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.

image 1

Amount of hedged item in consolidated balance sheet

Option 1

With hedge accounting

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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

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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.

Rebalancing by changing the hedge ratio

Rebalancing is a new concept introduced by a major amendment to IFRS 9 during November 2013. Rebalancing means adjustments made to the quantities of the hedged item or the hedging instrument of an existing hedging relationship for the purpose of maintaining a hedge ratio that complies with the hedge effectiveness requirements.
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Discontinuance of hedge accounting

As per the new requirements, hedge accounting cannot be voluntarily discontinued. Hedge accounting can be discontinued only if the hedge effectiveness requirements are not met or that the hedging instrument is liquidated. Even when the hedge effectiveness requirements are not met, the entity should adjust the hedge ratio through the process of rebalancing and continue with hedge accounting so long as the hedging relationship continues to meet the risk management objectives of the enterprise.
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What is a Cash flow hedge?

A cash flow hedge is a hedge of the exposure to variability in cash flows attributable to a particular risk associated with a recognised asset or liability or a component thereof. It covers future interest payments on variable-rate debt. It also covers a highly probable forecast transaction. The requirement is that such cash flows should affect the profit and loss account.
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Hedging fixed rate debt instrument with IRS

To calculate the change in the value of the hedged item for the purpose of measuring hedge ineffectiveness, an entity may use a derivative that would have terms that match the critical terms of the hedged item (this is commonly referred to as a ‘hypothetical derivative’), and, for example, for a hedge of a forecast transaction, would be calibrated using the hedged price (or rate) level.
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Disclosures in respect of hedge accounting

An entity shall apply the disclosure requirements for those risk exposures that an entity hedges and for which it elects to apply hedge accounting. Hedge accounting disclosures shall provide information about:
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Are RBI circulars relevant for ECL computation as per Ind AS 109?

A cash flow hedge is a hedge of the exposure to variability in cash flows attributable to a particular risk associated with a recognised asset or liability or a component thereof. It covers future interest payments on variable-rate debt. It also covers a highly probable forecast transaction. The requirement is that such cash flows should affect the profit and loss account.
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Relationship between components – cash flow hedge

If a component of the cash flows of a financial or a non-financial item is designated as the hedged item, that component must be less than or equal to the total cash flows of the entire item. However, all of the cash flows of the entire item may be designated as the hedged item and hedged for only one particular risk (for example, only for those changes that are attributable to changes in LIBOR or a benchmark commodity price).
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Hedging a net position – cash flow hedge

The previous conversion of IFRS 9, viz, IAS 39 did not allow a net position to be hedged. However, for several group companies, it is a normal practice for the risks to be transferred to one central business unit within the enterprise and take hedging position on a net basis. The risks transferred to the central business unit usually off sets one another’s risk. This enables the entity to reduce the transaction cost and also minimise the counter party credit risk. Ind AS 109 effectively allows hedging on the basis of net position for fair value hedge and for cash…
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Hedges of a net investment in a foreign operation

As per Ind AS 21, net investment in any foreign operation is the amount of the reporting entity’s interest in the net asset of that operation. Such foreign operations may be subsidiaries, associates, joint ventures or branches. Ind AS 21 requires an entity to determine the functional currency of each of its foreign operations as the currency of the primary economic environment of that operation. When translating the results and financial position of a foreign operation into a presentation currency, the entity is required to recognise foreign exchange differences in other comprehensive income until the foreign operation is disposed off.
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Accounting for net investment hedge – Only functional currency

Hedge accounting is applicable only to the foreign exchange differences arising between the functional currency of the foreign operation and the parent entity’s functional currency. It is not applicable for translation differences arising on account of presentation currency.
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