13 - Hedge Accounting and IFRS 9 Review

This set of flashcards covers key concepts and definitions related to hedge accounting as per IFRS 9, including strategies, risks, effectiveness criteria, and accounting treatments.

What is hedging?

A risk management strategy used to offset potential losses in one investment by taking an opposing position in a related asset.

What financial instruments are often used for hedging?

Derivatives such as options, futures, and swaps.

What is a fair value hedge?

A hedge of the exposure to changes in the fair value of a recognized asset or liability.

How does hedge accounting reduce profit or loss volatility?

By aligning accounting policies with risk management policies.

What are the costs associated with hedge accounting?

Complexity, potential for error, and administrative costs.

What items can be hedged?

Recognized assets/liabilities, unrecognized firm commitments, highly probable forecast transactions, or net investments in foreign operations.

What criteria must be met to apply hedge accounting?

Documented hedged item, hedging instrument, and expected hedge effectiveness at inception.

When should hedge accounting be discontinued?

When the hedging instrument expires or is sold, the criteria for hedge accounting are no longer met, or the designation is revoked.

What is an ineffective hedge?

A hedge where the movement of the hedging instrument exceeds the movement of the hedged item.

What is a cash flow hedge?

A hedge of the exposure to variability in cash flows of a recognized asset or liability.

What must be recognized for a cash flow hedge?

Only the movement on the hedging instrument is accounted for, not the hedged item.

What types of risk can be commonly hedged?

Market risk, price risk, interest rate risk, currency risk, credit risk, and liquidity risk.

What is intrinsic value in an option?

The difference between the spot price of the underlying asset and the exercise price of the option.

What is time value in an option?

The difference between the fair value of the option and its intrinsic value.

What is a business scenario for using a hedge?

When a company is concerned about loss of value of investments due to market fluctuations.

What accounts for hedge ineffectiveness?

Any excess movement of the hedging instrument not matched by the hedged item is recognized in profit or loss.

How is a foreign currency risk hedged in a loan?

By taking out a loan in the foreign currency.

What is rebalancing a hedge?

Adjusting the amount of either the hedged item or the hedging instrument to maintain the hedge ratio.

What is the difference between cash flow hedge and fair value hedge?

Cash flow hedge relates to variability in cash flows, while fair value hedge relates to changes in the fair value of an asset or liability.

What would result in a net investment hedge?

An investment in a foreign operation hedged against currency risk.

What is the treatment for ineffective portions of hedges?

They are recognized in profit or loss.

What is the role of IFRS 9 regarding hedge accounting?

It provides guidelines for the recognition and measurement of hedges.

What are firm commitments in the context of hedging?

Contracts to enter transactions at a future date that are not recognized in financial statements.

What is the treatment of transactions when hedge accounting criteria are not met?

The previous accounting entries are not reversed, and the hedged item does not adjust further.

What does economic relationship mean in hedging?

A correlation between the hedged item and the hedging instrument.

What is a contract with an interest rate swap?

A contract where parties exchange fixed and variable interest payments.

What must a company document at the inception of a hedge?

The hedged item, hedging instrument, and the specific risk to be hedged.

What effect does a successful hedge have on profit or loss?

It offsets losses, leading to a nil net effect if perfectly effective.

What items are unaffected in a fair value hedge?

Changes in fair values of recognized non-financial assets or liabilities.

How should movements on a hedging instrument be accounted for?

Movement should be taken to Other Comprehensive Income (OCI) rather than profit or loss for cash flow hedges.

What is a derivative?

A financial security whose value depends on the price of another asset.

What elements are not subject to hedge accounting?

Non-standardized transactions or those with no significant risk exposure.

What is the role of the hedged risk in hedge accounting?

It must be identifiable and likely to occur to qualify for hedge accounting.

What is hedge documentation?

Record keeping that outlines the details of the hedge and its expected effectiveness.

How does hedge accounting impact financial reporting?

It aligns actual market risks with accounting results, reducing discrepancies.

What is the existing accounting treatment for firm commitments under normal rules?

They are not recognized until fulfilled.

What should be considered when evaluating hedge effectiveness?

The hedge ratio and any changes to credit risk.

What is a common effective hedged item?

Natural hedges like foreign currency liabilities matched against assets.

How should gains/losses from a foreign currency loan be treated?

Recognized in profit or loss.

What is an administrative cost in hedge accounting?

Cost incurred to document and demonstrate hedge efficiency.

What does the effective interest method imply for interest income?

Interest income is recognized at the effective interest rate regardless of hedging.

Why is hedge accounting complex?

Due to the need for continuous monitoring and stringent documentation.

What are highly probable forecast transactions?

Future transactions identified as likely to occur, subject to hedging.

What happens if the hedge ratio changes?

The hedge must be rebalanced to maintain its effectiveness.

What financial statements reflect the impact of hedge accounting?

The balance sheet and profit or loss statements.

What is a

a common issue found in hedge accounting that can lead to misrepresentation.