Hedge Accounting for Embedded Derivative

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IMCO
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Hedge Accounting for Embedded Derivative

Post by IMCO »

Assume a financial asset embeds a derivative. Absent the ED the financial asset is a standard amortising loan.

Assume also that the risk/benefit of the ED is exactly countervailed by another transaction, specifically directed to that end.

These questions arise: (a) can hedge accounting be applied as regards the ED component of the financial asset (the hedged item) and the countervailing transaction (the hedging instrument). (b) Assuming so, and given that the net movement between the ED and the hedging instrument will always be nil (exactly countervailed), can the financial asset now be brought to account as a standard amortising loan?
pub_acco
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Re: Hedge Accounting for Embedded Derivative

Post by pub_acco »

You can designate the embedded derivative as a hedged item but usually you don't need to. You will have to measure both the ED and the hedging derivative at FVTPL, and in this way the P&L impact will be naturally cancelled by each other's. Anyway, you have to record an asset and liability separately unless the offsetting criteria of financial instruments are met (see IAS 32).
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Marek Muc
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Re: Hedge Accounting for Embedded Derivative

Post by Marek Muc »

hey pub_acco, I wonder about IFRS 9.4.3.2 which, as I see it, prohibits bifurcation of embedded derivative for accounting purposes if the host is a financial asset. Which means that the loan must be carried at FVOCI or FVTPL as the SPPI test will most likely be failed. So can we really say that the ED can be classified as hedged item if the ED cannot be bifurcated?
pub_acco
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Re: Hedge Accounting for Embedded Derivative

Post by pub_acco »

Oops, I believed it was a financial liability that embedded a derivative. Right, if it is a financial asset, then the host contract and embedded derivative must be accounted for together as.a single unit. That said, it is possible to designate the embedded derivative as a hedged item in a certain situation because IFRS 9.6.3.1 allows to designate a component of a single item as a hedged item, though doing so makes no sense when the financial asset is measured at FVTPL.
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Marek Muc
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Re: Hedge Accounting for Embedded Derivative

Post by Marek Muc »

Right, so then it is not possible to account for the loan asset at amortised cost even if the ED part is a hedged item
pub_acco
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Re: Hedge Accounting for Embedded Derivative

Post by pub_acco »

Agree.
IMCO
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Re: Hedge Accounting for Embedded Derivative

Post by IMCO »

Thank you for these responses.
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