Company Valuation Under IFRS : Interpreting and Forecasting ...

Chapter Four – Key issues in accounting and their treatment under IFRS
Exhibit 4.26: Commerzbank cash to profit reconciliation
2003 2002
€m €m
Net profit -2,320 -298
Non-cash positions in net profit and adjustments to
reconcile net profit with net cash provided by operating
activities:
Write-downs, depreciation, adjustments, write-ups to
fixed and other assets, changes in provisions and net
changes due to hedge accounting 929 1,114
Change in other non-cash positions:
Positive and negative fair values from derivative
financial instruments (trading and hedging
derivatives) 1,248 1,607
Profit from the sale of assests -291 88
Profit from the sale of fixed assets 4 -12
Other adjustments (mainly net interest income) -2,299 -4,000
Sub-total -2,729 -1,501
Source: Commerzbank annual report 2003
7.6 Building valuation models: What to do
Taking the three categories of hedge separately, gains or losses on fair value
hedges offset changes in value of the hedged entity, so there should be no impact
on the profit or cash flow that is being discounted. However, when thinking about
returns on capital employed, it is marked to market capital that we should ideally
be using, so the net value of fair value derivatives should be included in the
calculation.
With cash flow hedges, we only want to reflect the profit or cash effect of the
hedge when the underlying transaction crystallises, which is as it will be reflected
in the accounts. But, for the same reason, it would make sense to reverse gains
and losses on cash flow hedges out of equity in calculations of return on equity
or return on capital.
Unless it is known that a company is speculating (in which case the trading gain
or loss is clearly a trading gain or loss!) it might seem sensible to reverse out the
profit or loss from derivatives that are not classified as hedge transactions. The
problem with this is that if the derivative is effectively hedging a future
transaction then the gain or loss on the derivative will substantially offset a loss
or gain on the transaction, and leaving it in would provide a clearer impression
of the real economic position than leaving it out. If in doubt, it is probably better
to leave it in.
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