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Accounting Alert - October 2012

Staying on top of developments

More opportunities for hedge accounting proposed

Accounting Alert imageThe International Accounting Standards Board (IASB) has issued a draft of the new hedge accounting guidance that will form part of IFRS 9. The draft follows an exposure draft published in December 2010; the guidance is likely to be finalised early next year.

The draft includes amendments to hedge accounting requirements, made in response to criticism of IAS 39 which was often viewed as too stringent and not capable of reflecting risk management policies.

The three types of hedge accounting remain: cash flow; fair value and net investment hedges. However, there have been significant changes to the types of transactions eligible for hedge accounting, specifically a broadening of the risks eligible for hedge accounting of non-financial items.

Changes in the way forward contracts and derivative options are accounted for when they are in a hedge accounting relationship will reduce profit or loss volatility when compared with IAS 39 and therefore will be attractive for some entities.

In addition, the effectiveness test has been overhauled and replaced with the principle of an ‘economic relationship’. Retrospective assessment of hedge effectiveness is no longer required.

The flexibility of the new accounting requirements is counter-balanced by enhanced disclosure requirements about an entity’s risk management activities.

Some things are unchanged from IAS 39:

  • Applying hedge accounting remains a choice.
  • Terminology from IAS 39 is retained in many cases (hedged items, hedging instruments, fair value hedges, cash flow hedges, hedge ineffectiveness etc.).
  • The mechanics of fair value, cash flow and net investment hedge accounting have not been changed.
  • With the exception of hedge ineffectiveness related to hedges of equity investments designated as at fair value through other comprehensive income, all hedge ineffectiveness is recognised in profit or loss.
  • The method for determining how much ineffectiveness to recognise for cash flow hedges, often known as the ‘lower of test’ is largely unchanged.
  • General prohibition on hedge accounting with written options is retained.

The intended effective date of the hedge accounting chapter are annual periods beginning on or after 1 January 2015 with earlier application permitted. The requirements are to be applied prospectively with some limited exceptions.

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