Hedge accounting - ineffective portion on FV hedge

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Some guy
Posts: 5
Joined: 30 Nov 2021, 20:39

Hedge accounting - ineffective portion on FV hedge

Post by Some guy »

Hi all,

I'm running into some challenges with IFRS 7 hedge accounting disclosures, but first some background information:

* Hedged item: Company's debt with fixed interest rates (debt measured at amortized cost)
* Hedging item: Swap with variable interest rates
* Applying Fair Value Hedge accounting to swap company's fixed rates (received from counter party) against variable rates (payable by company)
* Hedge effectiveness is performed qualitatively using the Critical Terms Method


So here is my issue. IFRS 7 requires the following disclosures:

IFRS 7(24B) An entity shall disclose, in a tabular format, the following amounts related to hedged items separately by risk category for the types of hedges as follows:
(a)(iv) the change in value of the hedged item used as the basis for recognising hedge ineffectiveness for the period; and

Because the debt is measures at amortized cost (and not FV) and is assessed using the Critical Terms Method, I'm not understanding how this disclosure should be made.

Anyone have any insights on this topic?

Thanks
DJP
Trusted Expert
Posts: 132
Joined: 26 Jun 2020, 15:57

Re: Hedge accounting - ineffective portion on FV hedge

Post by DJP »

In a nutshell, this discloure is requiring you to show the carrying amount of the hedged item (debt instrument at amortised cost) and the accumulated fair value adjustments that you have been bookinkg on top of the amortised cost (because you are applying hedge accounting). Also please bear in mind that you may use the critical terms method to prove that you are 100% effective regarding the "risk element" that you are hedging, but there may be other elements in the hedging instrument that are a source of ineffectiveness (e.g. CVA/DVA).
Some guy
Posts: 5
Joined: 30 Nov 2021, 20:39

Re: Hedge accounting - ineffective portion on FV hedge

Post by Some guy »

DJP wrote: 01 Dec 2021, 09:43 In a nutshell, this discloure is requiring you to show the carrying amount of the hedged item (debt instrument at amortised cost) and the accumulated fair value adjustments that you have been bookinkg on top of the amortised cost (because you are applying hedge accounting). Also please bear in mind that you may use the critical terms method to prove that you are 100% effective regarding the "risk element" that you are hedging, but there may be other elements in the hedging instrument that are a source of ineffectiveness (e.g. CVA/DVA).

Thanks for the response.

With regards to your last sentence, I came across the appended article that proposes to assess the prospective use of hedge accounting with the critical terms method (in a simple hedging relationship), but for measuring the current period's ineffectiveness that a quantitative method, such as the dollar offset method, should be used. This is inline with your response about the potential ineffectiveness coming from, for example, CVA/DVA.

My followup question is about the dollar offset method in the context of the scenario I described in my original post. I haven't found much guidance on the method in IFRS related texts, but did find some in US GAAP ASC 815. The problem with the latter is that they use it to validate whether the hedge is highly effective (80%-125% test) rather than determining the IFRS effective and ineffective portions.

I'm hoping to avoid complicated financial modeling for what , I'm hoping, can be resolved with a simple solution.

So, for my original scenario with debt measured as amortized cost: how could I used the dollar offset method to determine the effective and ineffective portions?

Compare the change in FV of the debt to the change in the FV of the hedging instrument? If the FV change in the hedging instrument is greater than the change in the hedged item, then recognize the difference (over and above) as the ineffective portion in the PnL?

If the change is lesser than assume no ineffective portion?

Should the comparison in the change in FV be on a cumulative basis or periodic basis?

Thanks

https://www.cpdbox.com/010-how-to-test- ... ss-ifrs-9/
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