Last update 22/11/2019
Natural disasters Hedge accounting, how to deal with this combinations, contract go on but the business dies….. Here is how to report such issues under IFRS.
The natural disaster and potential subsequent events can disrupt many business transactions that may be postponed or cancelled. For example, entities may have been forecasting purchases of local goods or sales of their goods to local entities. Natural disasters Hedge accounting
Prior to the disaster, many such transactions may have constituted ‘highly probable’ hedged transactions in cash flow hedges under IFRS 9 Financial instruments (or IAS 39, if still applicable). However, purchases and sales that were considered highly probable a few weeks prior to the natural disaster, may no longer be highly probable (in full or partially) or may not be expected to occur at all.
Entities consider whether any hedges of forecast transactions may cease to qualify for hedge accounting (in full or partially) as a result of the disaster. The disaster could also affect the probability of
hedged forecast transactions, occurring at the same time, in the same amounts and under the same terms as originally designated, which may result in higher levels of ineffectiveness in the hedging relationship going forward. Natural disasters Hedge accounting
If the occurrence of the forecast transaction is no longer highly probable, the entity must cease hedge accounting. If the forecast transaction is no longer expected to occur, the entity reclassifies the accumulated gains or losses on the hedging instrument from other comprehensive income into profit or loss as a reclassification adjustment. However, if the occurrence of the forecast transaction is no longer highly probable but still expected, the cumulative effective portion remains in other comprehensive income until the forecast transaction either occurs or is no longer expected to occur.
After a natural disaster, an entity must assess the effectiveness of hedge relationships and identify any changes in their risk management objective. In particular, under IFRS 9, an entity would have to discontinue hedge accounting if it were determined that there is no longer an economic relationship, or if credit risk dominates the hedging relationship as a result of the natural disaster. Natural disasters Hedge accounting
Furthermore, the hedge ratio may need to be adjusted if the hedged item and hedging instrument no longer move in relation to each other as originally expected. The entity has to assess whether it expects this to be the case going forward and, if so, to ‘rebalance’ the hedge ratio to reflect the change in the relationship between the value drivers in hedged item and hedging instrument. For entities that use statistical methods such as regression analysis to assess ongoing qualification for hedge accounting, new data incorporating the effects of the disaster must be added to the assessment and cannot be discarded. Natural disasters Hedge accounting
In the case of a natural disaster, it is likely that there will be an impact on the effectiveness of hedging relationships, that may be so significant that an entity may conclude that the eligibility criteria for hedge accounting are no longer met under IFRS 9 (or IAS 39, if still applicable). In such cases, an entity would need to identify the specific event or change in circumstances that caused the hedging relationship to fail, and continue to follow hedge accounting up until the precise date of such an event, which is likely to be the date of the initial disaster (e.g., earthquake and tsunami). Natural disasters Hedge accounting
IFRS 9 allows for designation of a non-financial component as a hedged item, and, accordingly, the volume of eligible hedging relationships might increase for entities exposed to commodity price movements. Such hedge relationships are more likely to be impacted by natural disasters.
Hedged forecasted transactions ended – hedging relationship ends
A key requirement for obtaining cash flow hedge accounting is that the hedged forecasted transaction is probable of occurring. Natural disasters can affect operations, causing some transactions to be curtailed, delayed or canceled.
Companies that have designated forecasted transactions in cash flow hedging relationships e.g., purchases or sales of goods, or interest payments on debt, may determine that the hedged transaction is no longer probable of occurring within the originally specified time period, in which case hedge accounting should be discontinued prospectively. However, the related gains and losses in accumulated other comprehensive income should be reclassified in earnings only if it is probable that the forecasted transaction will not occur by the end of the period originally specified or within an additional two-month period thereafter.
See also: The IFRS Foundation