Accounting for Derivatives
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This edition first published 2015
© 2015 Juan Ramirez
First edition published 2007 by John Wiley & Sons, Ltd.
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Library of Congress Cataloging-in-Publication Data
Ramirez, Juan.
Accounting for derivatives: advanced hedging under IFRS 9 / Juan Ramirez. – Second edition.
pages cm. – (The wiley finance series)
Includes bibliographical references and index.
ISBN 978-1-118-81797-1 (hardback)
1. Financial instruments-Accounting-Standards. 2. Derivative securities-Accounting. 3. Hedging (Finance) – Accounting.
I. Title.
HF5681.F54R35 2015
657'.7-dc23
2014045650
Cover Design: Wiley
Top Image: ©iStock.com/nikada
Bottom Image: ©iStock.com/doockie
To my wife Marta and our children Borja, Martuca and David
Preface
The main goal of IFRS is to safeguard investors by achieving uniformity and transparency in the accounting principles. One of the main challenging aspects of the IFRS rules is the accounting treatment of derivatives and its link with risk management. Whilst it takes years to master the interaction between IFRS 9 (the main guidance on derivatives accounting) and the risk management of market risks using derivatives, this book accelerates the learning process by covering real-life hedging situations, step-by-step. Because each market risk – foreign exchange, interest rates, inflation, equity and commodities- has its own accounting and risk management peculiarities, I have covered each separately to address their particular issues.
Banks have developed increasingly sophisticated derivatives that have increased the gap between derivatives for which there is a consensus about how to apply IFRS 9 and derivatives for which their accounting is unclear. This gap will remain as long as the resources devoted to financial innovation hugely exceed those devoted to accounting interpretation. The objective of this book is to provide a conceptual framework based on an extensive use of cases so that readers can come up with their own accounting interpretation of any hedging strategy.
This book is aimed at professional accountants, corporate treasurers, bank financial engineers, derivative salespersons at investment banks and credit/equity analysts.
CHANGES TO THE PREVIOUS EDITION
The previous edition of Accounting for Derivatives was based on IAS 39. This second edition is based on IFRS 9, the accounting standard replacing IAS 39. IFRS 9 has incorporated a large number of new concepts including new hedge effectiveness assessment requirements, rebalancing and hedge ratio determination, a wider eligibility of hedged items, and a special treatment for options, forwards and cross currency swaps. New cases have been incorporated, especially in the chapters covering commodities and equity risk management. In addition three new chapters have been incorporated to the book: a chapter that provides a summary of IFRS 13 Fair Value Measurement with a special emphasis on credit/debit valuation adjustments (CVA/DVA), a chapter addressing hedging of share-based compensation plans and another chapter covering inflation risk.
Chapter 1
The Theoretical Framework – Recognition of Financial Instruments
IFRS 9 Financial Instruments is a complex standard. IFRS 9 replaced IAS 39 Financial Instruments: Recognition and Measurement. It establishes accounting principles for recognising, measuring and disclosing information about financial assets and financial liabilities. The objective of this chapter is to summarise the key aspects of financial instrument recognition under IFRS 9.
IFRS 9 is remarkably wide in scope and interacts with several other standards (see Figure 1.1). When addressing hedging there are, in addition to IFRS 9, primarily three standards that have an impact on the way a hedge is structured: IAS 21 The Effects of Changes in Foreign Exchange Rates, IAS 32 Financial Instruments: Disclosure and Presentation and IFRS 13 Fair Value Measurement.
Figure 1.1 Relevant accounting standards for hedging.
Whilst the International Accounting Standards Board (IASB) is responsible for setting the IFRS standards, jurisdictions may incorporate their own version. For example, entities in the European Union must apply the version of IFRS 9 endorsed by the EU, which might differ from the IASB's IFRS 9 standard.
1.1 ACCOUNTING CATEGORIES FOR FINANCIAL ASSETS
Under IFRS 9, a financial instrument is any contract that gives rise to both a financial asset in one entity and a financial liability or equity instrument in another entity.
IFRS 9 does not cover the accounting treatment of some financial instruments – for example, own equity instruments, insurance contracts, leasing contracts, some financial guarantee contracts, weather derivatives, loans not settled in cash (or in any other financial instrument), interests in subsidiaries/associates/joint ventures, employee benefit plans, share-based payment transactions, contracts to buy/sell an acquiree in a business combination, contracts for contingent consideration