Practical guide on general hedge accounting Dec 2013

Practical guide 4.1. Derivative financial instruments Neither IAS 39 nor IFRS 9 restricts the circumstances in which a derivative can be designated as a hedging instrument (provided the hedge accounting criteria are met), except for some written options. 4.2. Non-derivative financial instruments measured at fair value through P&L Under IAS 39, non-derivative financial instruments are only allowed as hedging instruments for hedges of foreign currency risk. Under IFRS 9, non-derivative financial instruments continue to be allowed as hedging instruments of foreign currency risk provided that such non-derivative financial instruments are not investments in equity instruments for which the entity has elected to present the changes in fair value in OCI. In addition, IFRS 9 also allows non-derivative financial instruments as hedging instruments to hedge other risks if measured at fair value through P&L. The only exception is for financial liabilities accounted for at fair value for which the changes in the liability’s own credit risk are presented in OCI – these are not eligible for designation as hedging instruments. For financial instruments that an entity has originally elected to designate at inception at fair value through P&L to mitigate an accounting mismatch (commonly referred as the ‘fair value option’), a designation as hedging instruments is allowed only if such designation mitigates an accounting mismatch, without recreating another one (that is, no conflict should exist between the purpose of the fair value option and the purpose of hedge accounting). PwC insight Whether or not this change will have any impact in practice is debatable, as IFRS 9 requires that such an item should be designated as the hedging instrument in its entirety or a proportion of it. In the past it has not been common practice for non-financial entities to designate non-derivative financial instruments at fair value through P&L. Therefore, on transition to IFRS 9 this change might be of limited use for these entities, however, the usefulness might subsequently increase, since entities can designate new financial instruments at fair value through P&L. 4.3. Embedded derivatives Under the requirements of IFRS 9 concerning the classification and measurement of financial instruments, embedded derivatives in financial assets are not accounted for separately. If there is an embedded derivative in a financial asset that would have been separated under IAS 39, the whole instrument will (in most cases) be carried at fair value through P&L. As a result, embedded derivatives in financial assets will no longer be eligible as hedging instruments on their own. As an alternative, entities could designate the instrument in its entirety (or a proportion of it) at fair value through P&L as a hedging instrument, as noted above. However, entities should note that designation at fair value through P&L is allowed only at inception; therefore, they can do this only for new financial instruments. For financial liabilities, on the other hand, most of the classification and measurement requirements in IAS 39 have been transferred into IFRS 9, including the paragraphs for separating embedded derivatives that are not closely related to the host instrument. This means that derivatives embedded in financial liabilities continue to be separated in some circumstances. If an embedded derivative is separated from the host instrument and accounted for separately, it continues to be eligible as a hedging instrument. 4.4. Hedging with purchased options The fair value of an option can be divided into two portions: the intrinsic value (which is determined in terms of the difference between the strike price and the current market price of the underlying) and the time value (that is, the remaining value of the option which reflects the volatility of the price of the underlying, interest rates and the time remaining to maturity). IAS 39 permits designation of either the entire fair value or only the intrinsic General hedge accounting PwC  15

Practical guide on general hedge accounting Dec 2013 | Page 17