Please find below the summary of the Exposure Draft on hedge accounting under IAS 39 issued by IASB on 9th December 2010.
We are all aware that IFRS is principle based while US GAAP is rule based. However, the hedge accounting portions of IAS 39 do contain certain rule based criteria for testing hedge effectiveness. The proposals in the ED seeks to move away from this by making this principle based.
The main objective of ‘hedge accounting’ under the current standards is to mitigate the recognition and measurement anomalies between the accounting for hedged items and to manage the timing of the recognition of gains or losses on derivative hedging instruments used to mitigate cash flow risk. As per the ED the objective is to represent in the financial statements the effect of managing exposures arising from particular risks that affect profit or loss.
So long ‘hedge accounting’ is considered to be a privilege and the entity is supposed to earn such privilege by fulfilling several rigourous conditions. Considering the fact that the new proposal are aimed at the entities to show the effect of managing risks in the financial statements, it will not be surprising if this is made mandatory soon.
|Parameter||Existing IAS 39 Standard||Proposed IFRS 9 Standard|
|Objective||To mitigate the recognition and measurement anomalies between the accounting for hedged items and to manage the timing of the recognition of gains or losses on derivative hedging instruments used to mitigate cash flow risk||To represent in the financial statements the effect of managing exposures arising from particular risks that affect profit or loss|
|Hedging instruments||A non-derivative financial asset/liability measured at fair value through profit or loss is not eligible for designation as a hedging instrument||A non-derivative financial asset/liability measured at fair value through profit or loss may be eligible for designation as a hedging instrument|
|Hedged items||An aggregated exposure that is a combination of an exposure and a derivative cannot be designated as a hedged item||An aggregated exposure that is a combination of an exposure and a derivative may be designated as a hedged item|
|Non-financial items||Risk component separately identifiable and reliably measureable may be designated as the hedged item in a hedging relationship but only for financial items||Risk component separately identifiable and reliably measureable may be designated as the hedged item in a hedging relationship for non-financial items also|
|Hedge effectiveness testing||Rule-based: The offset is within the range of 80-125 % a hedge is effective and only then it qualifies for hedge accounting||Principle-based: The hedging relationship should meet the objective of the hedge effectiveness assessment as laid down in the risk management policy of the entity|
|Retrospective testing||On an ongoing basis an entity should assess the effeictiveness of the hedge by retrospective testing||The assessment relates to expectations about hedge infectiveness and offsetting and therefore is only forward looking.|
|No retrospective testing|
|Rebalancing of a hedging relationship||There is no such thing as rebalancing.||When a hedge effectiveness assessment objective fails an entity can modify the hedge ratio to meet the objective of hedge effectiveness assessment, so long as the risk management objective remains unaltered|
|Modifying the hedge ratio is not permitted|
|Discontinuing hedge accounting||If the effectiveness testing fails either prospectively or retrospectively hedge should be discontinued||Hedge accounting shall be discontinued prospectively only when the hedging relationship ceases to meet the qualifying criteria affecting the risk management activities|
|Fair value hedges||The effective and ineffective portions are taken to the profit and loss||The gain or loss on the hedging instrument and the hedged item should be recognized in other comprehensive income. The ineffective portion should be transferred to profit and loss|
|Time value of options||The entire fair value of an option including the time value is treated as held for trading and is accounted for at fair value through profit or loss||When designated, entity should follow specific accounting requirements for accounting the time value of an option|
|Net position hedging||IAS 39 does not allow net positions to be hedged||Extend the use of hedge accounting to net positions, improving the link to risk management|
|Credit derivatives as hedging instrument||Under the current standards entities using credit derivatives do not achieve hedge accounting as it is operationally difficult if not impossible||Three alternative approaches of accounting proposed where credit risk is hedged by credit derivatives with separate qualification and discontinuation criteria|
|Hedges resulting in non-financial asset/ liability||Option to either basis-adjust or to route the hedge gain/loss directly in profit or loss from other comprehensive income||Proposal withdraws the choice and the hedge gain/loss should be subject to basis-adjustment|