Financial instruments – Hedge accounting
Groups and net positions
The IASB discussed the proposals in the hedge accounting exposure draft related to hedging groups and net positions. The exposure draft permitted the hedging of groups of items, but for cash flow hedges the exposure draft restricted hedging offsetting cashflows (net positions) when those cash flows affect profit or loss in different periods. This restriction was put in place to address various Board concerns.
The comment letter responses and outreach activities were very supportive of the proposals. However, the feedback received highlighted certain areas where constituents requested additional clarity or flexibility, those issues include:
- uncertainty as to whether the proposals on groups and net positions would be extended to portfolio/macro hedge accounting,
- a request for reconsidering the restriction on the application of hedge accounting to cash flow hedges of a net position with items that affect profit or loss in different periods,
- a request for considering the annual reporting period as the basis for the restriction instead of any reporting period (ie including interim reporting periods), and
- requests for additional guidance on the treatment of the amounts deferred in OCI if, in a cash flow hedge of a net position, the offsetting cash flows initially expected to occur in the same period subsequently change and are now expected to occur in different periods.
To address the request regarding removing the restriction on cash flow hedges impacting profit or loss across reporting periods, the staff presented the Board with five possible alternatives:
- Alternative 1 — Remove the restriction but only for forecast transactions designated in a net position where the forecast transactions are of the same nature and this is specified at the inception of the hedge,
- Alternative 2 — Remove the restriction for forecast transactions designated in a net position only where the reporting period in which the transactions are expected to affect profit or loss (the recognition pattern) and the nature of the transactions is specified at the inception of the hedge,
- Alternative 3 — Remove the restriction for forecast transactions designated in a net position only where the reporting period in which the transaction is expected to affect profit or loss (the recognition pattern), the nature and the volume of each forecast transaction are specified at the inception of the hedge,
- Alternative 4 — Eliminate the restriction completely, and
- Alternative 5 — Retain the proposals in the exposure draft.
The Board primarily considered Alternative 3 and Alternative 5 based on the staff recommendations. The Board was fairly split on the topic with certain Board members concerned over removing the restriction for cash flow hedges of forecast transactions because of the complexity and the potential for earnings management. Other Board members expressed support for removing the restriction as they pointed out that hedge accounting could be applied by entering in to two separate hedging relationships with derivatives for the gross amounts which seemed overly burdensome and costly when a single derivative for the net position would accomplish the same result. One of the IASB members questioned if there were any risks outside of foreign currency risk where cash flow hedging of forecast transactions would be used (for example, interest rate risk). The staff noted that the issues that have been raised by constituents have primarily been foreign currency related. The Board member said that limiting the removal of the restriction to only foreign currency transactions would alleviate some of this concerns.
Ultimately, the Board tentatively agreed (9 votes to 6 votes) to extend the eligibility for designation as a hedged item to net positions involving forecast transactions that affect profit or loss in different period when hedging foreign exchange risk.
[Note: The IASB Update clarified the Board's tentative decision during this session that cash flow hedges of net positions would only be available for hedges of foreign currency risk. The Board also tentatively decided to remove the restriction that the offsetting cash flows in a net position must affect the income statement in the same reporting period. Instead, the eligibility criteria would be extended to require that the items within the net position must be specified in such a way that the pattern of how they will affect the income statement is set out as part of the initial hedge designation.]
The Board also discussed financial statement presentation for hedging of groups and net positions. The exposure draft proposed that gains and losses on the hedging instrument would be presented in a separate financial statement line item when the hedging relationship involves a net position hedge that affects different line items in profit or loss (e.g. sales and cost of sales). Most comment letter respondents and outreach participants supported the exposure draft proposals; however, some respondents disagreed with the proposals. Those who disagreed felt that, among other reasons, such a net presentation would not adjust the financial statement line items affected by the hedged item and therefore create volatility within those income statement line items. However, the staff also note that presenting the gains or losses on the hedging instrument in as separate line item avoids considering transactions that do not exist (forecast transactions) and presenting artificial gains or losses to achieve a gross presentation.
The Board tentatively agreed that for a hedge of a group of items with offsetting hedged risk positions that affect different line items in the income statement (net position hedges) to present the reclassification of gains or losses on hedging instruments in a separate line item in the income statement without adjusting the line items affected by the forecast transactions.