Accounting for Interest Rate Swap

All topics related to IFRS Standards.
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Glad2010
Posts: 7
Joined: 24 Nov 2022, 12:45

Accounting for Interest Rate Swap

Post by Glad2010 »

Hi All,
I'm having to do the treasury related accounting after a long gap and require assistance from experts here please. WE have taken an IRS with a big fee for a term of 60 months as part of our refinancing condition from the lender on a separate refinancing deal. The IRS is on a pay fix/receive floating basis. I understand no entry required for the notional value in the deal and the net interest received/paid will be reflected in the P&L, but have the following questions:
1. Is this a fair value hedge? how to value the MTM to
2. How to account for the fee (£20m)paid in month 1 for a 60 month term?
3. Notional amount keeps changing (increasing) during the 5 year period. Any increase in the notional amounts to be accounted as DFI with an offsetting gain/loss through OCI or P&L under IFRS or a completely different treatment?
4. Would this IRS fee charged by the floating party to us qualifies for capitalisation under IAS 23 as the maximum amount from the lending will be used to construct the 'qualifying' asset?

Appreciate guidance and feedback to help me understand this.
Thanks
Glad
Leo
Posts: 908
Joined: 05 Apr 2020, 22:31

Re: Accounting for Interest Rate Swap

Post by Leo »

In order to respond to your question, we need to know what are you hedging against ?

The underlying hedged asset or liability please
Glad2010
Posts: 7
Joined: 24 Nov 2022, 12:45

Re: Accounting for Interest Rate Swap

Post by Glad2010 »

The underlying asset/liability is a liability ie a revolving loan facility obtained by us from a totally different lender.
Thanks
Leo
Posts: 908
Joined: 05 Apr 2020, 22:31

Re: Accounting for Interest Rate Swap

Post by Leo »

And whats the loans interest rate, is it variable or fox,?
Glad2010
Posts: 7
Joined: 24 Nov 2022, 12:45

Re: Accounting for Interest Rate Swap

Post by Glad2010 »

Interest rate is variable with a fixed component of margin % so in effect a variable rate overall. Thanks for looking into this..
Leo
Posts: 908
Joined: 05 Apr 2020, 22:31

Re: Accounting for Interest Rate Swap

Post by Leo »

Cash flow hedge, with variation of the value of the instrument in OCI.

Not sure how to record the fees thought, seem very high for me.
DJP
Trusted Expert
Posts: 345
Joined: 26 Jun 2020, 15:57

Re: Accounting for Interest Rate Swap

Post by DJP »

Hello,

Answering your questions:

1- It is a cash flow hedge, but you only account for it as a cash flow hedge if you formally designate this IRS in a hedge accounting relatonship (it is optional). If hedge accounting is not applied, you need to fair value the IRS at each reporting date and take the fair value changes to P&L.

2- Why is there a fee? Is it because the IRS has been entered into at non-market terms? In any case, you should take the fee to P&L immediately.

3 - You don't account for the notional amount. But the notional amount will impact the IRS's cash flows and therefore its market value at each reporting date (see 1 above for how to account for the IRS).

4- No. Assuming that you have a qualifying asset, only the borrowing costs relating to the loan facility will be capitalised according to IAS 23. You have entered into the IRS for hedging purposes, not to acquire the qualifying asset.

Hope this helps.
Glad2010
Posts: 7
Joined: 24 Nov 2022, 12:45

Re: Accounting for Interest Rate Swap

Post by Glad2010 »

Leo and DJP - thank you for your insight. In respect of fees taking it to P&L, should this be expensed on a 'period cost' basis or anything like effective interest method where frontloading is achieved?

Thanks
DJP
Trusted Expert
Posts: 345
Joined: 26 Jun 2020, 15:57

Re: Accounting for Interest Rate Swap

Post by DJP »

It should be booked immediately in P&L upon recognition of the IRS.

(Still not clear about what the fee is about.)
Leo
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Joined: 05 Apr 2020, 22:31

Re: Accounting for Interest Rate Swap

Post by Leo »

Yea 20m that's madness.
Glad2010
Posts: 7
Joined: 24 Nov 2022, 12:45

Re: Accounting for Interest Rate Swap

Post by Glad2010 »

Thank you both. I was going to book the fee on the 60 months basis ie proportion this over a 5 year period?
As regards the fee being high, £20m(£4m pa) this is for a max £400+m notional value and agreed by both parties. This works out to be appx 5% which is still high.
DJP
Trusted Expert
Posts: 345
Joined: 26 Jun 2020, 15:57

Re: Accounting for Interest Rate Swap

Post by DJP »

But why are you paying a fee? That's the question. An IRS entered into at market terms should have a nil value at inception.
Glad2010
Posts: 7
Joined: 24 Nov 2022, 12:45

Re: Accounting for Interest Rate Swap

Post by Glad2010 »

Agree fee is very high but it was agreed by both parties. Unfortunately, the real effect of capitalism takes precedence and financial institutions exploit start-ups.

Thank you all for contributing to this...
Glad2010
Posts: 7
Joined: 24 Nov 2022, 12:45

Re: Accounting for Interest Rate Swap

Post by Glad2010 »

For those who've been reading this thread with interest, fee is high based on the actuarial valuation for interest rate market volatility for the next 5 year term. Therefore, this is simply a cost of risk management of the financial asset. Client has other similar arrangements where fee is a very small number, but the currencies are different than the one for 20m fee.

Thank you all.
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