286 / 488
Chapter
25 /
Financial Instruments: Recognition and Measurement (lAS 39)
Dr Cash
93,000
Cr Equity
6,000
Cr Sales revenue
87,000
(To record the sale and the associated amount def erred
ill
equity related
to
the hedge ofthe sale)
277
8.6 Hedge of a Net Investment in a Foreign Operation
lAS 2 I defines a foreign opera tion as an entity that is a subsidiary , associate, joint venture, or
branch of a reporting entity, the activities of which are based or conducted in a country or currency
othe r than those of the reporting entity. A net investment in a foreign operatio n is the amount of the
reporting entity' s interest in the net assets of that operation, A hedge of net investmen t in a foreign
operation is accounted for like a cash flow hedge, In a hedge of a net investment, therefore,
changes in fair value of the hedging instrument are deferred as a separate component of equity to
the extent the hedge is effective (rather than being recognized immedia tely in profit or loss) and
recognized in profit or loss on the disposal of the net investment.
Ex ample
To hedge its net investment in a f oreign operation that has the Japanese yen as its fun ctional cur–
rency, Entity A borrows ¥IOO,OOO,OOO. Assuming all hedge accounting conditions are met, Entity
A
may designate its borrowing as a hedging instrument in a hedge of the net investment.
As
a result,
f oreign currency gains and losses
0/1
the borrowing that would otherwise have been included in
profit or loss under lAS 21 would instead be deferred in equity to the extent the hedge
is
effective
until the disposal of the net investment.
8.7 Hedge Effectiveness Assessment and Mea surement
8.7.1
As mentioned, two of the conditions for hedge accounting are that the hedge is
• Expected to be highly effective in achieving offsetting changes in fair value or cash flows
during the period for which the hedge is designated
(p rospective effec tiveness )
• Determined actually to have been highly effective throughout the reporting period for which
the hedge was designated
(retrospective effectiveness )
8.7.2
Generally, a hedge is viewed as being highly effective if actual results are within a range of
80% and 125%.
Example
If actual results are such that the gain on the hedging instrument
is
$90 and the loss on the hedged
item
is
$100, the degree of offset is 90%
( =
90/ 100), or 111%
( =
100 / 90). The hedge would be
considered to be highly effective because the degree ofoffset is between 80% and 125%.
8.7.3
Hedge effective ness is important not only as a condition for hedge accounting, but also be–
cause the measurement of hedge effectiveness determines how much ineffective ness will be re–
flected in profit or loss. To the extent the changes do not fully offset , such differences reflect inef–
fectivenes s that genera lly should be included in profit or loss. Such ineffective ness may exis t even
though a hedge is determined to be highly effective based on the prospective or retrospec tive hedge
effec tiveness assessment for purposes of continued qualification for hedge accounting.
Example
If, for a fa ir value hedge, the gain on the hedging instrument is $90 and the loss on the hedged item
is
$100, a net loss of$lO would be included in profit or loss.
8.7.4
For a qualifying cash flow hedge, ineffectiveness is included in profit or loss only to the
exte nt that the cumulative gain or loss on the hedging instrument exceeds the cumulative gain or
loss on the hedged item since the inception of the hedging relationship (overhedging). If the cu–
mulative gain or loss on the hedged item exceeds the cumulative gain or loss on the hedging in–
strument (underhedging), no ineffectiveness is reported. This is because-for a cash flow hedge–
the hedged item is a future transaction that does not qualify for accounting recognition.
Example
If, fo r a cash flow hedge, tire gain on tire hedging instrument in tire fi rst period afte r designation is
$490 and tire loss on the hedged item is $100, no ineffectiveness
is
included in profit or loss, be–
cause tire cumulative gain or loss on the Iredged item exceeds the cumulative gain or loss on tire
hedging instrument (" llItderhedging ").