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Contents
12.1 Deciding what instruments come within the scope of section 12.
12.2 Accounting policy choice.
12.2.1 Extract from FRS 102-Sections 12.2–12.2A.
12.2.2.1 What is the accounting policy choice?
12.2.2.2 What accounting policy to choose for an entity.
12.3.1 Extract from FRS 102-Section 12.3–12.5.
12.3.2.1 Items excluded from Section 12 of FRS 102:
12.3.2.2 Items coming within the scope of Section 12 of FRS 102.
12.3.2.2.1.1 Unguaranteed Capital and variation in return linked to a fund.
12.3.2.2.1.2 Collective investment funds.
12.3.2.2.1.3 Loan extension option where rate on the extension is determined at inception.
12.3.2.2.1.5 Variation in return which is dependent on future contingencies.
12.2.2.2.1.7 Investments with profit bonds.
12.3.2.2.1.8 Loans which are linked to value of net assets.
12.3.2.2.1.9 Loan repayments linked to repayments on another loan or tranche of a loan.
12.3.2.2.1.12 Leases with non-standard contractual terms.
12.3.2.2.1.13 Contingent consideration for the seller.
12.3.2.2.1.14.1 The own use exemption.
12.3.2.2.1.16 Warrants that can be settled in cash or in exchange for another financial instrument;
12.3.2.2.1.19 Repurchase agreements;
12.3.2.2.1.20 Compound financial instruments.
12.3.2.2.1.21 A firm commitment which is contractually binding.
12.3.2.2.1.22 Where the variable rate on a loan is leveraged.
12.3.2.2.1.23 Where a bond has a negative yield.
12.4 Initial recognition and subsequent measurement of financial assets and liabilities.
12.4.1 Extract from FRS 102-Section 12.6-12.9.
12.4.2.2 Subsequent recognition.
12.4.2.2.1 Subsequent recognition – General.
12.4.2.2.1.1.1 Financial instruments not permitted to be fair valued under Company Law.
12.4.2.2.1.1.1.1 The accounting treatment where this exception applies.
12.4.2.2.1.1.2.1 The accounting treatment where this exception applies.
12.4.2.2.1.1.3 Where hedge accounting is applied.
12.4.2.2.2 Financial instruments not permitted to be fair valued under Company Law.
12.4.2.2.2.1.1 Financial instruments permitted to be fair valued under Company Law.
12.4.2.2.2.1.1.2.2 Derivative financial instrument.
12.4.2.2.2.1.1.2.2.1 Derivative – defined.
12.4.2.2.2.1.1.2.2.1.1 Examples of Derivatives.
12.4.2.2.2.1.1.2.3 Eliminate an accounting mismatch.
12.4.2.2.2.1.1.2.4 Instrument contains an embedded derivative that is not closely related.
12.4.2.2.2.1.1.2.4.0 Overview.
12.4.2.2.2.1.1.2.4.2 Embedded derivative defined.
12.4.2.2.2.1.1.2.4.3 Identify whether the embedded derivative is or is not closely related.
12.4.2.2.2.1.1.2.4.3.1 Examples where the embedded derivative is not closely related.
12.4.2.2.2.1.1.2.4.3.2 Examples where the embedded derivative is closely related.
12.5.1 Extract from FRS 102 section 12.10 – 12.12.
12.5.2.1 The fair value model to utilise.
12.5.2.2 The fair value of a financial instrument due on demand.
12.5.2.3 Transaction costs and fair value.
12.5.2.4 Examples of fair valuation techniques for complex instruments.
12.5.2.5 Deferred tax and the fair value adjustments.
12.5.2.5.1 Deferred tax and fair value adjustments where they relate to trade assets/liabilities.
12.5.2.5.3 Deferred tax where hedge accounting is applied.
12.5.2.6 Examples of fair valuing financial instruments where market rates are not available.
12.5.2.7 Foreign currency forward contracts.
12.5.2.7.2 Accounting for forward foreign currency contracts – non hedging – Examples.
12.5.2.7.3 Accounting for interest rate swaps – non hedging – Examples.
12.6 Impairment of financial instruments measured at cost or amortised cost.
12.6.1 Extracts from FRS 102 – section 12.3.
12.7 Derecognition of a financial asset or financial liability.
12.7.1 Extract from FRS 102 – section 12.14.
12.7.2.1 Non-hedged instruments.
12.8.1 Extract from FRS102 section 12.15 – 12.17C.
12.8.2.2 Hedged item – defined.
12.8.2.3 Hedging instrument – defined.
12.8.2.4 Purpose of hedge accounting.
12.8.2.5 What can be hedged under hedge accounting?
12.8.2.6.1 Firm commitment – Defined.
12.8.2.6.2 Classification of Firm commitments as a hedge – fair value or cash flow hedge?
12.8.2.6.3 The exception for fair valuing firm commitments – Own use exception to fair value.
12.8.2.6.4 Determining the fair value of a commitment.
12.8.2.7 Forecast transaction.
12.8.2.7.1 Forecast transaction – Defined.
12.8.2.7.2 Forecast transaction – Indicators that such a transaction exists.
12.8.2.8 Intra-group hedging & when hedge accounting can be applied.
12.8.2.8.1 Intra-group hedging – Example.
12.9 Grouping of items as hedged items.
12.9.1 Extract from FRS102-Section 12.16B.
12.10 Hedging a component of an item.
12.10.1 Extract from FRS102-Section 12.16C.
12.10.2.2 Examples illustrating hedging a component of an item.
12.10.2.2.1 Hedging with a forward contract where contract is less than the probable sale amount.
12.10.2.2.2 Hedging part payments.
12.10.2.2.3 Hedging part payments.
12.11.1 Extract from FRS102-Section 12.17-12.17C.
12.11.2.1 What instruments can be classified as a hedging instrument?
12.11.2.2 Portion of a hedging instruments.
12.11.2.3 Instrument used to hedge a foreign currency risk.
12.11.2.4.1 What is an option and what is a written option?
12.11.2.4.2 Determining the fair value of an option and using it as a hedging instrument.
12.12 Conditions for hedge accounting.
12.12.1 Extract from FRS102-Section 12.18-12.18A.
12.12.2.1 When can hedge accounting be applied from and conditions must be met?
12.12.2.2 What is an economic relationship?
12.12.2.3 Designation and documentation.
12.12.2.4 Causes of hedge ineffectiveness.
12.12.2.4.2 Example of hedge ineffectiveness documented for an interest rate swap.
12.13 Accounting for qualifying hedging relationships.
12.13.1 Extract from FRS102-Section 12.19-12.19A.
12.13.2.1 The three types of hedge relationships for hedge accounting.
12.14.1 Extract from FRS102 – Section 12.19B-12.22.
12.14.2.1 What is a fair value hedge and what does it do?
12.14.2.2 The accounting for a fair value hedge.
12.14.2.2.1 Examples of fair value hedges and the accounting for same.
12.14.2.2.1.1 Fixed interest rate on a debt instrument (financial instrument).
12.14.2.2.1.1.1 Amortised cost on cessation of hedging where financial instrument exists.
12.14.2.2.1.2 Firm commitment not recognised on balance sheet.
12.14.2.2.1.3 Hedge of a foreign currency risk of an unrecognised firm commitment.
12.15.1 Extract From FRS 102 – Section 12.22(b) and 12.23.
12.15.2.1 Cash flow hedge defined.
12.15.2.2 Accounting for cash flow hedges – hedge accounting.
12.15.2.3 Examples of cash flow hedge accounting.
12.15.2.3.1 Forward contract for a probable forecasted sale.
12.15.2.3.1.1 Forward contract for a probable forecasted sale.
12.15.2.3.1.2 Forward contract for a probable forecasted purchase.
12.15.2.3.2 Hedge of variability in cash flows in a floating rate loan due to interest rate risk.
12.15.2.3.2.1.1 Fair valuing an interest rate swap.
12.15.2.3.2.3 Hedge of variability in cash flows in a floating rate loan due to interest rate risk.
12.16 Hedges of a net investment in a foreign operation.
12.16.1 Extract from FRS 102 Section 12.24.
12.16.2.1 Net investment in a foreign operation defined.
12.16.2.2 When can a net investment in a foreign operation be hedged?
12.16.2.3 What is the hedged item and instrument in a net investment in a foreign operation?
12.17 Discontinuing hedge accounting.
12.17.1 Extract from FRS102 Section 12.25 to 12.25A.
12.17.2.2 When can/must hedge accounting be discontinued and is it applied retrospectively.
12.17.2.2.1 Fair value hedge and discontinuance rules.
12.17.2.2.2 Cash flow hedge and discontinuance rules.
12.17.2.2.3 Net investment in a foreign operation hedge and discontinuance rules.
12.17.2.2.4 Examples of discontinuance.
12.18 Taxation of fair valuing derivatives – current and deferred tax.
12.19.1 Extract from FRS102-Section 12.25B.
12.20.1 Extracts from FRS 102 section 12.26 – 12.29.
12.20.2.2 Sample Disclosure requirements.
12.20.2.2.1 Extract from accounting policy notes.
12.20.2.2.2 Extract of notes to the financial statements – Financial instruments note disclosures.
12.20.2.2.3 Extract of notes to the financial statements – interest disclosures.
12.20.2.2.3.1 Note: Interest receivable and similar income.
12.20.2.2.3.2 Note: Interest payable and similar expenses.
12.20.2.2.4 – Debtors Disclosures.
12.20.2.2.5 – Creditors disclosures.
12.20.2.2.7 Statement of Comprehensive Income.
12.20.2.2.8 – Statement of Change in Equity.
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12.16 Hedges of a net investment in a foreign operation
12.16.1 Extract from FRS 102 Section 12.24
12.24 Hedges of a net investment in a foreign operation, including a hedge of a monetary item that is accounted for as part of the net investment (see Section 30 of FRS 102), shall be accounted for similarly to cash flow hedges from the date the conditions of paragraph 12.18 are met:
(a) the portion of the gain or loss on the hedging instrument that is determined to be an effective hedge shall be recognised in other comprehensive income (see paragraphs 12.23(a) and (b)); and
(b) the ineffective portion shall be recognised in profit or loss. The cumulative gain or loss on the hedging instrument relating to the effective portion of the hedge that has been accumulated in equity shall not be reclassified from equity to profit or loss on disposal or partial disposal of the foreign operation.
12.16.2 OmniPro comment
12.16.2.1 Net investment in a foreign operation defined
A net investment in a foreign operation is the amount of the reporting entity’s interest in the net assets of that operation. An entity may have a monetary item that is receivable from or payable to a foreign operation. An item for which settlement is neither planned nor likely to occur in the foreseeable future is, in substance, a part of the entity’s net investment in that foreign operation, and is accounted for in accordance with Section 30.13 of FRS 102. Such monetary items may include long-term receivables or loans. They do not include trade receivables or trade payables.
12.16.2.2 When can a net investment in a foreign operation be hedged?
This hedge can only be used for the retranslation of foreign operations in the consolidated financial statements. It cannot be used for individual financial statements. That said it may be possible to hedge foreign currency borrowings as a fair value hedge of the foreign currency exposure of the foreign equity investment, provided that all the conditions for hedging are met.
12.16.2.3 What is the hedged item and instrument in a net investment in a foreign operation?
The hedged item is the net assets of the foreign operation including goodwill and the hedging instrument can either be foreign currency borrowings or foreign currency forward contracts.
12.16.2.4 Accounting for a net investment in a foreign operation when hedge accounting conditions in Section 12.18 of FRS 102 apply
As per Section 12.24 of FRS 102 the movement on fair value of the hedging instrument (i.e. the foreign currency borrowings or foreign currency forward contracts) is recognised in other comprehensive income to the extent the hedge is effective. Any ineffectiveness is recognised in the profit and loss. The amount recognised in OCI is not recycled following the disposal or partial disposal of the subsidiary.
12.16.2.4.1 Example illustrating accounting for a net investment in a foreign operation when hedge accounting conditions in Section 12.18 of FRS 102 apply
Example 28: Net investment in a foreign operation (Extracted from Appendix to Section 12 of FRS 102
Hedge accounting: Net investment in a foreign operation
This example illustrates the accounting for a net investment hedge in the consolidated financial statements. The entity has a foreign operation and hedges its exposure to foreign currency risk in the foreign operation by the use of a foreign currency loan.
12A.6 On 1 April 20×5 an entity with functional currency CU acquires an investment in an overseas subsidiary (with functional currency FC) at a cost of FC1,200,000. On the same day the entity takes out a loan with a third party of FC1,200,000 to finance the investment. This example disregards the effects of interest or other transaction costs associated with the loan.
This example assumes that the carrying amount of the investment denominated in FC is impaired below FC1,200,000 as presented in the table below, which causes ineffectiveness.
The entity’s financial year ends on 31 December.
This example assumes that the qualifying conditions for hedge accounting in paragraph 12.18 of FRS 102 are met from 1 April 20X5.
The table below sets out the applicable exchange rates, the carrying amount of the loan and the foreign exchange gains and losses on the loan as determined in accordance with Section 30, as well as the retranslation differences on the foreign investment recognised in other comprehensive income in accordance with Section 30 of FRS 102.
| 1 Apr 20X5 | 31 Dec 20X5 | 31 Dec 20X6 | ||||
| Spot exchange rate CU:FC | 0.35:1 | 0.3:1 | 0.45:1 | |||
| Loan (hedging instrument) | ||||||
| Carrying amount under Section 30 of FRS 102 |
(FC1,200,000) x CU0.35:FC= (CU420,000) |
(FC1,200,000) x CU0.3:FC= (CU360,000) |
(FC1,200,000) x CU0.45:FC= (CU540,000) |
|||
| Cumulative gain/(loss) | nil |
(CU360,000) – (CU420,000)= CU60,000 |
(CU540,000) – (CU420,000)= (CU120,000) |
|||
| Gain/(loss) | nil |
(CU360,000) – (CU420,000)= CU60,000 |
(CU540,000) – (CU360,000)= (CU180,000) |
|||
| 1 April 20X5 |
31 December 20X5 |
31 December 20X6 |
||||
| Investment in foreign operation (hedged item) | ||||||
| Retranslation difference in accordance with Section 30 of FRS 102 | nil | (CU55,000)* | CU157,500** | |||
| Cumulative retranslation differences | nil |
(CU55,000) – 0= (CU55,000) |
CU157,500 + (CU55,000)= CU102,500 |
|||
Key to table:
* This is the exchange difference referred to in paragraph 30.20 of FRS 102 which is recognised in other comprehensive income. The amount under paragraph 30.20(a) is CU5,000 and under paragraph 30.20(b) (CU60,000). The calculation is based on the translation of the FC200,000 loss at the average rate of 0.325CU:FC.
**This is the exchange difference referred to in paragraph 30.20 which is recognised in other comprehensive income. The amount under Section 30.20(a) of FRS 102 is CU7,500 and under Section 30.20(b) of FRS 102 CU150,000. The calculation is based on the translation of the FC100,000 profit at the average rate of 0.375CU:FC.
12A.7 Hedge accounting:
31 December 20X5
A component of equity is adjusted to the lower of (in absolute amounts) the cumulative exchange gain on the loan of CU60,000 and the cumulative retranslation difference on the net investment of (CU55,000).
In accordance with paragraph 12.24(a) of FRS 102, a gain of CU55,000 on the loan is recognised in other comprehensive income. The remainder of the gain of CU5,000 is recognised in profit or loss, as required by paragraph 12.24(b) of FRS 102.
Accounting entry:
Note that only the accounting entry in relation to hedge accounting as described in paragraph 12.24 of FRS 102 is shown. Other accounting entries in relation to the loan and the investment in the foreign operation would be required in practice.
| Debit | Credit | |
| Loan | CU60,000 | |
| Other comprehensive income | CU55,000 | |
| Profit or loss | CU5,000 |
31 December 20X6
A component of equity is adjusted to the lower of (in absolute amounts) the cumulative exchange loss on the loan of CU120,000 and the cumulative exchange difference on the net investment of CU102,500.
The amount recorded in equity changes from CU55,000 to (CU102,500), a change of (CU157,500). In accordance with paragraph 12.24(a) of FRS 102 a loss of CU157,500 on the loan is recognised in other comprehensive income. The remainder of the loss of CU22,500 is recorded in profit or loss, as required by paragraph 12.24(b) of FRS 102.
| Accounting entry: | Debit | Credit |
| Other comprehensive income | CU157,500 | |
| Profit or loss | CU22,500 | |
| Loan | CU180,000 |
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Examples
Example 1: Unguaranteed Capital and variation in return linked to a fund.
Example 2: Collective investment funds.
Example 3: Loan extension option (Section 11.9 (AB) of FRS 102).
Example 5: Variation in return (Section 11.9 (aB) of FRS 102).
Example 6: Prepayment options (Section 11.9 (c) of FRS 102.
Example 6a: Investments held at fair values – market rates available.
Example 6b: Fair valuing complex financial instruments where no active market available.
Example 6c: Fair valuing complex financial instruments where no active market available.
Example 6d: Fair valuing complex financial instruments where no active market available.
Example 8: Foreign currency forward contract to hedge a sale.
Example 9: Foreign currency forward contract to hedge a future purchase.
Example 10: Interest rate swap – non hedge accounting.
Example 11: Hedging in a group context.
Example 13: Hedging with a forward contract where contract is less than the probable sale amount.
Example 14: Hedging part payments.
Example 15: Hedging part payments.
Example 16: Partial term hedging.
Example 17: Portion of a hedging instruments.
Example 19: Forward contract option.
Example 22: Hedge of a foreign currency risk of an unrecognised firm commitment.
Example 23: Forward contract for a probable forecasted sale.
Example 24: Probable forecasted purchase of equipment.
Example 26: Fair valuing an interest rate swap.
Example 27: Hedge of variability in cash flows in a floating rate loan due to interest rate risk.
Example 28: Net investment in a foreign operation (Extracted from Appendix to Section 12 of FRS 102.
Example 29: Discontinuance of a cash flow hedge – forecasted sale/purchase.
Example 30: Cash flow hedge example.
Example 31: Interest rate swap – cash flow hedge accounting.
Example 32: Sample Disclosure Requirements.
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