Practical guide on general hedge accounting Dec 2013 | Page 21
Practical guide
Entities that hedge commodity price risk that is only a component of the overall price risk of the item, are likely
to welcome the ability to hedge separately identifiable and reliably measurable components of nonfinancial items.
PwC insight:
An example of a contractually specified risk component that we have come across in practice is a contract to
purchase a product (such as aluminium cans), in which a metal (such as aluminium) is used in the production
process. Contracts to purchase aluminium cans are commonly priced by market participants based on a
building block approach, as follows:
The first building block is the London Metal Exchange (LME) price for a standard grade of
aluminium ingot.
The next building block is the grade premium or discount to reflect the quality of aluminium used, as
compared to the standard LME grade.
Additional costs will be paid for conversion from ingot into cans and delivery costs.
The final building block is a profit margin for the seller.
Many entities may want to use aluminium LME futures or forwards to hedge their price exposure to
aluminium. However, IAS 39 did not allow just the LME component of the price to be the hedged item in a
hedge relationship. All of the pricing elements had to be designated as being hedged by the LME future. This
caused ineffectiveness, which was recorded within P&L; and, in some cases, it caused sensible risk
management strategies to fail to qualify for hedge accounting. By contrast, IFRS 9 allows entities to designate
the LME price as the hedged risk, provided it is separately identifiable and reliably measurable.
When identifying the non-contractually specified risk components that are eligible for designation as a hedged
item, entities need to assess such risk components within the context of the particular market structure to
which the risks relate and in which the hedging activity takes place. Such a determination requires an
evaluation of the relevant facts and circumstances, which differ by risk and market.
The Board believes that there is a rebuttable presumption that, unless inflation risk is contractually specified, it
is not separately identifiable and reliably measurable, and so it cannot be designated as a risk component of a
financial instrument. However, the Board considers that, in limited cases, it might be possible to identify a risk
component for inflation risk, and provides the example of environments in which inflation-linked bonds have a
volume and term structure that result in a sufficiently liquid market that allows a term structure of zero-coupon
real interest rates to be constructed.
PwC insight:
Although allowing hedges of risk components of non-financial item is very beneficial for entities, the wording
in IFRS 9 is unclear. IFRS 9 requires an entity to assess risk components (that are separately identifiable and
reliably measurable) within the context of the particular market structure to which the risk or risks relate and
in which the hedging activity takes place. However, there are no criteria specified to be used in the analysis of
the market structure, nor are there any definitions of the market to be analysed. For example, a manufacturer
of woollen jumpers might want to hedge its exposure to wool prices. This manufacturer considers that wool
prices are separately identifiable and reliably measurable because the amount of wool used in a jumper can
be computed from product specifications and wool prices are available in the market. Is the physical presence
of wool in its products enough, or should additional considerations be taken into account regarding the
market structure? Would the market structure differ between a manufacturer of generic woollen jumpers, as
compared to a manufacturer of a well-known, expensive brand of woollen jumpers, or for manufacturers in
different geographic locations? This will be an area subject to a high degree of judgement based on specific
facts and circumstances.
General hedge accounting
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