ACT3127 Advanced Financial Accounting II

1. ACT3127 Advanced Financial Accounting II Financial Instruments FRS 132 : Presentation and DisclosureIFRS 7: Disclosure

2. Contents • Hedging and Hedge Accounting • FRS 132: FI – Presentation and Disclosures • IFRS 7: Disclosures • Conclusion

3. Hedging: what is “Hedging arrangements involve a hedging instrument offsetting movements in a hedged item” (139.9) • “hedged item” – foreign currency debt • “hedging instrument” – foreign currency forward contract

4. Hedging: the challenge • Effective hedging: eliminate??? • Risk exposed: operating – manufacturing & marketing activities financial – exposure to market factors • Which one to hedge? - distinguish the risks that company is paid to take and the ones that are not

5. Hedge Accounting • “..Match the two halves of the hedging relationship, so as not to affect the income statement one-sidedly..” • Note: ALL trading instrumentsmust be classified as “FV through P&L”. Other FI may be classified under “FV through P&L”. • Not mandatory

6. Hedge Accounting: criteria “Hedge accounting can be used only if certain strict criteria are met” (139.88) • Hedge formally designated and documented at inception • Expected to be highly effective (AG105) • CFH – forecast transaction must be highly probable and must present an exposure to variations in cash flows that could ultimately affect profit & loss • Effectiveness can be reliably measured • Assessed on an ongoing basis and determined actually to have been highly effective throughout the reporting periods

7. Hedge Accounting: Effectiveness test • Prospective effectiveness test - forward-looking - at inception and prepare for FS • Retrospective effectiveness test - backward-looking - prepare for FS

8. Hedge Accounting: how to apply • Understand risk exposures and their effects on financial statements evaluate the risks exposed to how do you want to manage

9. Hedge Accounting: how to apply 2. Designate/document hedge relationship - to qualify, include: risk management objective and strategy identification of the hedging instrument the related hedge item or transaction nature of the risk being hedged method of assessing the effectiveness of the hedge

10. Hedge Accounting: how to apply • Account for the hedge relationship Fair-value hedge Cash-flow hedge Exposure to changes in fair-value Gains / losses recognised in current net income Exposure to variability of cash flows Gains / losses recognised in other comprehensive income (equity)

11. Hedge Accounting: how to apply 4. Discontinue hedge accounting inneffective or terminated (prospective basis)

12. Hedge Accounting: how to apply 5. Provide disclosure Company’s objectives and strategy Sufficient information to understand hedge accounting’s effect on financial statements

13. Further readings • C.J. Woelfel, Hedging, Encyclopedia of Banking & Finance (9th Edition) • I.H. Giddy, The Corporate Hedging Process, Bank of Montreal • I.P.N. Hague, Hedging and new standards, Accounting Standards Board (Canada) • PWC, IAS 139 – Achieving hedge accounting in practice • KPMG Guide: FRS 139 – Financial Instruments: Recognition and Measurement

14. FRS 132 : Presentation & Disclosure • Presentation (132:15) • financial assets, liability or equity • in accordance with the substance of the contract and definition of the above groups

15. FRS 132 : Presentation & Disclosure • Disclosure - To provide information to enhance understanding…(132:51)

16. IFRS 7 : Disclosures • 70 additional disclosure requirements Criteria used to classify Capital management strategy Qualitative disclosure: risks faced and the strategies used to manage them

17. Conclusions