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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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12.18 Taxation of fair valuing derivatives – current and deferred tax
In Ireland, the tax rules follow the accounting rules. Therefore where the derivatives are recognised in the profit and loss they are taxable/tax deductible in that period and therefore no deferred tax is to be recognized. Where certain items are capital items then these are not taxable/tax deductible ever and therefore no deferred tax is required. However where the hedge is recognised in other comprehensive income/cash flow hedge reserve, then these are not taxed/tax deductible until it is transferred to the P&L which creates a timing difference and therefore requires deferred tax to be recognised.
Therefore in the majority of cases there will be no deferred tax impact where the adjustments are posted to the profit and loss account. However on transition to FRS 102 if as a result of transition adjustments, they have fallen out for tax purposes, these will be taxed/tax deductible over a five year period.
Where hedge accounting is applied and the adjustments are posted through other comprehensive income, deferred tax will arise on these adjustment as these will not be taxable/tax deductible until the adjustments are recycled to the profit and loss. The deferred tax adjustment is posted to other comprehensive income.
In other countries deferred tax will arise if the adjustment is not taxed in the period it is recognsied whether that be in the profit and loss account or the Other comprehensive income. The deferred tax rate to utilize will depend on the rate it will be taxed at in the future.
Example 30: Cash flow hedge example
On 1 December 20X3 Company A whose functional currency is CU secured a highly probable contract with a foreign currency customer worth FC100,000. The sale is expected to happen on 31 March 20X5 of the following year.
In contemplation of the sale Company A enters into a forward FX contract to sell FC100,000 at a rate of CU1:FC0.80.
Assume the spot rate at 31 December 20X3 was CU1:FC0.80. Assume deferred tax of 10% applies as it is taxable at the trade rate when it materializes and hits the P&L.
The forward rate quoted for the foreign currency contract at 31 December 20X3 by the bank for a contract that matures on 31 March is CU1:FC0.75. Note this can also be obtained by taking the year end spot rate then then taking the quoted forward basis points (the average of the bid and ask rate) and adding these on.
Assume the conditions for hedge accounting in Section 12.18 of FRS 102 applies.
The journals required for year ended 31 December 20X3 are:
| CU | CU | |
| Dr – Cash Flow Hedge Reserve/Other comprehensive Income | 8,333 | |
| Cr Forward Contract Liability | 8,333* |
Being journal to reflect fair value of the forward contract at the year-end (i.e. posted to OCI as it meets the condition for hedging).
| CU | CU | |
| Dr Deferred Tax Asset
(CU8,333*10%) |
833 | |
| Cr Deferred Tax in Cash Flow Hedge Reserve | 833 |
Being journal to reflect deferred tax on the above adjustment
*Fair value of the forward contract:
Amount of CU that will be obtained on 31 March at contracted rate of CU1:FC0.80 is FC100,000/FC0.80= CU125,000.
Note any FC balances in the balance sheet at 31 December should be retranslated to the year-end spot rate.
Amount of euros that could theoretically be obtained on 31 March at contracted rate of CU1:FC0.75 is FC100,000/FC0.75 = CU133,333.
Fair value loss at 31 December 2013/1 January 2014 is CU133,333-CU125,000 = CU8,333.
Journals required for year ended 31 December 20X4
| CU | CU | |
| Dr Forward Contract Liability | 8,333 | |
| Cr Other Comprehensive Income – Cash Flow Hedge Reserve | 8,333 |
Being journal to reverse the journals posted in 20X3 as the contract has now matured assuming the FX gain on the contract has already been posted to the P&L (i.e. contract settled for CU125,000 (FC100,000/FC0.80) less the FC100,000 at the spot rate at 31 March of CU1:FC0.84p i.e. (CU119,048)= CU5,952.
| CU | CU | |
| Dr Deferred Tax in OCI/Cash Flow Hedge Reserve | 833 | |
| Cr Deferred Tax Asset
(CU8,333*10%) |
833 |
Being journal to reflect reversal of deferred tax recognised on transition as the contract has now matured.
If another forward contract was entered into in 20X4 and 20X5, the same type of journals would be required.
Example 31: Interest rate swap – cash flow hedge accounting
Company A gets a loan for CU100,000 on 1 January 2012 at a variable rate which is repayable in 5 years.
At the same time Company A enters into an interest rate swap with a third party e.g. another bank for a 5 year period whereby Company A will pay the fixed rate of 6% to the third party and the third party will pay the floating rate to Company A. The notional amount hedged is CU100,000 and the variable rate at inception such that the swap has a nil fair value is 6%. The expected average variable interest rate set in advance at the start of the year was 6%, 5% and 8% for 2012, 2013 and 2014 respectively. Interest is paid the following year.
The entity has also chosen to hedge account as it meets the hedge accounting requirements in Section 12.18.
Assume at the 31 December 20X3, the fair value of the interest rate swap was a loss of CU5,000 up to that date. Under cash flow hedge rules assume CU1,000 of this would be recognised in the profit and loss account the due to this element being ineffective and the remaining CU4,000 is to be recognised in the cash flow hedge reserve.
The adjustments required are:
At 31 December 20X3
| CU | CU | |
| Dr Cash Flow Hedge Reserve | 4,000 | |
| Dr Profit and Loss Account – FX loss – Fair value on interest rate swap on ineffective portion | 1,000 | |
| Cr Interest Rate Swap Liability | 5,000 |
Being journal to recognise the fair value of the interest rate swap.
| Dr Deferred Tax Asset | CU
400 |
CU
|
| Cr Deferred Tax in Cash Flow Hedge Reserve
(CU4,000*10%) |
400 |
Being journal required to reflect the deferred tax on the above adjustment.
The journals for 31 December 20X4:
| CU | CU | |
| Dr Deferred Tax in OCI/Cash Flow Hedge reserve | 400 | |
| Dr Deferred Tax in P&L | 100 | |
| Cr Deferred Tax in Asset | 500 |
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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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