Accounting for the forward element
Transaction-related hedged item
Change in the fair value of the forward element of a forward contract that hedges a transaction related hedged item should be recognised in other comprehensive income to the extent it relates to the hedged item. The cumulative change in the fair value arising from the forward element of the forward contract shall be accounted for as follows:
- Non-financial item: If the hedged item subsequently results in the recognition of a non-financial item or a firm commitment for a non-financial item, the entity shall include the amount directly in the carrying amount of the asset or the liability. This is known as basis adjustment.
- Others: The amount shall be reclassified from the separate component of equity to profit or loss as a reclassification adjustment in the same period or periods during which the hedged expected future cash flows affect profit or loss (for example, when a forecast sale occurs). This is known as reclassification adjustment.
- Amount not expected to be recovered: The portion of the amount that is not expected to be recovered in future periods shall be immediately reclassified into profit or loss as a reclassification adjustment.
The forward element of a forward contract relates to a transaction related hedged item if the nature of the hedged item is a transaction for which the forward element has the character of costs of that transaction.
Example: The forward element relates to a hedged item that results in the recognition of an item whose initial measurement includes transaction costs (for example, an entity hedges an inventory purchase denominated in a foreign currency, whether it is a forecast transaction or a firm commitment, against foreign currency risk and includes the transaction costs in the initial measurement of the inventory).
As a consequence of including the forward element in the initial measurement of the particular hedged item, the forward element affects profit or loss at the same time as that hedged item. Similarly, an entity that hedges a sale of a commodity denominated in a foreign currency against foreign currency risk, whether it is a forecast transaction or a firm commitment, would include the forward element as part of the cost that is related to that sale (hence, the forward element would be recognised in profit or loss in the same period as the revenue from the hedged sale).
Time-related hedged item
A forward contract can be considered as being related to a time period because its forward element represents charges for a period of time (which is the tenor for which it is determined). An entity should assess the type of hedged item on the basis of the nature of the hedged item regardless of whether the hedging relationship is a cash flow hedge or a fair value hedge.
The forward element of a forward contract relates to a time-period-related hedged item if the nature of the hedged item is such that the forward element has the character of a cost for obtaining protection against a risk over a particular period of time.
- If commodity inventory is hedged against changes in fair value for six months using a commodity forward contract with a corresponding life, the forward element of the forward contract would be allocated to profit or loss (amortised on a systematic and rational basis) over that six-month period.
- A hedge of a net investment in a foreign operation that is hedged for 18 months using a foreign-exchange forward contract, which would result in allocating the forward element of the forward contract over that 18-month period.
Example: A forward contract hedges the exposure to variability in three-month interest rates for a three-month period that starts in six months’ time. The forward element is amortised during the period that spans seven to nine months.
The accounting for the forward element of a forward contract is applicable even when the forward element is nil. In that case, an entity should recognise any fair value changes attributable to the forward element in other comprehensive income, even though the cumulative fair value change attributable to the forward element over the total period of the hedging relationship is nil.
Hence, if the forward element of a forward contract relates to:
- a transaction-related hedged item, the amount in respect of the forward element at the end of the hedging relationship that adjusts the hedged item or that is reclassified to profit or loss would be nil.
- a time-period-related hedged item, the amortisation amount related to the forward element is nil.
Aligned forward element
The accounting for the forward element of forward applies only to the extent that the forward element relates to the hedged item (aligned forward element). The forward element of a forward contract relates to the hedged item if the critical terms of the forward contract (such as the nominal amount, life and underlying) are aligned with the hedged item. Hence, if the critical terms of the forward contract and the hedged item are not fully aligned, an entity shall determine the aligned forward element, ie, how much of the forward element included in the forward contract (actual forward element) relates to the hedged item. An entity determines the aligned forward element using the valuation of the forward contract that would have critical terms that perfectly match the hedged item.
If the actual forward element and the aligned forward element differ, an entity shall determine the amount that is accumulated in a separate component of equity as follows:
a) if, at inception of the hedging relationship, the absolute amount of the actual forward element is higher than that of the aligned forward element the entity shall:
(i) determine the amount that is accumulated in a separate component of equity on the basis of the aligned forward element; and
(ii) account for the differences in the fair value changes between the two forward elements in profit or loss.
b) if, at inception of the hedging relationship, the absolute amount of the actual forward element is lower than that of the aligned forward element, the entity shall determine the amount that is accumulated in a separate component of equity by reference to the lower of the cumulative change in fair value of:
(i) the absolute amount of the actual forward element; and
(ii) the absolute amount of the aligned forward element. Any remainder of the change in fair value of the actual forward element shall be recognised in profit or loss.