As the mandatory effective date of 1 January 2018 approaches, we are considering a different element of IFRS 9 Financial Instruments on a regular basis. This month we take a look at the hedge accounting policy choices available to entities on transition to IFRS 9.
What choices are available?
On transition to IFRS 9, entities have an accounting policy choice to continue applying the hedge accounting requirements of IAS 39 instead of applying the new requirements in IFRS 9 until the IASB’s macro hedge accounting project is completed. This accounting policy choice must be applied to all hedge relationships, ie it cannot be applied on a hedge-by-hedge basis. Entities that have chosen to continue with IAS 39 are free to adopt IFRS 9 in any subsequent reporting period. However, once an entity has chosen to apply IFRS 9, it will not be possible to revert back to IAS 39.
How should I decide?
Some key considerations for making this choice are set out below.
Potential opportunities of applying IFRS 9
The new hedge accounting requirements in IFRS 9 are widely considered to represent a significant improvement compared to the complex and rules-based requirements in IAS 39. IFRS 9 is more principles-based, provides a better link to risk management and treasury operations and should result in more hedging strategies qualifying for hedge accounting. Some of the more significant improvements include:
- The removal of the prescriptive 80% - 125% hedge effectiveness thresholds which will result in more hedging relationships being eligible for hedge accounting (this issue was covered in the May edition of Business Edge)
- More exposures are eligible to be designated as hedged items, including:
- Risk components of non-financial items, eg the benchmark risk component of a future commodity purchase or sale
- Aggregated exposures that include derivatives, eg a loan plus an interest rate swap can be treated as a single hedged item if that aggregated exposure is subsequently hedged for another risk such as foreign currency risk
- A new approach to accounting for costs of hedging, eg the time value of purchased options, which should result in less profit or loss volatility
Implementing IFRS 9
While the mechanics of hedge accounting remain largely the same under IFRS 9, there are some differences which need to be considered for both new and existing hedge relationships prior to the date of initial application. For example, entities will need to:
- Make sure all existing hedge relationships continue to qualify for hedge accounting under the new criteria
- Consider whether there are any new designations or changes to existing designations to be made
- Create and/or update hedge accounting systems and processes for new and existing hedge relationships eg to implement the new hedge effectiveness criteria and rebalancing requirements
- Create and/or update hedge accounting documentation for new and existing hedge relationships eg to document the entity’s risk management strategy and objective, the hedge ratio and potential sources of ineffectiveness
- Gather the data required for the more extensive qualitative and quantitative disclosure requirements on hedge accounting now included in IFRS 7 Financial Instruments – Disclosures. For example, entities will be required to disclose a detailed description of their risk management strategy, how hedging activities might affect cash flows and the effect of hedge accounting on the financial statements by risk category (eg interest rate risk, foreign currency risk). Some of the detailed information must be provided by risk category and by type of hedge (eg fair value hedge, cash flow hedge) whereas under IAS 39 hedge accounting disclosures were by type of hedge.
Staying with IAS 39
Entities choosing to continue applying IAS 39 can continue for the time being with their existing hedge designations, hedge accounting processes and documentation. However, they will still be required to comply with the enhanced IFRS 7 disclosure requirements.
For help and advice on IFRS 9 please get in touch with your usual BDO contact or Dan Taylor.
Read more on IFRS 9:
IFRS 9 Explained – Solely Payments of Principal and Interest
IFRS 9 Explained – Business Models
IFRS 9 Explained – the new expected credit loss model
IFRS 9 explained - modifications of financial liabilities
IFRS 9 explained – the classification of financial assets
IFRS 9 explained – Hedge effectiveness thresholds
IFRS 9 explained - Impairment and the simplified approach
IFRS 9 Explained – Available For Sale Financial Assets
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