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FRC publishes amendments to FRS 102 in relation to hedge accounting and classification of financial instruments

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23 Jul 2014

The Financial Reporting Council (FRC) has today issued 'Amendments to FRS 102 'The Financial Reporting Standard Applicable in the UK and Republic of Ireland': Basic financial instruments and Hedge accounting'.

The amendments follow consultation on the proposals set out in both Financial Reporting Exposure Draft (FRED) 51 Draft amendments to FRS 102: The Financial Reporting Standard applicable in the UK and Republic of Ireland: Hedge Accounting and FRED 54 Draft amendments to FRS 102 – Basic financial instruments

Basic financial instruments 

Under FRS 102, a debt instrument must be regarded as ‘basic’ in order for it to be measured at amortised cost. The amendments revise the criteria that determine whether a debt instrument is ‘basic’ and is intended to reduce the need for entities to measure debt instruments at fair value. 

The amendments permit amortised cost measurement for a broader range of debt instruments where it adequately captures the risk associated with those financial instruments. 

Examples illustrating the application of the revised requirements are included within the amendments.  In particular, under the revised FRS 102 some inflation-linked debt instruments, which would not have met previously the definition of basic financial instruments under FRS 102, would now be classified as basic.  

Hedge Accounting 

Under FRS 102, derivatives such as interest rate swaps, forward contracts and option contracts would not be ‘basic’ financial instruments and would be measured at fair value through profit and loss (FVPL). Hedge accounting allows the matching of gains or losses on those instruments with the recognition of losses or gains on items hedged.   

The amendments replace the restrictive hedge accounting requirements previously in FRS 102 with a set of hedge accounting principles based on the IFRS 9 Financial Instruments hedge accounting model.  As a result of the amendments, there will be more opportunities for entities to apply hedge accounting. 

In addition to broadening the eligibility criteria, the amendments also remove the requirement that an entity must expect the hedging instrument to be highly effective in offsetting the hedged risk in order to apply hedge accounting.  Instead the amendments require there to be “an economic relationship between the hedged item and the hedging instrument”. 

These are the final amendments to FRS 102 for financial instruments before its mandatory effective date (1 January 2015), enabling FRS 102 reporters to make an informed decision about which recognition and measurement rules to apply (i.e. those of Sections 11 and 12, IAS 39 Financial Instruments: Recognition and Measurement or IFRS 9). 

The amendments include flexible transition provisions allowing retrospective designation of hedge relationships irrespective of which recognition and measurement rules are applied.

Alongside the amendments the FRC has also issued an Impact Assessment and Feedback Statement that summarises the feedback received in relation to FRED 51 and FRED 54.

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