Akuntansi Lindung Nilai

Akuntansi Lindung Nilai
Agenda
The Basic
Hedged Items
Hedging Instruments
Hedge Effectiveness
Accounting Criteria
Ilustrations
Summary
What is hedging?
Hedging
is the economic process of

entering into a transaction in order to
reduce risk.
Hedging involves entering into a second

transaction, the returns of which will change in the
opposite way to those of the initial transaction
What is Hedge Accounting?
Hedge accounting is the application of special

rules to account for the component parts of
the hedging relationship
An entity is only allowed to use hedge accounting subject

to strict conditions.
Not all hedging activities of an entity will qualify for hedge
accounting, and therefore, hedge accounting is a
privilege and not a right
The requirements for hedge accounting are contained in

IAS 39.
Risk Exposure
Hedge transactions are used to reduce risk
exposure. But what are the possible risks?
Example 1 Sterling Effort plc, a GBP functional
company, has a firm commitment in six months'
time to purchase an item of machinery for a fixed
amount in US $.
The risk:
Sterling Effort has a foreign exchange exposure
to the US $. The cost to Sterling Effort in GBP of
the future US $ purchase will vary with the US
$/GBP exchange rate.
6
Risk Exposure
Example 2: Highlife Bank plc has variable rate debt (LIBOR

+ 2%).
The risk:
Highlife Bank is exposed to variability in its cash outflows
on its future interest payments, which will vary with the
LIBOR interest-rate index.
Example 3: Lasting Returns plc has an equity investment in
Worthy Venture plc.
The risk:
Lasting Returns has a price or fair value exposure on its
equity investment in Worthy Venture plc. Lasting Returns'
ability to generate returns on its investment in Worthy
Venture on a future sale will vary with the market price for
Worthy Venture plc
Reducing risk exposure

To
reduce risk exposure companies enter

into hedging transactions
Companies hedge risks evident in items
that are already recognised on their
balance sheets, as well as hedge risks in
respect of future transactions that have yet
to occur.
Reducing risk exposure

Sterling Effort enters into a forward contract to buy
US $ for the same amount and same maturity as
its firm commitment to purchase an item of
machinery in US $.
Highlife Bank enters into a pay fixed, receive
floating interest rate swap with the same nominal
amount as its variable rate loan and indexed to
the same index (LIBOR) and with the same
maturity as its loan.
Lasting Returns purchases a put option to sell its
investment in Worthy Venture at a specified price
at a specified future date.
Lack of offset
The financial instruments that Sterling Effort, Highlife
Bank and Lasting Returns entered into to hedge
their risk exposures are derivatives. It is also
possible to use non-derivative financial instruments
to hedge foreign currency risk. Under IAS 39 all
derivatives must be recognised in the balance sheet
at fair value. However, often the items that the
companies hedge are either not yet recorded on the
balance sheet or are recorded, but not measured at
fair value. Therefore, there is a mismatch in the
timing of recognition of the gains and losses in profit
and loss. This is where hedge accounting comes in.
10
Achieving offset
Companies can employ hedge accounting
to achieve offset in profit or loss . There are
three principal methods or types of hedge
accounting, which achieve offset in different ways:
Cash flow hedge accounting
Fair value hedge accounting
Net investment hedges (otherwise known as
hedging a net investment in a foreign
operation)
11
Hedging Relationship
12
Hedge Accounting
13
Hedge Accounting
Types
Hedge
Item is
Accounting Treatment
FV
FA/FL/ firm both the hedged item & hedging instrument are
commitme revalued to FV, and the opposite gain & loss are
nt
recognized in the income statement
Cash flow
forecast
future
transaction
(or
firm
commitme
nt for forex
txn)
Net
investme
nt
foreign the hedging instrument (usually a loan) is revalued

subsidiary
to FV with any gain/ loss recognized in reserves to
offset against the gain/loss on the foreign
subsidiary. The offset is limited to the gain/ loss
recognized on the subsidiary.
14
the hedging instrument is revalued to FV and the

gain/ loss is taken to separate reserve. When the
hedged item is recognized, the separate reserve is
recycled to income statement, or if it is a nonmonetary asset/ liability the recycling can be the
cost of the hedged item.
Cash flow hedge accounting

Cash flow hedge accounting recognises changes in
the fair value of the hedging instrument outside
profit or loss in equity and recycles them into the
income statement when the hedged item affects
profit or loss.
This is known as a cash flow hedge because it is the
exposure to the variability in future cash flows that is
being hedged.
15
Fair value hedge accounting

Fair value hedge accounting adjusts the recognised
asset or liability that is being hedged for movements
in the hedged risk so as to offset in profit and loss
changes in the fair value of the hedging instrument.
This is referred to as a fair value hedge because it is
the fair value of the designated risk that is being
hedged.
16
Net investment hedges

A third and final category of hedge accounting is
hedging a net investment in a foreign operation.
This is accounted for similarly to a cash flow hedge
17
Kondisi yg harus terpenuhi sebelum Hedge

Accounting dapat diterapkan
Reliable
measurement of
effectiveness
FORMAL
DESIGNATION
Formal hedge
documentation +
risk management
policy
18
The hedge is
expected to be and is
highly effective
Criteria for hedge accounting
19
The requirements of hedge accounting
There two principal requirements that have to be

met to achieve hedge accounting.
Hedge effectiveness
Formal designation
20
Hedge Accounting Criteria

Terdapat kebijakan tertulis, tujuan manajemen
risiko & strategi lindung nilai (identifikasi
instrumen, transaksi yang dilindungi, sifat risiko,
penilaian efektivitas instrumen lindung nilai)
Hubungan lindung nilai diharapkan efektif (highly
effective), yaitu keuntungan/kerugian potensial
dari suatu transaksi dapat di offset oleh
kerugian/keuntungan potensial dari transaksi
lindung nilai
21
Hedge effectiveness
One of the criteria that must be met for an economic
hedge to qualify for hedge accounting is that it is
highly effective. A hedge is highly effective if the
changes in the fair value or cash flows of the
hedged item attributable to the hedged risk - for
example, due to changes in interest rates or foreign
exchange rates - are offset by the changes in fair
value or cash flows of the hedging instrument within
a range of 80-125%.
22
Formal Designation
IAS 39 only allows an entity to apply hedge
accounting if it specifically designates the hedging
instrument and the hedged item from the point in
time when it wants to commence applying hedge
accounting. There are strict criteria that must be met
for each hedge accounting relationship to qualify for
hedge accounting
23
Formal Designation
24
Consistent with the companys risk management

strategy
The hedge must be consistent with the
companys documented risk management
strategy. To comply with this condition an entity
will have to have a policy document in place
where it specifies the risk exposures it hedges
and permissible hedging instruments.
Formal Designation
25
Measurable, with ineffectiveness quantified and

recognised in profit or loss
The actual level of effectiveness of the hedge
must be measurable and any ineffectiveness
must be recognised in profit or loss.
Formal Designation
26
Prospective effectiveness
The hedge must be expected to be highly effective.
This assessment is known as the prospective
effectiveness test.
Retrospective effectiveness
The effectiveness of the hedge must be assessed on an
on-going basis (at least at every reporting date) and must
actually be highly effective
This assessment is known as the retrospective
effectiveness test.
Effectiveness Testing
THE HEDGE IS EXPECTED TO BE
AND HAS BEEN HIGHLY EFFECTIVE
PROSPECTIVE
TEST
(highly effective)
AT INCEPTION
AT EACH
REPORTING DATE
AND
RETROSPECTIVE TEST
([80-125%])
27
28
Qualifying hedged items

There are specific rules within IAS 39 that
limit which items can be considered hedging
items.
A hedged item must be an identified hedged
item or group of items that could affect profit
or loss and qualify for hedge accounting
under IAS 39.
29
Qualifying hedged items

A hedged item can be a:
a recognised asset or liability
an unrecognised firm commitment
a highly probable forecast transaction
a net investment in a foreign operation that
could affect profit or loss
30
What Can You Hedge?

Highlyprobable
probable
Highly
forecast
forecast
transaction
transaction
FIRM
FIRM
COMMITMENT
COMMITMENT
Single item
Group of similar items

(sharing the same risk)
ASSETLIABILITY
LIABILITY
ASSET
Proportions of an item
Netinvestment
investmentin
in
Net
foreignoperations
operations
foreign
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What Can You Hedge

GROUP OF SIMILAR ITEMS
32
OK
+10%
+10%
+9%
+11%
+10%
OK
+10%
+11%
-4%
-10%
+43%
What Cant You Hedge?

FUTURE PROFIT
STREAMS
NET POSITION
(e.g. group of
forecast sales and
purchases in
foreign currency)
Portions of risks of
non-financial
assets and
liabilities
(except for FX risk)
DERIVATIVE
INSTRUMENTS
HTM ASSETS (for

interest rate and
prepayment risks)
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SHARES OWN
Hedging Portions
Qualifying items
An entity can designate all changes in the cash
flows or fair value of a hedged item in a hedging
relationship. An entity can also designate only
changes in the cash flows or fair value of a hedged
item above or below a specified price or other
variable (a one-sided risk).
The intrinsic value of a purchased option hedging
instrument (assuming that it has the same principal
terms as the designated risk), but not its time value,
reflects a one-sided risk in a hedged item.
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Hedging Portions
Example:
an entity can designate the variability of future cash
flow outcomes resulting from a price increase of a
forecast commodity purchase above a certain level.
In such a situation, only cash flow changes that
result from an increase in the price above the
specified level are designated. The hedged risk
does not include the time value of a purchased
option because the time value is not a component of
the forecast transaction that affects profit or loss.
35
Hedging Portion: Financial Items

To be eligible for hedge accounting, the designated
risks and portions must be separately identifiable
components of the financial instrument, and changes
in the fair value or cash flows of the entire financial
instrument arising from changes in the designated
risks and portions must be reliably measurable.
Unless an inflation portion is a contractually specified
portion of cash flows of an inflation linked bond,
inflation is not separately identifiable and reliably
measurable and is not eligible for designation as a
hedged risk or portion of a financial instrument
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Financial Items: Example

It is possible to designate something other
than the entire fair value change or cash flow
variability of a financial instrument as the
hedged item.
To see how this works, lets take the example
of a five-year 6% fixed rate loan asset, which
has not been classified as HTM.
37

1.
2.
3.
38
Hedge the full fair value of the cash flows on

the loan, in other words, all the contractual
cash flows
Hedge the fair value of some (but not all) of the
loan - for example, the fair value of 50% of the
loan - a proportion of all the contractual cash
flows.
Hedge the fair value changes or cash flow
variability on all cash flows attributable to a
specific risk only - for example, interest rate
risk (but not all risks).

4.
5.
6.
39
Hedge some (but not all) of the cash flows for cash flow
variability or fair value changes attributable to a specific
risk only - for example, designate the impact of
movements in interest rates on 50% of the cash flows (a
hedge of a specific risk on a proportion of all cash flows).
The designated risk and portion must be separately
identifiable and must be reliably measurable.
Hedge the fair value movement on principal only (a
hedge of a portion of the cash flows). The designated
portion must be separately identifiable and must be
reliably measurable.
Hedge the fair value movement due to interest rate risk
(and not all risks) on the principal only. The designated
risk must be separately identifiable and must be reliably
measurable.
Non-financial items
A non-financial asset or liability can only be
designated as a hedged item for foreign currency
risk, or in its entirety for all risks. For example, an
entity cannot designate as the hedged item the
copper component in its forecast purchase of
bronze. Even though the price of bronze may be
highly correlated to the price of copper, the price of
copper is only a portion of the change in value of the
price of bronze. A non-financial item, such as
bronze, can only be designated as hedged in its
entirety for all risks or for foreign currency risk.
40
Non-financial items
It may be possible to designate a copper forward as
a hedging instrument in hedging the price of bronze
if:
theres a high degree of correlation between
the price of bronze and the price of copper, and
it can be demonstrated that the copper forward
will be highly effective in hedging the price of
bronze
Any hedge ineffectiveness must be recognised in
profit or loss.
41
Firm commitments and forecast transactions
It's important to distinguish between forecast

transactions and firm commitments.
Forecast transactions are always cash flow
hedged, whereas
Firm commitments are generally fair value
hedged.
42
Firm Commitment
A firm commitment is a binding agreement for the
exchange of a specified quantity of resources at a
specified price on a specified future date or dates.
An example is a legally binding purchase agreement
to take delivery of 100,000 bushels of corn on 30
September 20X1 for $2 per bushel.
43
Firm Commitment
A commitment is binding if it is enforceable either
legally or otherwise. To be enforceable, the
agreement should provide for remedies that are
available to the parties to the contract in the event of
non-performance.
44
Forecast Transaction
A forecast transaction is an uncommitted but
anticipated future transaction.
For example, a forecast purchase of 100,000
bushels of corn to be used in an entitys
manufacturing process in October. The forecast
transaction is identified in May.
45
An Exception
If an entity is hedging the foreign exchange risk in a firm
commitment, this may be accounted for either as a fair value
hedge or a cash flow hedge.
Example
Heavy Metal plc has a contract to sell 500 bulldozers to
Demolition Hire plc for delivery in six months time, at a fixed
price in Euros that is determined today. Heavy Metals
functional currency is Sterling
Heavy Metal simultaneously enters into a foreign currency
forward to hedge the Euro exposure arising from its firm
commitment. It can designate the forward as a hedging
instrument in either a cash flow hedge or a fair value hedge
of its foreign currency firm commitment.
46
Non-qualifying items
There are also risk exposures that do not qualify for
designation as hedged items in a hedge relationship.
These non-qualifying exposures include:
Intra-group items
Overall business risks
Held-to-maturity investments
Derivatives
Net positions
Own shares
47
48
Intra-group items
Transactions between entities within the same
group can only be designated as hedged items in
the entity-only financial statements, not in the
consolidated financial statements of the group.
This is because inter-company transactions do
not expose the entity to a risk that affects
consolidated profit or loss.
Overall
business risks
Overall business risk cannot be hedged
because it cannot be specifically identified
and measured.
For example, an entity cannot apply hedge
accounting to a hedge of a risk of a
transaction not occurring which will result
in less revenue. This is an overall business
risk.
49
50
Held-to-maturity investments
A held-to-maturity (HTM) investment cannot be a hedged
item with respect to interest rate risk or prepayment risk.
To hedge an HTM investment for those risks would be
inconsistent with the entitys stated indifference to future
profit opportunities for that asset, as evidenced by its
decision to classify the asset as HTM.
However, an HTM asset can be a hedged item with
respect to foreign currency risk and credit risk.
Derivatives
Derivatives cannot be designated as hedged items.
However, theres one exception. A written option can
qualify as a hedging instrument if it is designated as an
offset to a purchased option.
51
Net positions
A hedge of an overall net position does not qualify for
hedge accounting.
This is because hedge effectiveness is required to be
measured by comparing the change in fair value or cash
flows of a hedging instrument and a specific hedged item
(or group of similar items).
A net position is not a specific item.
52
Own shares
An entitys transactions in its own equity cannot be
hedged because they do not expose the entity to a
particular risk that could impact profit or loss.
For example, a forecast dividend payment cannot be a
hedged item, as IAS 32 requires that distributions to
equity holders are debited directly to equity and therefore
they do not impact profit or loss.
53
An exception
54
As an exception, the foreign currency risk of an

intragroup
monetary
item
(e.g.
a
payable/receivable between two subsidiaries)
may qualify as a hedged item in the consolidated
financial statements if it results in an exposure to
foreign exchange rate gains or losses that are not
fully eliminated on consolidation in accordance
with IAS 21.
An exception
55
In addition, the foreign currency risk of a highly

probable forecast intragroup transaction may
qualify as a hedged item in consolidated financial
statements provided that the transaction is
denominated in a currency other than the
functional currency of the entity entering into that
transaction and the foreign currency risk will
affect consolidated profit or loss.
56
Qualifying hedging instruments

As with hedging items, there are specific rules governing
which financial instruments can be used as hedging
instruments.
Definition
A hedging instrument is normally a derivative. But for a
hedge of the risk of changes in foreign currency exchange
rates only, a hedging instrument can be:
a non-derivative financial asset or a non-derivative
financial liability, whose fair value or cash flows are
expected to offset changes in the fair value or cash
flows of a designated hedged item so that the hedged
item is effectively hedged
57
Non-derivatives
Some examples of non-derivative hedging
instruments are loans and deposits denominated in
a foreign currency.
A common example of using a non-derivative
financial instrument as a hedging instrument is to
use a foreign denominated debt liability as a hedge
of a net investment in a foreign operation.
58
Exception
There are some rules governing the use of derivatives as
hedging instruments
Derivatives
Unless it is a written option, a derivative carried at fair
value can always be used as a hedging instrument
provided:
it meets the condition of effectiveness
the necessary documentation is in place

supporting the hedge relationship
it is designated for the entirety of its duration to

maturity
59
Exception
Written options
A written option cannot be designated as a hedging
instrument unless it is designated as an offset to a
purchased option.
This is because where an entity writes an option, it
effectively takes on risk. The potential loss on a written
option could be significantly greater than the potential
gain in value of the hedged item that an entity seeks to
hedge
60
Splitting a Derivative
A hedging derivative cannot be split into component
parts with one of those component parts designated
as the hedging instrument, except as follows:
the intrinsic value and time value of an option
can be separated, with only the intrinsic
element designated as the hedging instrument
the interest and spot elements of a forward can
be separated, with only the spot element
designated as the hedging instrument
61
Splitting a Derivative
62
Example
Global Holdings plc enters into a forward contract to sell
$1,000,000 for 636,943 in three months time to hedge
the foreign exchange translation risk associated with
movements in the spot rate relating to its investment in its
US subsidiary, PanAmerica. PanAmerica has net assets
of $1,000,000 in Global Holdings consolidated group
accounts
Global designates the hedged risk as movements in spot
rate only. Movements in the fair value of the premium or
discount (the forward points) implicit in the fair value of
the forward contract will therefore not give rise to hedge
ineffectiveness and are recognised separately in profit or
loss
Other possible designations

Here are some other possibilities for the
designation of hedging instruments:
Hedging more than one risk
Hedging with more than one derivative
Hedging with a combination of derivatives
and non-derivatives
63
Other possible designations
64
Hedging more than one risk

A hedging instrument can be designated as hedging
more than one risk, provided all other hedge
accounting criteria are met.
Hedging with more than one derivative
Two or more offsetting derivatives can be jointly
designated as a hedging instrument.
Hedging with a combination of derivatives and nonderivatives
A combination of a derivative and a non-derivative
instrument (for hedges of foreign currency risk only)
can be designated in combination as the hedging
instrument
65
Requirements
IAS 39 doesnt prescribe a specific method for
assessing hedge effectiveness. However, it does
require an entity:
to specify at inception of the hedge relationship
the method it will apply to assess the
effectiveness; and
to apply that method consistently for the
duration of the hedging relationship
66
Assessing effectiveness
Here are some key questions about
effectiveness
How is effectiveness assessed?
When is effectiveness assessed?
Can effectiveness be assumed?
67
hedge
68
How
Several mathematical techniques can be used to
assess hedge effectiveness, including ratio analysis
and various statistical methods like regression
analysis. The appropriateness of a given method will
depend on the nature of the risk being hedged and
the type of hedging instrument used. The method
specified must be:
Consistent with managements risk management
strategy and objective.
Applied consistently to all similar hedges unless
different methods are explicitly justified.
69
When
Effectiveness must be assessed, at a minimum, at each
balance sheet date, including interim financial statements.
Can effectiveness be assumed?
Even where the principal terms of the hedging instrument
and of the entire hedged asset or liability or hedged
forecast transaction are the same, an entity cannot
assume hedge effectiveness under IFRS.
Hedge effectiveness must be both assessed and
measured. This is because significant hedge
ineffectiveness may arise from other sources - for
example, as a result of changes in the liquidity of the
hedging instruments or their credit risk.
Basis Risk
It is not always possible for an entity to find a hedging
instrument with exactly the same terms as the item it
wishes to hedge. This is where basis differences arise.
Basis differences result from using a hedging
instrument that is based on a specific risk, which is
similar, but not identical, to the risk being hedged in the
hedged item.
For interest sensitive items, basis differences result
from differences in interest indices - for example,
LIBOR versus Treasury rates, three-month LIBOR
versus six-month LIBOR and from credit differences.
70
Basis Risk
71
Example
Deep and Dark plc has a forecast purchase of
Grade A cocoa for use in its chocolate production
process.
Exchange-traded cocoa futures are indexed to
Grade B cocoa. Hence, there is a difference in
basis or grade between Deep and Darks
hedged purchase and the futures available to it
from the market to hedge its exposure.
Examples of methods to test effectiveness
72
Selection of an Appropriate Effectiveness Testing

Methodology
73
Perfect or almost
perfect relationships
Ratio analysis
Asset/ liability
mismatch hedging
(eg. asset swaps)
Price vs price
regression or
variance-reduction
analysis
Portfolio hedging
(net position hedges)
Change in price vs
change in price
regression analysis
Common Effectiveness Testing

Methodologies
Ratio analysis - calculates the ratio of the change in the fair value
of the hedged item to the change in the fair value of the hedging
instrument.
Regression analysis - a statistical technique used to analyze the

relationship between one variable (the dependent variable) and one
or more other variables (known as independent variables).
Variance reduction analysis - compares the statistical variance of

the fair value of the combined portfolio (i.e. hedged item and
hedging derivative together) with the statistical variance of the fair
value of the hedged item alone.
The entity can select the method depending on its risk management
strategy. Different methods can be used for different types of hedges.
[IAS 39.147]
74
Effectiveness Testing Methodologies

Variations
75
Hypothetical derivative approach -the measurement of

hedge effectiveness is based on a comparison of the
change in the fair value of the actual swap and the change
in fair value of a perfect hypothetical swap
Change in cash flows approach for a cash flow
hedging relationship effectiveness may be tested by
assessing the offset of variability of cash flows.
VaR reduction analysis the measurement of hedge
effectiveness is based on existing risk measures used by
the bank, but would need to be performed on a
relationship level
Ways to improve effectiveness

To improve hedge effectiveness, entities can employ
one of the following methods.
Hedge ratio
Designate certain risks
Certain risks in action
76
Hedge Ratio
77
To improve the effectiveness of the hedge, an

entity may choose a hedge ratio other than oneto-one.
If an entity hedges an item with a hedging
instrument with a different basis, a regression
analysis can be performed to establish a
statistical relationship between the two items. IAS
39 uses the example of a transaction based on
Brazilian coffee prices hedged with a transaction
based on Colombian coffee prices to represent a
statistical relationship.
Hedge Ratio
78
If a valid statistical relationship such as historical

correlation between the two variables (for
example, between the unit prices of Brazilian
coffee and Colombian coffee) can be
demonstrated, the slope of the regression line can
be used to establish the hedge ratio that would
maximise expected effectiveness. If the slope of
the regression line is, say, 1.02, a hedge ratio
based on 0.98 quantities of hedged items to 1.00
quantities of the hedging instrument will maximise
expected effectiveness.
Designate Certain Risks

To improve hedge effectiveness, an entity can
elect to only designate certain risks inherent in a
hedged item as being hedged.
The concept of hedging portions, which involves
designating an identifiable and separable portion
of the risk on the financial asset or liability as the
hedged item, can result in considerable
ineffectiveness being eliminated. This is because
the designated risk is a specifically identifiable risk
inherent in the hedged item
79
Certain Risks in Action

Smith-Jones plc reduced the risk of ineffectiveness by doing
the following:
Smith-Jones plc entered into a receive-fixed payvariable LIBOR interest rate swap to fair value hedge
issued fixed rate debt. The interest rate index in the
hedging instrument was LIBOR. LIBOR rate reflects the
credit quality of AA financial institutions. Even though
Smith-Jones plc was not an AA rated company, it
designated the portion of risk equivalent to this rate, i.e.
it hedged the LIBOR swap rate only
It purposely excluded from the designation fair value
movements of the debt due to movements in its own
credit quality.
Therefore,
Smith-Jones
reduced
the
risk
of
ineffectiveness.
80
81
Accounting Treatment
A hedge is accounted for as follows:
Effective portion
The portion of the gain or loss on the hedging instrument
that is determined to be effective in hedging the hedged
item is deferred in a separate reserve in equity.
The effective portion does not stay in equity without ever
being recognised in profit or loss. It is moved out of equity
and reclassified into profit or loss, or recycled, when the
hedged item affects profit or loss
Ineffective portion
The ineffective portion of the gain or loss on the hedging
instrument is recognised immediately in profit or loss.
82
Deferred Gains or Losses

The amount of gains or losses on the designated
hedging instrument that can be deferred in the
separate component of equity in cash flow hedge is
limited to the lesser of the following (in absolute
amounts):
83
the cumulative gain or loss on the hedging instrument

from inception of the hedge and
the cumulative change in fair value (present value) of
the expected future cash flows on the hedged item from
inception of the hedge
Deferred Gains or Losses
84
Where the cumulative change in value in the hedging

instrument for the hedged risk is less than the cumulative
change in value of the hedged item for that risk, the entity
has under-hedged its cash flow exposure. Such a
difference will not be reflected in profit or loss as hedge
ineffectiveness assuming the level of ineffectiveness is not
so great so as to preclude hedge accounting.
This is different to fair value hedges where both overhedging and under-hedging will lead to ineffectiveness in
profit or loss, as both gains and losses on the hedged item
and hedging instrument are recognised in profit or loss.
Forecast Transactions
When considering hedges of forecast transactions
you need to bear in mind the following key facts:
The rules for forecast transactions
What does highly probable mean?
Probability: some considerations
85
The rules for forecast transactions

For cash flow hedges of forecast transactions, the
forecast transaction must:
be highly probable and
present an exposure to variations in cash flows
that could ultimately affect reported profit or
loss
86
What does highly probable mean?

The following should be considered in determining
whether a forecast transaction is highly probable:
the length of time until a forecast transaction is
projected to occur, and
the quantity of the forecast transaction
87
Probability: some considerations

Other factors being equal, the more distant a
forecast transaction is, the less likely it is that it
can be considered probable and the stronger the
evidence would need to be to support an
assertion that it is highly probable. A transaction
forecast to occur in five years may be less likely
than a transaction forecast to occur in one year.
However, forecast interest payments for the next
20 years on variable-rate debt typically are
probable if supported by an existing contract.
88
Forecast Transaction: A mini example
Less evidence is generally needed to support

forecast sales of 100,000 units in a particular
month than is needed to support forecast
sales of 950,000 units in that month, even if
the entitys recent sales have averaged
950,000 units per month for the past three
months.
89
Basis Adjustments
An entity can choose between two accounting
policies regarding the gains and losses
deferred in equity if a cash flow hedge of a
forecast transaction subsequently results in
the recognition of a non-financial asset (or a
non-financial liability).
90
Basis Adjustments
An entity can either:
1.
Reclassify the associated gains and losses into
profit or loss in the same period, or periods, during
which the asset acquired or liability assumed affects
profit or loss (such as in the periods that
depreciation expense or cost of sales is recognised
that derives from the non-financial item).
2.
Basis adjust the carrying amount of the asset or
liability with the associated gains and losses
deferred in equity. Basis-adjusting involves
removing the associated gain or loss from equity
and including it in the initial cost of the asset or
liability, in which case such gain or loss will
automatically impact profit or loss when the nonfinancial item is depreciated or sold.
91
Basis Adjustments : Effect

The accounting policy that an entity chooses
must be applied consistently to all such hedges.
Whichever policy is chosen the impact of
recycling deferred hedging gains or losses into
profit or loss will be the same. Hedging gains or
losses will be recycled into profit or loss when
the hedged non-financial item is depreciated,
sold, or otherwise impacts profit or loss.
However, if an entity expects that all or a portion
of a loss recognised directly in equity will not be
recovered in one or more future periods, it must
reclassify the amount that is not expected to be
recovered into profit or loss immediately
92
Qualifying amounts of gains/losses

What would be the amount of gains or losses on the
designated hedging instrument that could be deferred in the
separate component of equity in a cash flow hedge in the
following circumstances?
Hedging
Derivatives
93
The fair value of future cash flows decreases by $232

& the fair value of the hedging instruments increases
by $221
The fair value of future cash flows increases by $4,432

& the fair value of the hedging instruments decreases
by $4,624
The fair value of future cash flows decreases by

$3,534 & the fair value of the hedging instruments
increases by $4,567
Equity
Income
Statement
Hints:
Where the entity has under-hedged its cash
flow risk exposure, so the change of in
value in hedging instrument for hedged risk
is less then change in value of the hedged
item for that risk, that difference will not be
reflected in in profit or loss as hedge ineffectiveness.
94

Answer:
Hedging
Derivatives
95

$232 & the fair value of the hedging instruments
increases by $221
Equity
Income
Statement
221
221
The fair value of future cash flows increases by

decreases by $4,624
4,624
4,432
192

increases by $4,567
4,567
4,567
The hedge relationship in No. 3 is not highly effective, hence does not
qualify for hedge accounting.
Discontinuance (1/2)
CRITERIA FOR HEDGE
ACCOUNTING ARE NO
LONGER MET
(documentation,
effectiveness testing)
THE HEDGING
INSTRUMENT
EXPIRES, IS SOLD,
TERMINATED OR
EXERCISED
REVOCATION OF THE
DESIGNATION
(managements decision)
PROSPECTIVE DISCONTINUANCE OF HEDGE

ACCOUNTING
96
96
Discontinuance (2/2)
FAIR VALUE
HEDGE
CASH FLOW
HEDGE
NET INVESTMENT
HEDGE
97
97
IF THE HEDGED ITEM IS A FINANCIAL

INSTRUMENT MEASURED AT
AMORTISED COST, AMORTISATION OF
ANY ADJUSTMENT OF ITS CARRYING
AMOUNT
GAINS AND LOSSES ACCUMULATED
IN EQUITY REMAIN IN EQUITY UNTIL
THE HEDGED ITEM WILL IMPACT
PROFIT OR LOSS EXCEPT IF THE
FORECAST TRANSACTION NO LONGER
EXPECTED TO OCCUR
GAINS AND LOSSES ACCUMULATED

IN EQUITY REMAIN IN EQUITY UNTIL
THE DISPOSAL OF THE FOREIGN
OPERATION
Discontinuation
When to discontinue?
An entity must discontinue prospectively cash flow hedge
accounting if:
the hedging instrument expires or is sold, terminated or
exercised, or
the hedge no longer meets the hedge accounting
criteria (for example, if it is no longer highly effective or
its effectiveness is no longer measurable), or
the forecast transaction is no longer expected to occur,
or
the entity de-designates the hedge relationship
98
Discontinuation
If an entity discontinues hedge accounting by dedesignating the hedging relationship, it may elect
to designate prospectively a new hedging
relationship with the same hedging instrument,
provided the new hedging relationship meets the
requirements for hedge accounting.
But whats the effect of discontinuing cash flow
hedge accounting on hedging gains or losses that
have already been recognised in equity?
99
Discontinuation
The impact
When a cash flow hedge is discontinued, the
cumulative gain or loss on the hedging instrument
deferred in equity:
continues to be separately recognised in equity
(provided the forecast transaction is still
expected to occur), and
is then removed and included in profit or loss,
when the forecast transaction occurs.
100
Discontinuation
The impact
If, however, the forecast transaction is no
longer expected to occur, the cumulative gain
or loss on the hedging instrument is
recognised immediately in profit or loss
101
Common sources of ineffectiveness
Following some of the common sources of ineffectiveness

for a cash flow hedge, these include, amongst other
factors:
Changes in timing of the highly probable forecast
transaction.
Basis risk, where an entity hedges an item with a
hedging instrument with a different basis
Off-market hedging derivatives
Derivative features embedded in the hedged item or
hedging instrument
102
Common sources of ineffectiveness

Examples:
Where the forecast transaction is expected to occur in an
earlier period than originally anticipated but the hedging
instrument must be designated for the whole of its
remaining period to maturity. (changes in timing)
A LIBOR swap that reprices every six months when the
hedged item is variable LIBOR interest that reprices every
three months. (Basis risk)
If at inception of the hedge, the fair value of the hedging
derivative is not zero. (Off-market hedging derivatives)
Embedded call, prepayment or termination features
( Derivative)
103
104
105
Definition
A cash flow hedge is 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
106
Cash flow hedge exposures

Here are some common assets, liabilities, and
forecast transactions that are hedged, using cash
flow hedging:
107
Variable rate liabilities like loan payables

Variable rate assets like investments in bonds
Highly probable forecast purchases
Highly probable forecast sales
Variable rate liability

An example of this is hedging a variable rate debt
instrument with a floating to fixed interest rate swap.
The cash flow hedge reduces future cash flow variability
of interest rates on the debt.
Variable rate assets

An example of this is hedging the forecast reinvestment
of interest and principal received on a fixed rate bond.
108
Highly probable forecast purchases

An example of this is a hedge of the forecast purchase of 100,000
bushels of corn in October to be used in an entitys manufacturing
process with a forward commodity contract to buy the same amount
of corn in October.
Highly probable forecast sales

An example of this is a hedge of the forecast sale of an available-forsale investment at the end of the fourth quarter with a put option with
the same exercise date.
109
Accounting for a cash flow hedge
110
Cash Flow Hedge

Cash flow
hedge
Period
1
Total
Hedged Item
30
Derivative
(30)
111
P&L
Period
2
30
(30)
(30)
0
(30)
0
Cash Flow Hedge Example (1/5)

On 30/9/09 a UK company (functional currency: )
expects to buy equipment for US$ 1m. The
delivery date should be 31/3/10 and the payment
date of 30/6/10.
The company enters into a forward exchange
contract to purchase US$ 1m at a fixed exchange
rate, in order to hedge the foreign exchange risk.
The forward contract is designated as a cash flow
hedge of the exchange risk of the forecast
transaction.
112
Cash Flow Hedge Example (2/5)
Applicable exchange rates are as follows:

Date
Spot
Forward
30/9/09
1.22
1.23
31/12/09
1.23
1.24
31/3/10
1.25
1.25
30/6/10
1.26
N/A
FV of FX contract on 31/12/09 and 31/3/10 as determined

from market quotes is 9,500 and 19,700 respectively. At
30/6/10 the FV is 30,000 the net amount that is due to be
settled at that date.
113
Cash Flow Hedge Example (31/12/09)

(3/5)
Transaction
Balance Sheet
Dr
Recognise gain in
FV of forward
since 30/9/09
114
Forward
asset
9,500
Cr
Income
Statement
Dr
Cr
Equity
Dr
Cr
Hedging
reserve
9,500

(4/5)
Transaction
Balance Sheet
Dr
Recognise
receipt of
equipment at
spot
Cr
Income
Statement
Dr
Cr
Equity
Dr
Equipment Payables
Asset
1,250,000
1,250,000
Recognise gain Forward

on fv of forward asset
since 31/12
10,200
Gains deferred
in equity are
included in the
assets
115
Cr
Hedging
reserve
10,200
Equipment
Asset
19,700
Hedging
reserve
19,700

(5/5)
Transaction
Balance Sheet
Dr
Payment for
equipment at
spot rate and
exchange loss
on the payable
since 31/3
Payable
1,250,000
Gain on
forward
contract for the
period
Forward
asset
10,300
Net settlement
under forward
contract
116
Cash
30,000
Cr
Income Statement
Dr
Cr
Cash
FX Loss
1,260,000 10,000
FX Gain
10,300
Forward
Asset
30,000
Equity
Dr
Cr
117
summary of hedge accounting

Companies exposed to financial risks can enter
into hedging transactions to hedge those risks.
Where the hedged item or transaction is either not
recognised in the balance sheet or is not
measured at fair value, there will be a mismatch in
the timing of recognition of gains and losses in
profit and loss between the hedged item and the
hedging derivative as the derivative is always
measured in the balance sheet at fair value.
118

Hedge accounting achieves matching in the
timing of recognition of gains and losses on the
hedged item and the hedging instrument in profit
and loss.
There are three methods of hedge accounting:
cash flow, fair value and net investment hedge
accounting.
119

For a hedge to qualify for hedge accounting it
must be highly effective (between 80-125%).
A hedge must also be consistent with the
companys
risk
management
strategy,
prospectively and retrospectively effective, its
effectiveness must be measureable, and any
ineffectiveness must be recorded in profit and
loss.
120
Rules of Hedge Accounting
Hedged Items Summary

Hedging a portion of the total instrument is
allowed;
Partial term hedging is allowed;
Can only hedged FX risk or total risk for non
financial Items;
Explained conditions for designating groups of
items as one hedged item;
Cannot hedging net positions; and
Instruments subject to prepayment can be a
hedged item.
121
Summary
A cash flow hedge is a hedge of an exposure to
variability in cash flows that could affect profit or
loss. A forecast transaction must be highly
probable to qualify for cash flow hedge
accounting.
In a cash flow hedge the effective portion of the
change in fair value of the hedging instrument is
recognised outside profit and loss in equity and
recycled into profit and loss when the hedged item
affects profit and loss.
122
Summary
For a cash flow hedge that results in the
recognition of a non-financial asset or liability the
hedging gains or losses can basis adjust the
hedged asset or liability.
When the hedge is discontinued and the forecast
transaction is no longer expected to occur any
hedging gains or losses deferred in equity must
be taken to profit or loss immediately.
123

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