. Like option time value, it appears that the delta between market value and amortized time values may be caught up in OCI.
Option Time Value In response to outreach activities the time value on plain vanilla collars will follow the ED proposed treatments on vanilla puts and calls: time value will be either amortized to income on a rational basis or held and reclassified to income when the hedged item impacts earnings depending on the nature of the hedged item.
Foreign Exchange Hedges
Net Position Hedges The original draft of the ED allowed for hedges of net positions for foreign currency risk when the effects to the P&L, for both parts of the net position, were in the same reporting period. This timing restriction was lifted as a result of feedback during the comment period highlighting that cash inflow transactions and cash outflow transactions even if recorded a the same period could impact earnings in different periods. To offset potential risk of earnings management from this change, additional documentation requirements at inception were added. All forecasted transactions identified as a part of net position must be specified so that the pattern of how they affect P&L is outlined.
Under IAS 39 there is a mandatory “own-use” scope exception for derivative accounting when the underlying is actually used in the company’s business. This exception primarily impacts companies with commodity risk. The original ED proposed that if “own-use” contracts were used by a company to manage its business on a fair value basis and the net exposure is maintained at a position close to zero they should be accounted for as derivatives and measured at fair value. The feedback on this proposed change in the ED was that while it was helpful for some companies it was not helpful for others and could create new exposures. As a result the fair value accounting treatment on “own-use” contracts will be an election rather than a mandate if it eliminates or significantly reduces an accounting mismatch.
Disclosures As a result of feedback concerning commercial sensitivity around the proposed disclosure requirements, revisions were made to focus on the terms and conditions of the hedging instrument rather than amount, timing and uncertainty of future cash flows. All other subject areas of the ED were reconfirmed and we can expect additional clarification and examples to be added shortly.
Remaining Topics and Timeline The topic of hedges of credit risk using credit derivatives has not yet been discussed. The IASB wants to address the issue specifically. The types of disclosures that would be useful for entities that reset hedging relationships frequently or apply a “dynamic” hedging process have not yet been discussed or determined. The transition and effective date are also pending. It is expected, though, that the Board will vote on the ED in either quarter 4 of 2011 or quarter 1 of 2012.