16 Appendix 16A Hedging Derivatives Used For Hedging Organizations face economic and financial risks Hedging is the use of derivatives to hedge these risks Hedging has value because it generally ID: 305082
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Slide1
1
CHAPTER
16
Appendix 16A
HedgingSlide2
Derivatives Used For HedgingOrganizations face economic and financial risks
Hedging is the use of derivatives to hedge these risks
Hedging
has value because it generally reduces uncertainty/risk and therefore volatilityMust separate the act of hedging (to reduce economic and financial risks) from the accounting
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2Slide3
Need for Hedge Accounting StandardsIf symmetry in accounting exists, the
gains/losses
created by hedging offset in the same period
In this situation, there is no need for special hedge accountingIf there is no symmetry in accounting, the gains/losses created by hedging do not offset in same period – In this situation, companies may choose to apply hedge accounting so that the gains/losses do
offset
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3Slide4
Hedge Accounting Optional hedge accounting may be available when the following are met:
When the hedge is entered into
Identify the exposure
Designate that hedge accounting appliedDocument risk management objectives and strategiesReasonable assurance should exist that the firms’ risk management policy is being maintained
Hedge effectiveness can be reliably measuredHedging relationship is reassessed at regular intervals
If involves forecasted transactions, probable that transactions will occur
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4Slide5
Hedge AccountingUnder IFRS, two types of hedges identified for hedge accounting – fair value and
cash flow
hedgesUnder ASPE, only certain transactions qualify for optional hedge accountingCopyright John Wiley & Sons Canada, Ltd.5Slide6
Hedge AccountingFair Value Hedge
To offset exposure to fair value changes of
recognized
asset or liabilityUnder IFRS, hedged item valued at fair value and gains/losses booked to net incomeCash Flow HedgeOffset risks of
future cash flow variabilityUnder IFRS, gains/losses on hedging item reported as part of Other Comprehensive Income
Under
ASPE,
not recognized until the transaction is settled
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6Slide7
Fair Value Hedge - ExampleInvestment purchased at a cost
of
$
1,000 (designated as FV-OCI under IFRS but is FV-NI under ASPE due to an active market):FV-OCI Investment (IFRS) 1,000 FV-NI Investments (ASPE) 1,000 Cash 1,000
Option contract to sell shares at $1,000 purchased for $10
Derivatives-Financial Assets/Liabilities
10
Cash
10
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7Slide8
Fair Value Hedge - ExampleAt year end, assume investment value is $1,050:
FV-OCI
Investment (IFRS) 50 FV-NI Investments (ASPE) 50
Unrealized Gain or Loss 50
Unrealized Gain/Loss
50
Derivatives-Financial Assets/Liabilities
50
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8Slide9
Put Option as a Fair Value HedgeUnder hedge accounting, the
gain
on
the hedged item and the loss on the underlying derivative are booked through net income The gain is thus offset by the loss on the derivativeUnder IFRS, hedge accounting allows for a modifying of the way we normally account for
a FV-OCI investmentUnder ASPE, the accounting is symmetrical and thus the impact is the same despite the fact that this type of transaction does not quality for hedge accounting
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9Slide10
Cash Flow Hedge – ExampleGiven:
Jones Corp enters into a 5-year interest rate swap with B
Terms are:
Principal sum involved is $1 millionJones will make payments at the fixed rate of 8%Jones will receive payments at variable or floating rates
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10Slide11
Cash Flow Hedge – ExampleCopyright John Wiley & Sons Canada, Ltd.
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Party A
Party B
Financial
Intermediary
A pays B at a fixed (or floating) rate
B pays A using the opposite rate of A
Cash
Interest Rate Swap
–
ExampleSlide12
Cash Flow Hedge – ExampleValue of the swap determined at the end of each year
Function of the difference between the fixed (contract) rate and the prevailing rate of interest
Value of the swap contract reported on the
Statement of Financial Position using discounted cash flow modelUnder IFRS, any gain on the hedging item is reported as part of Comprehensive IncomeUnder ASPE, the swap contract is not recognized until it is settled
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12Slide13
Forward Contract as a Cash Flow HedgeForward
contracts may be used to hedge anticipated future transactions (and the associated cash flow risks) i.e. a purchase commitment
Gives the holder the right to purchase at a preset price
Under IFRS, recorded in Other Comprehensive IncomeUnder ASPE, not recognized until settled
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13Slide14
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