ipsas 29—financial instruments: recognition and measurement - IFAC

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FINANCIAL INSTRUMENTS: RECOGNITION AND MEASUREMENT 1209 Debit Credit Receivables – LC10 Payables LC5 – Forward contract – LC25 Net assets/equity – LC5 Basis adjustment (inventory) LC35 – Gains and losses – – Internal contracts – – These total net balances are different from those that would be recognized if the internal derivatives were not eliminated, and it is these net balances that IPSAS 29 requires to be included in the consolidated financial statements. The accounting entries required to adjust the total net balances before elimination of the internal derivatives are as follows: (a) To reclassify LC15 of the loss on B’s internal derivative that is included in inventory to reflect that FC150 of the forecast purchase of inventory is not hedged by an external instrument (neither the external forward contract of FC250 in TC nor the external payable of FC100 in A); and (b) To reclassify the gain of LC15 on A’s internal derivative to reflect that the forecast revenues of FC150 to which it relates is not hedged by an external instrument. The net effect of these two adjustments is as follows: Dr Net assets/equity LC15 Cr Inventory LC15 F.1.8 Combination of Written and Purchased Options In most cases, IPSAS 29.AG127 prohibits the use of written options as hedging instruments. If a combination of a written option and purchased option (such as an interest rate collar) is transacted as a single instrument with one counterparty, can an entity split the derivative instrument into its written option component and purchased option component and designate the purchased option component as a hedging instrument? No. IPSAS 29.83 specifies that a hedging relationship is designated by an entity for a hedging instrument in its entirety. The only exceptions permitted are splitting the time value and intrinsic value of an option and splitting the interest element and spot price on a forward. Question F.1.3 addresses the issue of whether and when a combination of options is considered as a written option. IPSAS 29 IMPLEMENTATION GUIDANCE PUBLIC SECTOR
FINANCIAL INSTRUMENTS: RECOGNITION AND MEASUREMENT F.1.9 Delta-Neutral Hedging Strategy Does IPSAS 29 permit an entity to apply hedge accounting for a “delta-neutral” hedging strategy and other dynamic hedging strategies under which the quantity of the hedging instrument is constantly adjusted in order to maintain a desired hedge ratio, for example, to achieve a delta-neutral position insensitive to changes in the fair value of the hedged item? Yes. IPSAS 29.83 states that “a dynamic hedging strategy that assesses both the intrinsic value and time value of an option contract can qualify for hedge accounting.” For example, a portfolio insurance strategy that seeks to ensure that the fair value of the hedged item does not drop below a certain level, while allowing the fair value to increase, may qualify for hedge accounting. To qualify for hedge accounting, the entity must document how it will monitor and update the hedge and measure hedge effectiveness, be able to track properly all terminations and redesignations of the hedging instrument, and demonstrate that all other criteria for hedge accounting in IPSAS 29.98 are met. Also, it must be able to demonstrate an expectation that the hedge will be highly effective for a specified short period of time during which the hedge is not expected to be adjusted. F.1.10 Hedging Instrument: Out of the Money Put Option Entity A has an investment in one share of Entity B, which it has classified as available for sale. To give itself partial protection against decreases in the share price of Entity B, Entity A acquires a put option on one share of Entity B and designates the change in the intrinsic value of the put as a hedging instrument in a fair value hedge of changes in the fair value of its share in Entity B. The put gives Entity A the right to sell one share of Entity B at a strike price of CU90. At the inception of the hedging relationship, the share has a quoted price of CU100. Since the put option gives Entity A the right to dispose of the share at a price of CU90, the put should normally be fully effective in offsetting price declines below CU90 on an intrinsic value basis. Price changes above CU90 are not hedged. In this case, are changes in the fair value of the share of Entity B for prices above CU90 regarded as hedge ineffectiveness under IPSAS 29.98 and recognized in surplus or deficit under IPSAS 29.99? No. IPSAS 29.83 permits Entity A to designate changes in the intrinsic value of the option as the hedging instrument. The changes in the intrinsic value of the option provide protection against the risk of variability in the fair value of one share of Entity B below or equal to the strike price of the put of CU90. For prices above CU90, the option is out of the money and has no intrinsic value. Accordingly, gains and losses on one share of Entity B for prices above CU90 are not attributable to the hedged risk for the purposes of assessing hedge effectiveness and recognizing gains and losses on the hedged item. Therefore, Entity A recognizes changes in the fair value of the share in net assets/equity if it is associated with variation in its price above CU90 (IPSAS 29.64 IPSAS 29 IMPLEMENTATION GUIDANCE 1210
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ipsas 29—financial instruments: recognition and measurement - IFAC

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