ipsas 29—financial instruments: recognition and measurement - IFAC
ipsas 29—financial instruments: recognition and measurement - IFAC
ipsas 29—financial instruments: recognition and measurement - IFAC
Create successful ePaper yourself
Turn your PDF publications into a flip-book with our unique Google optimized e-Paper software.
FINANCIAL INSTRUMENTS: RECOGNITION AND MEASUREMENT<br />
F.4 Hedge Effectiveness<br />
F.4.1 Hedging on an After-Tax Basis<br />
Hedging is often done on an after-tax basis. Is hedge effectiveness assessed after<br />
taxes?<br />
IPSAS 29 permits, but does not require, assessment of hedge effectiveness on an after-tax<br />
basis. If the hedge is undertaken on an after-tax basis, it is so designated at inception as<br />
part of the formal documentation of the hedging relationship <strong>and</strong> strategy.<br />
F.4.2 Hedge Effectiveness: Assessment on Cumulative Basis<br />
IPSAS 29.98(b) requires that the hedge is expected to be highly effective. Should<br />
expected hedge effectiveness be assessed separately for each period or<br />
cumulatively over the life of the hedging relationship?<br />
Expected hedge effectiveness may be assessed on a cumulative basis if the hedge is<br />
so designated, <strong>and</strong> that condition is incorporated into the appropriate hedging<br />
documentation. Therefore, even if a hedge is not expected to be highly effective in a<br />
particular period, hedge accounting is not precluded if effectiveness is expected to<br />
remain sufficiently high over the life of the hedging relationship. However, any<br />
ineffectiveness is required to be recognized in surplus or deficit as it occurs.<br />
To illustrate: an entity designates a LIBOR-based interest rate swap as a hedge of a<br />
borrowing whose interest rate is a UK base rate plus a margin. The UK base rate<br />
changes, perhaps, once each quarter or less, in increments of 25–50 basis points,<br />
while LIBOR changes daily. Over a period of 1–2 years, the hedge is expected to be<br />
almost perfect. However, there will be quarters when the UK base rate does not<br />
change at all, while LIBOR has changed significantly. This would not necessarily<br />
preclude hedge accounting.<br />
F.4.3 Hedge Effectiveness: Counterparty Credit Risk<br />
Must an entity consider the likelihood of default by the counterparty to the<br />
hedging instrument in assessing hedge effectiveness?<br />
Yes. An entity cannot ignore whether it will be able to collect all amounts due under<br />
the contractual provisions of the hedging instrument. When assessing hedge<br />
effectiveness, both at the inception of the hedge <strong>and</strong> on an ongoing basis, the entity<br />
considers the risk that the counterparty to the hedging instrument will default by failing<br />
to make any contractual payments to the entity. For a cash flow hedge, if it becomes<br />
probable that a counterparty will default, an entity would be unable to conclude that the<br />
hedging relationship is expected to be highly effective in achieving offsetting cash<br />
flows. As a result, hedge accounting would be discontinued. For a fair value hedge, if<br />
there is a change in the counterparty’s creditworthiness, the fair value of the hedging<br />
instrument will change, which affects the assessment of whether the hedge relationship<br />
is effective <strong>and</strong> whether it qualifies for continued hedge accounting.<br />
IPSAS 29 IMPLEMENTATION GUIDANCE 1228