Illustration of a net investment hedge by a parent entity

Entity A is the Parent having INR as its functional currency. Subsidiary B has Euro as its functional currency. Subsidiary C has GBP as its functional currency and the functional currency of Subsidiary D is USD. Subsidiary B has ECB amounting to $ 50 million. The following diagram best illustrates the hierarchy with corresponding investments in the subsidiary entities.

Amount of hedged item in consolidated balance sheet

Option 1

With hedge accounting

Hedged item: Parent hedges net investment in Subsidiary D amounting to $50 million

Hedging instrument: ECB held by Subsidiary B $50 million which is a non-derivative and hence only the spot component of foreign exchange risk can be designated as the hedged risk

Accounting treatment:

1. The foreign exchange difference on translation of $50 million which is the net investment in Subsidiary D will be taken to Foreign Currency Translation Reserve to the extent the hedge is effective.
2. The foreign exchange difference on $ 50 million which is the ECB of Subsidiary B will be taken to Foreign Currency Translation Reserve to the extent the hedge is effective.
3. The ineffective portion is taken to profit and loss account in the consolidated financial statement of the Parent A.

Without hedge accounting

Subsidiary B’s foreign exchange difference would be taken the Profit and Loss account in the consolidated statement of accounts of Parent A.

Foreign exchange difference on account of net investment in Subsidiary D would be taken to other comprehensive income in the consolidated statement of accounts of Parent A.

Option 2

Hedged item: Subsidiary C’s net investment in Subsidiary D, viz, GBP/USD – FX risk on $ 50 million

Hedging instrument: ECB held by Subsidiary B $50 million which is a non-derivative and hence only the spot component of foreign exchange risk can be designated as the hedged risk

Accounting treatment:

The translation difference of INR/USD pertaining to the net investment in Subsidiary D would be reflected in the consolidated balance sheet of the Parent A as follows:

1. GBP/USD FX difference would be shown in Foreign Currency Translation Reserve of Subsidiary D
2. GBP/EUR FX difference translated to INR would be shown in the Profit and Loss account
3. EUR/INR FX difference would be shown in the other comprehensive income

Parent A cannot designate ECB in Subsidiary B as hedging instrument for both INR/USD (net investment in Subsidiary D) as well as GBP/USD (net investment of Subsidiary C in Subsidiary D) in the consolidated financial statements. A single hedging instrument can be used in a hedge only once.

Note: Subsidiary C in its consolidated financial statements cannot apply hedge accounting as the hedging instrument, viz, $ 50 million ECB is held by Subsidiary B which is outside the group (Subsidiary C and Subsidiary D).

What happens when Subsidiary D is disposed of?

The following amount will be reclassified to Profit and Loss account from Foreign Currency Translation Reserve on disposal of Subsidiary D:

1. Foreign exchange difference recognised in Foreign Currency Translation Reserve as the effective portion of the hedge from the hedging instrument-ECB amounting to $ 50 million by Subsidiary B; and
2. Foreign exchange difference recognised in Foreign Currency Translation Reserve as the effective portion of the hedge from the hedged item of net investment in Subsidiary D amounting to $ 50 million.

Ind AS Accounting Standards