Accounting for Financial Instruments Set 4

• Group perspective in consolidated financial statements to be taken into consideration for assessing derecogntion
• All subsidiaries incl. all special purpose entities (SPE's) to be consolidated before question of derecognition arises
• Scope of consolidated financial statements determine who is considered as transferee
  • derecogntion not possible if SPE has to be consolidated on group level
  • derecognition is possible for separate financial statements

• Subject of assessment to be defined (component approach)
  • extent to which derecognition principles apply
    • derecognition of part of a financial asset or
    • derecognition of the entire asset or a group of similar financial assets
• Criteria for partial recognition
  • specifically identified cash flows (e.g. interest rate strip)
  • fully proportionate (pro-rata) share of the cash flows (e.g. transfer of the rights to a 90% share) or
  • fully proportionate (pro-rata) share of specifically identified cash flows (e.g. transfer of rights to a 90% share of interest cash flows)

• Derecognition of a financial asset when contractual rights of cash flows from the financial asset expireExamples
• Examples
  • receivables have been repaid
  • options have not been exercised

• Derecogntion also if contractual rights are not expired, but all risks and rewards of ownership are transferred
  • transfer of contractual rights to receive all of the cash flows
  • no tranfer of contracutal rights to receive the cash flos, but contractual obligation to pay all of the cash flows  of the financial asset (pass through)
• Transfer of contractual rights of a financial asset
  • Sale or cession
    • Legal continuity of transfer in case of an insolvency of the transferring party
    • (remaining) servicing itself is harmless
    • silent cession is harmless, if the transferee is able to convert it in an open cession or rather the preconditions for a conversion are on the behalf of the transferee
• If contractual rights to receive cash flows retained, a financial asset can only be derecognised in conjunction with a pass through arrangement
• Conditions applicable for pass through arrangements
  • no additional obligation to pay amounts to recipient (e.g. credit enhancements or guarantess)
  • no possibility of control by the seller
  • payment is made
    • in full and
    • without any significant delay (forwaring within 3 months)
• Assessmnet of whether risks and rewards of ownership of a financial asset have been substantially transferred based on the entity's exposure to the variability in the present value of the future net cash flows from the financial asset before and after the transfer
  • an entity has retained substantially all risks and rewards of ownership if its risk position has not significantly changes
  • an entity has transferred substabtially all risks and rewards of ownership if its exposure to such variability is not significant in relation to the total variability in present value of future net cash flows

• Assets also derecognised if the entity has not retained or transferred risks and rewards but has transferred control (control apporach)
• Control is transferred if transferee has practical ability to sell or pledge the asset in its entirely to an unrelated third party without any restritction
• Indications against a transfer of control
  • no active market for the transferred asset (even if no active market is required)
  • collection activity taken by the trnsferring party (passing through)
  • variable purchase price discounts to hich the transferring party is entitled if the asset can only be sold with this discount
• Recoverable guarantees or other risk assumptions of the transferring party, which expire in case of resale, always lead to a control fo the transferring party
• -> disposition is not probable

• Transferred asset continues to be recognised to the extent of continuing involvement
• Extent of the entity's continuting involvement in the transferred asset is the extent to which it is exposed to changes in the value of the transferred asset
• Example of recognition
  • transferor gives guarantee
  • transferee keeps variable purchase price reduction
  • sale of 90% of receivables and subordination of the remaining part of the transferor in favour of the transferee

• Securities that result from the measurement and securitisation of one or more portfolios of financial assets (receivables)
• Objective of securitising entity is reducing the strain on the balance sheet by transferring securities to a special purpose entity (SPE)
• Further objectives
  • improving liquidity situation
  • improving financing conditions
  • developing new financial markets

• Important characterisitics
  • security repurchase agreements
    • in reutrn for payments securities are transferred to another party
    • retransfer obligation or retransfer right
  • securities lending agreements
    • transfer of securities with the obligation of retransfer of securities (merely) in same constitution, quality and quantity

• Pension provider keeps the control of the transferred securities
• Securities still recognised az pension provider
• Pension provider keeps current profit as well
• Accounting like a secured borrowing
• Transferred securties are collaterals that have no special accounting rules

• Risks and rewards
  • risk position of pension provider depends on exercising probability of the put option of the recipient
  • put option of the recipient of the pension is deep in the money than the related substantial risks and rewards are retained
  • put option of the recipient of a pension is deep out of the money, than the related substantial risks and rewards are transferred
  • put option of the recipient of a pension is neither deep in the money nor deep out of the money than the related substantial risks and rewards are neither retained nor transferred
  • financial asset is available at market at any time - derecognition is possible, because entity has not retained control
  • financial asset is not available at market at any time - derecogntion is not completely possible, because entity has retained control
• Control
  • Exercising probability is neither high nor low
  • pension provider has lost the control, if the recipient of the pension has the ability to sale the transferred securities (e.g. there is an active market)
• Continuing involvement
  • exercising probability is neither high nor low
  • pension provider keeps control
  • recognition at pension provider with an amount of the continuing involvement (amount of the put option)

• Risks and rewards
  • accounting treatment analogue to genuine pension transaction
  • security lending agreement that provides cash deposit from the borrower to be accounted as secured loan transaction

• Hedging
  • Offsetting an open position at risk by entering into an equal and opposite position
• Hedge accounting
  • Recognition of offsetting effects of changes in fair values or cash flows of
    • hedging item and
    • hedging instrument
  • in financial statements
• Objective of hedge accounting
  • Simultaneous and identical presentation of hedged item and hedging instrument
  • Elimination of impact on profit or loss

• As hedged items may qualify
  • assets
  • liabilities
  • firm commitments
  • highly probable forecast transactions
  • net investment in a foreign operation
  • or groups of those items
• Held to maturity investments cannot be a hedged item with respect to interest rate or repayment risk

• Qualifying hedging instruments are
  • derivatives or
  • for a hedge of a foreign currency risk non-derivative financial asset of non-derivative financial liabilities
• Proportion of entire hedging instrument may be designated as hedging instrument in a hedging relationship
• Written options do in general not qualify as hedging instrument

• Transaction based hedging, i.e. hedging of a single risk with a single hedging instrument
• Hedging more than one risk with a single hedging instrument (e.g. currency and interest rate risk)
• Hedging a single risk with a combination of hedging instruments
• Hedging of portions of risks

• Macro hedges with exception of portfolio hedges of interest rate risk
• Hedging of internal transactions
• Hedging of groups of assets, liabilities, firm commitments or highly probable forecast transactions with unequal risk exposure

• Fair value hedge
  • Hedge of (portion of) financial asets/ liabilities and firm commitments against a particular market risk
  • Main intent of application - debt instruments with fixed rates, i.e. fair value hedge is linked to asset with fixed interest rate
• Cash flow hedge
  • Hedge of future, risk carrying cash flows and anticipated transactions
  • Main intent of application - debt instruments with variable interest rate, i.e. cash flow hedge is linked to liability with variable interest rate

• Upon designation of hedging relationship documentation of
  • hedging relationship
  • hedging objectives and
  • hedging strategies
• Documentation to include identification of
  • hedging instrument
  • hedged item or underlying transaction
  • risk to be hedged
• If forecast transaction is to be hedged, evidence of high probability and of related variations in cash flows

• Measurability of hedge effectiveness
• Expectation of high effectiveness at inception of hedging relationship in conjunction with IAS 39
• Assessment of effectiveness during hedging relationship (effectiveeness range of 80& to 125%)
• Continuous assessment of hedge effectiveness (at least quarterly)

• No method for assessing hedge effectiveness specified in IAS 39
• Adopted method to be
  • appropriate
  • used in a consistent way for similar hedges and
  • documented
• Effectiveness always to be measured between external hedging instrument and hedged item
• Evidence of effectiveness to be provided on period-by-period or cumulative basis over full term of hedging relationship
• If critical terms of hedged item and hedging instrument match exactly, then prospective hedge effectiveness can be assumed
  • notional and principal amount
  • term
  • repricing dates
  • dates of interest and principal receipts and payments
  • basis of measuring interest rates
• There is no exeption from requirement to demonstrate retrospective effectiveness (no short cut methods)

• Hedge accounting to be discontinued if
  • Hedge no longer meets criteria for hedge accounting
  • Hedging instrument expires or is sold, terminated or exercised
  • forecast transaction is no longer expected
  • designation is revoked
• Replacement or roll over of a hedging instrument possible

• Separate measurement of hedged item and edging instrument with recognition of measurement effects
  • of hedged item according to rules for relevant category
  • hedging instrument in profit or loss

• Hedging balance sheet line items and firm commitments or identifiable components therof against possible fair value changes with effect on profit or loss resulting from a specific risk
  • hedging fixed interest rate loans against risk resulting from change of market interest rate
  • hedging future obligations to deliver resources against change in resource prices (price changing risk)

• Hedged item
  • adjustment of carrying amount by fair value changes attributable to hedged risk (hedge adjustment)
  • immediate recognition of these fair value changes in profit or loss
  • -> deivatin from general accouting principles for hedged instruments
• Hedging instrument
  • immediate recogntion of fair value changes in profit or loss
  • -> in accordance with general accounting principles for derivatives

• Hedging of cash flows of recognised assets or liabilities and forecasted transactions against potential variability in cash flows that could affect profit or loss and result from a specific risk
  • swap to convert a variable interest-bearing financial asset or a variable interest-bearing financial liability to a fixed interest rate financial asset or fixed interest rate financial liability
  • hedging of foreign currency risk of a highly probable purchase commitment with a fixed price in foreign currency

• Hedging of  a forecast transaction requires that the transaction is highly probable
• No hedged item if forecast transaction cannot be sufficiently specified
• Possible changes in timing of a hedged forecast transaction do not affect originally designated hedging relationship if effectiveeness does not change
• In assessing likelihood that a transaction will occur, an entity should consider the following circumstances
  • frequuency of similar past transactions
  • financial and operational situation of entity which may prevent to carry out the transaction
  • substantial commitments of resources to a particular activity
  • extentof loss or disruption of operations that could result if the transaction does not occur
  • existence of transactions with substantially different characterisitics that might be used to achieve the same bsuiness purpose
  • entity's business plan

• Hedged itme
  • no adjustemtn of carrying amounts/recognition of adjustemnts of financial assets classified as available-for-sale directly in equity
  • -> in accordance with general accounting principles for hedged items
• Hedging instrument
  • all changes attributable to effective portion of hedge to be recognised directly in revaluation reserve
  • reclassification of gains and losses recognised directly in equity into profit or loss in period in which hedged transaction affects profit or loss (at latest upon termination of hedging relationship)
  • -> deviation from general accounting principles for derivatives
• If the hedged item is a forecast transaction that results in assets or liabilities, gains or losses attributable to hedging instrument that were recognised directly in equity are treated as follows
  • financial assets or financial liabilities
    • reclassification into proit or loss in same period in which hedged item affects profit or loss
  • non-financial asset or non-finanacial liability
    • same treatment as for financial assets/liabilities or inclusion in initial carrying amount of non-financial asset or liability

siehe Bild

• At beginning of hedge relationship
  • Step 1: determination of net exposure
  • Step 2: designation of hedged items in maturity ranges
  • Step 3: designation of hedged risk
  • Step 4: designation of hedging instruments
  • Step 5: prospective effectiveness test
• At date of next effectiveness test
  • Step 6: determination of additions and disposals
  • Step 7: test of effectiveness (retorspectively)
  • Step 8: journal entries
  • Step 9: termination of hedge relationship
  • Step 10: new designation and start with step 1