IFRS PRACTICAL IMPLEMENTATION GUIDE AND WORKBOOK

Chapter 25 / Financial Instruments: Recognition and Measurement (lAS 39)

271

(a) Changes in fair value of the hedged item are recognized in the current period to offset the recognition of changes in the fair value of the hedging instrument. This is the accounting treatment for fair value hedges. (b) Changes in fair value of the hedging ins trument are def erred as a separate component of equity to the extent the hedge is effective and released to profit or loss in the time periods in which the hedged item impacts profit or loss. This is the accounting treatment for cash flow hedges and hedges of net investments in foreign operations. Practical Insight Hedge accounting is not always necessary to reflect the effect of hedging activities in the fi– nancial statements. When consistent accounting principles apply to offsetting positions (e.g., when both the hedging instrument and the hedged item are accounted for at fair value or at amortized cost), there is no need for an entity to apply hedge accounting to achieve consistent accounting for the offsetting positions. 8.3 Hedge Accounting Conditions As discussed, hedge accounting is optional and allows entities to defer or acce lerate the recognition of gains and losses under otherwise applicable accounting requirements. To prevent abuse, there– fore, lAS 39 limits the use of hedge accounting to situations where special hedge accounting con– ditions are met. To qualify for hedge accounting, the hedging relationship should meet three condi– tions related to the designation, documentati on, measurement, and effectiveness of the hedging re– lationships. These conditions are (I ) There is formal designation and documentation of the hedging relationship and the entit y' s risk management objec tive and strategy for undertaking the hedge. Hedge accounting is permitted only from the date such designation and documentation is in place. (2) The hedging relationship is effective a] The hedge is expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk ("prospective" effectiveness). b] The effectiveness of the hedge can be measured reliably. c] The hedge is assessed on an ongoing basis and determined actually to have been highly effective throughout the financi al reporting periods for which the hedge was desig– nated ("retrospective" effectiveness). (3) For cash flow hedges of forecas t transactions, the hedged forecast transaction must be highly probable and must present an exposure to variations in cash flows that could ulti– mately affect profit or loss. Example The designation and documentation ofa hedging relationship should include identification of • The hedging instrumentts)

• The hedged item(s) or transactionis} • The nature of the risk(s) being hedged

• How the entity will assess the hedging instrument 's effectiveness in offsetting the exposure to changes in the hedged item 's fair value or the hedged transaction 's cash fl ows attributable to the hedged risk

Case Study 14

This case considers the reasons and conditions for hedge accounting. Required

( 1) Describe the three types of hedging relationships specified by lAS 39. (2) Discuss in what circumstances entities may want to apply hedge accounting. (3) Discuss the conditions for hedge acco unting.