Section 12 – Practical Examples

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Example 1: Forward Contracts

Company A entered into a forward contract to hedge against foreign exchange movements as the company engages in a significant volume of foreign currency (FC) sales. The year end is 31 December. It entered into a forward contract on 1 November to sell CU100,000 of FC in return for CU at a set rate of CU1:FC0.80 maturing on 31 March.

Assume the spot rate at 31 December was CU1:FC0.70.

The forward rate quoted for an FC contract at 31 December by the bank for a contract that matures on 31 March is CU1:FC0.75.

The accounting requirement as a result of entering into this forward contract at 31 December year end assuming it does not meet the conditions for hedge accounting are:

	CU	CU
Dr Foreign Exchange Loss in P&L	8,333
Cr Forward Contract Liability		8,333*

Being journal to reflect fair value of the forward contract at the year end

*Fair value of the forward contract:

Amount of CU that will be obtained on 31 March at contracted rate of CU1:FC0.80= FC100,000/0.80= CU125,000

Note any FC balances in the balance sheet at 31 December should be retranslated to the year-end spot rate.

Amount of CU that could theoretically be obtained on 31 March at contracted rate of CU1=FC0.75= FC100,000/0.75= CU133,333

Fair value loss at 31 December = CU133,333-CU125,000 – CU8,333

The accounting required on 31 March on settlement is (assuming no movement between year-end date and 31 March):

	CU	CU
Dr Forward Contract Liability	8,333
Cr Foreign Exchange Gain		8,333

Being journal to derecognise the liability on the contract maturing

Example 2: Foreign currency forward contract to hedge a sale

Company A expects to sell a large volume of goods for FC100,000 on 31 March. The year-end date is 31 December. As a result the company enters into a forward contract to sell FC100,000 to the bank at a rate of CU1:FC0.80.

Assume it does not meet the conditions for hedge accounting.

The forward rate quoted for FC contract at 31 December by the bank for a contract that matures on 31 March is CU1:FC0.75.

The accounting required at 31 December is the same as example 1. On the eventual sale here if we assume the spot rate was CU1:FC0.85 the journal would be:

	CU	CU
Dr Bank	117,647
Cr Sales (FC100,000/0.85)		117,647

Being journal to reflect sale

	CU	CU
Dr Bank (CU125,000-CU117,647)	7,353
Dr Forward Contract Liability	8,333
Cr Foreign Exchange Gain		15,686

Being journal to reflect cash received from the bank on transfer of the FC100,000 at the forward rate of CU7,353 and the reversal of the prior fair value adjustment as the sale is now closed out. Therefore the overall gain in the contract is CU7,353 which is what has ultimately been reflected in the P&L (CU8,333 debit in year 1 – CU7,353 credit on completion and CU8,333 credit on derecognition of the forward contract liability).

Example 3: Foreign currency forward contract to hedge a future purchase

Company A expects to purchase a piece of equipment for FC100,000 on 31 March. The year-end date is 31 December. As a result the company enters into a forward contract to purchase FC100,000 from the bank at a rate of CU1:FC0.80.

Assume it does not meet the conditions for hedge accounting.

The forward rate quoted for the FC contract at 31 December by the bank for a contract that matures on 31 March is CU1:FC0.75.

The accounting at 31 December is as follows:

	CU	CU
Dr Forward Contract Asset	CU8,333
Cr Foreign Exchange Gain		CU8,333

Being journal to reflect fair value of option.

Example 4: Interest rate swap – non hedge accounting

Company A gets a loan for CU100,000 at a fixed rate of 5% which is repayable in 5 years.

At the same time Company A enters into an interest rate swap with a third party e.g. another bank for a 5 year period whereby Company A will pay the floating rate to the third party and the third party will pay the fixed rate to Company A. The notional amount hedged is CU100,000. Assume the current average variable interest rate for the year was 6%.

Assume this does not meet the requirements for hedge accounting and that interest is paid every 6 months (no accruals) and there is no credit risk on debt. Assume at the end of year 1 that there was a loss of CU5,000 in the interest rate swap.

The accounting entries required at the end of year 1 would result in the following P&L and balance sheet impact. The effect is that an additional CU5,000 hits the profit and loss for the fair value of the swap at the year-end:

12 PE 1

Example 5: Hedging in a group context

Sub A whose functional currency is sterling has been provided with a euro loan from its parent company whose functional currency is euro. Therefore in Sub A’s entity financial statements there is a foreign exchange gain/loss which when converted to euro for consolidation purposes is included in the profit and loss. This is not eliminated on consolidation as the Parent company has no exposure. Sub A enters into a forward contract to hedge the FX exposure and hedge accounts.

Given the Sub A has a forward contract in place, Parent A can hedge account in the consolidated financial statements such that there is no hit to the profit and loss for the foreign exchange difference.

In this case the parent company can also hedge this exposure themselves by entering into a foreign contract which meets the condition for hedging rather than the subsidiary entering into the forward contract.

Example 6: Hedging with a forward contract where contract is less than the probable sale amount

Company A who has a euro functional currency has entered into a probable forecasted transaction for FC100,000. Company A has taken out a forward contract to cover FC70,000 of this sale.

In this instance under Section 12.16C, the company can designate the FC70,000 as the hedged item.

Example 7: Hedging part payments

Company A entered into a purchase contract in which it will pay 10 payments over the next year. In this example Company A can designate 5 of these payments to be considered for hedge accounting and treated as the hedged item and the other 5 where it takes out a forward contract to cover the five payments.

These payments are separately identifiable.

Example 8

Company A gets a loan for CU100,000 at a fixed rate of 5% which is repayable in 5 years.

At the same time Company A enters into an interest rate swap with a third party e.g. another bank for a 5 year period (notional amount is CU50,000) whereby Company A will pay the floating rate to the third party and the third party will pay the fixed rate to Company A.

In this case this specified notional amount of CU50,000 can be held as the hedged item.

Example 8B: Partial term hedging

Company A gets a loan for CU100,000 at a fixed rate of 5% which is repayable in 5 years.

At the same time Company A enters into an interest rate swap with a third party e.g. another bank for a 2 year period whereby Company A will pay the floating rate to the third party and the third party will pay the fixed rate to Company A.

In this case the specified notional amount of CU50,000 can be held as the hedged item.

Example 9: Portion of a hedging instruments

Company A has a highly probable sale forecasted for FC100,000. It enters into a forward contract to cover this.

On inception Company A believes there is 75% chance of making the sale. Therefore Company A can designate FC75,000 of the sale as the hedged item.

Depending on whether the remaining 25% can be used as a hedge for something else, fair value may be posted to other comprehensive income or the profit and loss where it cannot be utilised as a hedge.

Example 10: Portion of a hedging instrument not allowed

Company A gets a variable loan for CU100,000 which is repayable in 5 years.

At the same time Company A enters into an interest rate swap with a third party e.g. another bank for an 8 year period (notional amount of swap is CU100,000) whereby Company A will pay the fixed rate to the third party and the third party will pay the floating rate to Company A.

In this case this is not an allowable hedge accounting treatment as the term of the swap is more than the hedged item itself.

If the Variable loan was for 8 years and swap for 5 years, it would then be an allowable hedge.

Example 11: Forward contract option

Company A whose functional currency is CU operates a toy production and sales business. Each year it sets its prices in FC and gives it to customers. The prices do not change in the year. The company maintains a FC bank account.

In order to hedge the risk of the CU/FC exchanges affecting future sales prices and the CU amount taken in after conversion, company A enters into a call option from the bank where they can convert FC100,000 in four months time (which is the expected sales in the first four months) at a rate of CU1:FC0.80.

The spot rate at the time of obtaining the option was CU1:FC0.85.

In this case Company A can designate the intrinsic value of the forward option as a hedge against movement in the CU/FC FX rates. The exposure hedged is the variability in cash flows where the FX rate exceeds CU1:FC0.80. A call option has intrinsic value if the strike price (CU1:FC0.80) is below the spot exchange rate (opposite for put option). Therefore a hedge will not exist until the spot rate goes below the CU1:FC0.80 rate.

Example 12: Fair value hedge – Interest rate swap – fixed interest rate on a debt instrument (carried at amortised cost)

Company A gets a loan for CU100,000 at a fixed rate of 7% which is repayable in 5 years.

At the same time Company A enters into an interest rate swap with a third party (e.g. another bank) for a 5 year period whereby Company A will pay the floating rate to the third party and the third party will pay the fixed rate to Company A (i.e. receive fixed, pay variable). The notional amount hedged is CU100,000. Assume the current average variable interest rate for the year was 6%.

At the end of year 1 the interest rate swap has a positive fair value of CU6,100 and the negative fair value of the loan attributable to the hedged interest rate risk is CU5,600.

The accounting entries required at the end of year 1 assuming all other conditions for hedge accounting have been met and the interest has already been charged and paid/received:

	CU	CU
Dr Swap fair value on balance sheet	6,100
Cr Swap FV loss in P&L		6,100
Dr Loan fair value gain in P&L	5,600
Cr Loan Liability		5,600

Being journal to reflect fair value of loan and swap.

The final balance sheet will look like the below:

12 PE 2

Note in accordance with 12.22 if the hedge is discontinued before the loan is repaid in 5 years time the CU5,600 would have to be credited as interest to the profit and loss at the effective interest rate from that date to bring the liability to CU100,000 by the end of year 5. The amortisation does not take place until the hedge is ceased, it remains present and moves in line with the fair value adjustments year on year.

If the swap is in place for all 5 years then the movement in fair values year on year will bring it back to CU100,000.

Example 13: Firm Commitment

Company A has committed with company B to purchase 10,000 products (which are nuts and are used regularly) from them at a fixed price of CU10 per product and they will be delivered in two months’ time (it is now 1 December and year end is 31 December). As the ownership does not pass until they are delivered under the agreement the products are not recognised on the balance sheet of Company A until delivery.

At 31 December the price of the product increased to CU12 per product.

Assume there are no further changes in the fair value up to the date the products are delivered.

As the price changed from CU10 to CU12 from the date of entering the commitment to the year end, this means that there is a fair value in the commitment at the year-end; that being the fact that the commitment is now worth CU2*10,000 = CU20,000. In essence if Company B were to pull out of this on that day it would have to pay CU20,000 to Company A.

Per Section 12.21 this CU20,000 would be shown as an asset on the balance sheet and the gain shown as a credit to the profit and loss. The journals required are:

	CU	CU
Dr Fair Value of firm commitment	20,000
Cr Gain on firm commitment in P&L		20,000

On the goods being delivered and the commitment honored on 31 January, the goods would be recognised on the balance sheet:

	CU	CU
Dr Inventory	100,000
Cr Creditors		100,000

Being journal to reflect liability.

	CU	CU
Dr Inventory	20,000
Cr Fair Value of firm commitment		20,000

Being journal to reclassify the fair value adjustment to be included in the cost of inventory in accordance with Section 12.21.

Example 14: Hedge of a foreign currency risk of an unrecognised firm commitment

On 9 June 20X5 an entity enters into a purchase agreement with a third party over a non-financial asset in a foreign currency (FC) for FC515,000. On the same day, the entity enters into a forward currency contract to buy FC500,000 for CU1,000,000. Under the purchase agreement, the non-financial asset will be delivered and paid for on 30 March 20X6, the same day the forward currency contract is required to be settled.

In this example the hedged item is the total of the commitment of FC515,000 and the hedging instrument is the forward contract to buy FC500,000. Since the nominal amounts of the two contracts do not match, hedge ineffectiveness arises. It should be noted that in practice an entity could avoid ineffectiveness arising for this reason by identifying an amount of FC500,000 of the total commitment as the hedged item in accordance with paragraph 12.16C.

For simplification, this example disregards other sources of ineffectiveness, e.g. counter party credit risk associated with the forward currency contract.

The entity’s financial year ends on 31 December.

This example assumes that the qualifying conditions for hedge accounting in paragraph 12.18 are met from 9 June 20X5.

The table below sets out the applicable forward exchange rates, the fair value of the forward currency contract (the hedging instrument) and the hedging gains/losses on the purchase commitment (the hedged item) on the relevant dates. This example ignores the effects of discounting.

	9 June 20X5	31 Dec 20X5	30 March 20X6
Forward exchange rate (CU:FC)	2:1	2.2:1	2.16.1
Forward currency contract (hedging instrument)
Fair Value	Nil	FC500,000xFC0.2: = CU100,000	FC500,000 x FC0. 16: = CU80,000{
Fair value change	Nil	CU100,000 – 0 = CU100,000	CU80,000-CU100,000= (CU20,000)
Purchase commitment (hedged item)
Cumulative hedging (loss){	Nil	(FC515,000) x FC0.2:=(CU103,000)	(FC515,000) x FC0. 16: = (CU82,400)
Hedging (loss)/Hedging (loss)/ gain	Nil	(CU103,000) – 0 = (CU103,000)	(CU82,400)- (CU103,000)= CU20,600

Key to table:

This is the fair value of the contract prior to settlement in accordance with paragraph 12.20(b), the commitment is fair valued only for the hedged risk, which in this example is the forward exchange rate risk.

12A.2 Hedge accounting:

Note that there are no hedge accounting entries on 9 June 20X5.

31 December 20X5

(1) In accordance with paragraph 12.20(a) the fair value gain of CU100,000 on the forward currency contract is recognised in profit or loss.

(2) In accordance with paragraph 12.20(b) the cumulative hedging loss of CU103,000 on the commitment is recorded as a liability with a corresponding loss recognized in profit or loss.

Accounting entries:

Ref		Debit	Credit
(1)	Forward currency contract	CU100,000
	Profit or Loss		CU100,000
(2)	Profit or Loss	CU103,000
	Hedged item (commitment)		CU103,000

30 March 20X6

(1) In accordance with paragraph 12.20(a) the fair value loss of CU20,000 on the forward currency contract is recognised in profit or loss.

(2) In accordance with paragraph 12.20(b) the hedging gain on the commitment of CU20,600 is recognised in profit or loss with a corresponding adjustment to the recognised liability from CU103,000 to CU82,400.

(3) In accordance with paragraph 12.21 the non-financial asset’s carrying amount is adjusted to include the cumulative hedging loss on the hedged item of CU82,400.

Note A: For illustrative purposes the accounting entry in respect of the settlement of the forward currency contract in cash for CU80,000 is shown below.

Note B: For illustrative purposes the accounting entry for the purchase of the non-financial asset at the applicable spot rate of FC2.16: for CU1,112,400 (settled in cash) is shown below.

Accounting entries:

Ref		Debit	Credit
(1)	Profit or Loss	CU20,000
	Forward currency contract		CU20,000
(2)	Hedged item (commitment)	CU20,600
	Profit or Loss		CU20,600
(3)	Hedged item (commitment	CU82,400
	Property, plant and equipment (PP&E)		CU82,400
(A)	Cash	CU80,000
	Forward currency contract		CU80,000
(B)	Property, plant and equipment (PP&E)	CU1,112,400
	Cash		CU1,112,400

Example 15a: Forward contract for a probable forecasted sale

On 1 December Company A whose functional currency is euro secured a highly probable contract with a FC customer worth FC100,000. The sale is expected to happen on 31 March of the following year.

In contemplation of the sale Company A enters into a forward FX contract to sell FC100,000 at a rate of CU1:FC0.80.

Assume the spot rate at 31 December was CU1:FC0.70.

Assume the spot rate at 31 March was CU1:FC0.84.

Assume the spot rate at 31 May was CU1:FC0.85.

The forward rate quoted for sterling contract at 31 December by the bank for a contract that matures on 31 March is CU1:FC0.75.

The accounting requirement as a result of entering into this forward contract at 31 December year end and 31 March assuming it meets the conditions for hedge accounting are:

12 PE 3

*Fair value of the forward contract at 31 December:

Amount of CU that will be obtained on 31 March at contracted rate of CU1:FC0.80 is FC100,000/0.80= CU125,000.

Note any FC balances in the balance sheet at 31 December should be retranslated to the year-end rate.

Amount of CU that could theoretically be obtained on 31 March at contracted rate of CU1:FC0.75 is FC100,000/0.75= CU133,333

Fair value loss at 31 December is CU133,333-CU125,000 – CU8,333

** Fair value of the forward contract at 31 March:

Amount of CU that will be obtained on 31 March at contracted rate of CU1:FC0.80 is FC100,000/0.80= CU125,000

The fair value at the date of expiration is therefore the CU125,000 less FC100,000 at the spot rate at 31 March of CU1:FC0.84 i.e. (CU119,048)= CU5,952

Movement to be posted to reflect the CU5,952 is CU5,952 plus the debit previously posted of CU8,333 is CU14,285.

If the above was related to a probable purchase for inventory, the journals would be of similar type but obviously the foreign exchange loss/gain will be the opposite way around.

Example 15b: Probable forecasted purchase of equipment

On 1 December Company A whose functional currency is euro secured a highly probable purchase of a piece of equipment with a sterling (FC) supplier worth FC100,000. The delivery of the equipment is expected to happen on 31 March of the following year and be paid for on 31 May.

In contemplation of the purchase Company A enters into a forward FX contract to sell FC100,000 at a rate of CU1:FC0.80.

Assume the spot rate at 31 December was CU1:FC0.70.

Assume the spot rate at 31 March was CU1:FC0.84.

Assume the spot rate at 31 May was CU1:FC0.85.

Assume for this example the purchase goes ahead and was paid on 31 May.

The forward rate quoted for the foreign currency contract at 31 December by the bank for a contract that matures on 31 March is CU1:FC0.75.

The forward rate quoted for the foreign currency contract at 31 March by the bank for a contract that matures on 31 March is CU1:FC0.83.

The accounting requirement as a result of entering into this forward contract at 31 December year end, 31 March and 31 May assuming it meets the conditions for hedge accounting are:

12 PE 4

12 PE 5

Example 16: Hedge of variability in cash flows in a floating rate loan due to interest rate risk (Example extracted from Appendix to Section 12 of FRS 102)

Cash flow hedge accounting – Hedge of variability in cash flows in a floating rate loan due to interest rate risk.

This example illustrates the accounting for a cash flow hedge of interest rate risk associated with a floating rate loan. The entity borrows money at a floating rate and enters into an interest rate swap with the effect of paying a fixed rate overall.

12A.3 On 1 January 20X5, an entity borrows CU10,000,000 from a bank at a floating rate of 3-month LIBOR plus 2.5 per cent. The interest is payable annually in arrears on 31 December. The loan is repayable on 31 December 20X7.

On 1 January 20X5 the entity also enters into an interest rate swap with a third party, under which it receives 6-month LIBOR and pays a fixed rate of interest of 4.5 per cent. The notional amount of the swap is CU10,000,000. The swap is settled annually in arrears on 31 December and expires on 31 December 20X7.

The LIBOR rates on the loan and the interest rate swap are reset and fixed annually in advance on 31 December based on the expected LIBOR rates applicable at that time. Note that in practice the loan and swap interest rates would be reset more frequently than assumed for the purpose of simplification in this example.

The entity hedges the variability of the interest rate payments on the bank loan based on 3-month LIBOR. It should be noted that because the entity receives interest based on 6-month LIBOR under the interest rate swap, ineffectiveness will arise because the expected cash flows of the hedged item and the hedging instrument differ. The fair value of the interest rate swap may be affected by other factors that cause ineffectiveness, for example counter party credit risk, but these have been disregarded in this example.

There are no transaction costs.

The entity’s financial year ends on 31 December. This example assumes that the qualifying conditions for hedge accounting in paragraph 12.18 are met from 1 January 20X5. The table in paragraph 12A.5 summarises the impact of hedge accounting on the interest rate swap, profit or loss and other comprehensive income. The table below sets out the applicable LIBOR rates, interest payments and swap settlements. The fair values of the interest rate swap and the hedged item shown in the table are shown for illustrative purposes only.

Note that in practice, when forecasted variable interest rate payments are the hedged item, the fair value of a hypothetical swap, that would be expected to perfectly offset the hedged cash flows, is used as a proxy of the fair value of the hedged item. The hypothetical derivative in this scenario is a fixed to floating interest rate swap with terms that match those of the loan and a fixed rate of 4.3 per cent, which for the purpose of this example, is the interest rate where the fair value of the hypothetical swap is nil at the inception of the hedging relationship.

	1 Jan 20X5	31 Dec 20X5	31 Dec 20X6	31 Dec 20X7
Actual 3-month LIBOR	4.3%	5%	3%	n/a
Actual 6-month LIBOR	4.5%	4.9%	3.2%	n/a
Interest payments based on 3-month LIBOR	n/a	CU10m x (4.3% + 2.5%)= CU680,000	CU10m x (5% + 2.5%)= CU750,000	CU10m x (3% + 2.5%)= CU550,000
Interest rate swap (hedging instrument)
Fair value	nil	CU78,000	(CU89,000){	(CU130,000){
Fair value change	nil	CU78,000 – 0= CU78,000	(CU89,000) – CU78,000= (CU167,000)	(CU130,000) – (CU40,000)§ – (CU89,000)= (CU1,000)
Swap settlement receipts/ (payments) based on 6-month LIBOR	n/a	CU10m x (4.5% – 4.5%)= nil	CU10m x (4.9% – 4.5%)= CU40,000	CU10m (3.2%* – 4.5%)= (CU130,000)
Hedged item
Fair value	nil	(CU137,000)	CU59,000	CU130,000

Key to table:

{: This valuation is determined before the receipt of the cash settlement of CU40,000 due on 31 December 20X6.

{: This valuation is determined before the payment of the cash settlement of CU130,000 due on 31 December 20X7.

: CU40,000 is the settlement of the interest rate swap as at 31 December 20X6 which affects the fair value of the swap, but is not included in the fair value of the swap at 31 December 20X6 of CU89,000.

12A.4 Hedge accounting:

31 December 20X5

(1) In accordance with paragraph 12.23(a), the cash flow hedge reserve is adjusted to the lower of (in absolute amounts) the cumulative gain on the hedging instrument (ie the interest rate swap), which equals its fair value, of CU78,000 and the cumulative change in fair value of the hedged item, which equals its fair value of (CU137,000). In accordance with paragraph 12.23(b), the gain of CU78,000 on the interest rate swap is recognised in other comprehensive income.

(2) The fixed interest element on the hypothetical swap is CU430,000, the same amount as the variable rate component. The variability of the 3-month LIBOR did therefore not affect profit or loss during the period. The reclassification adjustment in accordance with paragraph 12.23(d)(ii) is nil. (Note that no accounting entry is shown below.)

Note A: For illustrative purposes the accounting entry for interest payments is shown below. Note that in practice the accrual and payment of interest may be recorded in separate accounting entries.

Accounting entries:

Note that the accounting entries shown are only those relevant to demonstrate the effects of hedge accounting. In practice other accounting entries would be required, eg an entry to recognise the loan liability.

Ref		Debit	Credit
(1)	Interest rate swap	CU78,000
	Other comprehensive income		CU78,000
(A)	Profit or Loss	CU680,000
	Cash		CU680,000

31 December 20X6

(1) In accordance with paragraph 12.23(a), the cash flow hedge reserve is adjusted to the lower of (in absolute amounts) the cumulative loss on the hedging instrument (ie the interest rate swap) which equals its fair value of (CU89,000) and the cumulative change in fair value of the hedged item, which equals its fair value of CU59,000. The cash flow h medge reserve moves from CU78,000 to (CU59,000), a change of (CU137,000). In accordance with paragraph 12.23(b), a loss of CU137,000 on the interest rate swap is recognised in other comprehensive income, as this part of the loss is fully off-set by the change in the cash flow hedge reserve. The remainder of the loss on the interest rate swap of CU30,000 is recognised in profit or loss, as required by paragraph 12.23(c).

(2) The fixed interest element on the hypothetical swap is CU430,000, whilst the variable rate component is CU500,000. The variability of the 3-month LIBOR affects profit or loss during the period by CU70,000. Accordingly, the reclassification adjustment in accordance with paragraph 12.23(d)(ii) is CU70,000.

Note B: For illustrative purposes the accounting entry for the settlement of the swap is shown below.

Accounting entries:

Ref		Debit	Credit
(1)	Other comprehensive income	CU137,000
	Profit or loss
	Interest rate swap		CU167,000

(2)	Other comprehensive income	CU70,000
	Profit or loss		CU70,000
(A)	Profit or loss	CU750,000
	Cash		CU750,000
(B)	Cash	CU40,000
	Interest rate swap		CU40,000

31 December 20X7

(1) In accordance with paragraph 12.23(a), the cash flow hedge reserve is adjusted to the lower of (in absolute amounts) the cumulative loss on the hedging instrument (ie the interest rate swap) which equals the fair value of (CU130,000) and the cumulative change in fair value of the hedged item, which equals its fair value of CU130,000. The cash flow hedge reserve moves from (CU129,000) to (CU130,000), a change of (CU1,000). In accordance with paragraph 12.23(b), the loss of CU1,000 on the interest rate swap is recognised in other comprehensive income.

(2) The fixed interest element on the hypothetical swap is CU430,000, whilst the variable rate component is CU300,000. The variability of the 3-month LIBOR affects profit or loss during the period by (CU130,000). Accordingly, the reclassification adjustment in accordance with paragraph 12.23(d)(ii) is (CU130,000).

Note B: For illustrative purposes the accounting entry for the settlement of the swap is shown below.

Accounting entries:

Ref		Debit	Credit
(1)	Other comprehensive income	CU1,000
	Interest rate swap		CU1,000
(2)	Profit or loss	CU130,000
	Other comprehensive income		CU130,000
(A)	Profit or loss	CU550,000
	Cash		CU550,000
(B)	Interest rate swap	CU130,000
	Cash		CU130,000

12A.5: The table below summarises the effects of the accounting entries shown in paragraph 12A.4 on the interest rate swap, profit or loss and other comprehensive income.

Description	Interest rate swap	Other comprehensive income	Profit or loss
31 December 20X5
Opening balance	nil	nil	–
Interest on the loan	–	–	CU680,000
Interest rate swap fair value movement	CU78,000	(CU78,000)	–
Closing balance	CU78,000	(CU78,000)	–
31 December 20X6
Opening balance	CU78,000	(CU78,000)		–
Interest on the loan	–	–	CU750,000
Interest rate swap fair value movement	(CU167,000)	CU137,000	CU30,000
Settlement receipt interest rate swap	(40,000)	–	–
Reclassification from cash flow hedge reserve	–	CU70,000	(CU70,000)
Closing balance	(CU129,000)	CU129,000	–
31 December 20X7
Opening balance	(CU129,000)	CU129,000	–
Interest on the loan	–	–	CU550,000
Interest rate swap Movement	(1,000)	1,000	–
Settlement payment interest rate swap	CU130,000	–	–
Reclassification from cash flow hedge reserve	–	(CU130,000)	CU130,000
Closing balance	nil	nil	–

Key to table:

This is the balance of the cash flow hedge reserve.

Example 17: Net investment in a foreign operation (Extracted from Appendix to Section 12 of FRS 102

Hedge accounting: Net investment in a foreign operation

This example illustrates the accounting for a net investment hedge in the consolidated financial statements. The entity has a foreign operation and hedges its exposure to foreign currency risk in the foreign operation by the use of a foreign currency loan.

12A.6 On 1 April 20×5 an entity with functional currency CU acquires an investment in an overseas subsidiary (with functional currency FC) at a cost of FC1,200,000. On the same day the entity takes out a loan with a third party of FC1,200,000 to finance the investment. This example disregards the effects of interest or other transaction costs associated with the loan.

This example assumes that the carrying amount of the investment denominated in FC is impaired below FC1,200,000 as presented in the table below, which causes ineffectiveness.

The entity’s financial year ends on 31 December.

This example assumes that the qualifying conditions for hedge accounting in paragraph 12.18 are met from 1 April 20X5.

The table below sets out the applicable exchange rates, the carrying amount of the loan and the foreign exchange gains and losses on the loan as determined in accordance with Section 30, as well as the retranslation differences on the foreign investment recognised in other comprehensive income in accordance with Section 30.

	1 Apr 20X5	31 Dec 20X5	31 Dec 20X6
Spot exchange rate CU:FC	0.35:1	0.3:1	0.45:1
Loan (hedging instrument)
Carrying amount under Section 30	(FC1,200,000) x CU0.35:FC= (CU420,000)	(FC1,200,000) x CU0.3:FC= (CU360,000)	(FC1,200,000) x CU0.45:FC= (CU540,000)
Cumulative gain/(loss)	nil	(CU360,000) – (CU420,000)= CU60,000	(CU540,000) – (CU420,000)= (CU120,000)
Gain/(loss)	nil	(CU360,000) – (CU420,000)= CU60,000	(CU540,000) – (CU360,000)= (CU180,000)

	1 April 20X5	31 December 20X5	31 December 20X6
Investment in foreign operation (hedged item)
Retranslation difference in accordance with Section 30	nil	(CU55,000)	CU157,500
Cumulative retranslation differences	nil	(CU55,000) – 0= (CU55,000)	CU157,500 + (CU55,000)= CU102,500

Key to table:

This is the exchange difference referred to in paragraph 30.20 which is recognised in other comprehensive income. The amount under paragraph 30.20(a) is CU5,000 and under paragraph 30.20(b) (CU60,000). The calculation is based on the translation of the FC200,000 loss at the average rate of 0.325CU:FC.

This is the exchange difference referred to in paragraph 30.20 which is recognised in other comprehensive income. The amount under paragraph 30.20(a) is CU7,500 and under paragraph 30.20(b) CU150,000. The calculation is based on the translation of the FC100,000 profit at the average rate of 0.375CU:FC.

12A.7 Hedge accounting:

31 December 20X5

A component of equity is adjusted to the lower of (in absolute amounts) the cumulative exchange gain on the loan of CU60,000 and the cumulative retranslation difference on the net investment of (CU55,000).

In accordance with paragraph 12.24(a), a gain of CU55,000 on the loan is recognised in other comprehensive income. The remainder of the gain of CU5,000 is recognised in profit or loss, as required by paragraph 12.24(b).

Accounting entry:

Note that only the accounting entry in relation to hedge accounting as described in paragraph 12.24 is shown. Other accounting entries in relation to the loan and the investment in the foreign operation would be required in practice.

	Debit	Credit
Loan	CU60,000
Other comprehensive income		CU55,000
Profit or loss		CU5,000

31 December 20X6

A component of equity is adjusted to the lower of (in absolute amounts) the cumulative exchange loss on the loan of CU120,000 and the cumulative exchange difference on the net investment of CU102,500.

The amount recorded in equity changes from CU55,000 to (CU102,500), a change of (CU157,500). In accordance with paragraph 12.24(a) a loss of CU157,500 on the loan is recognised in other comprehensive income. The remainder of the loss of CU22,500 is recorded in profit or loss, as required by paragraph 12.24(b).

Accounting entry:

	Debit	Credit
Other comprehensive income	CU157,500
Profit or loss	CU22,500
Loan		CU180,000

Example 18

On 1 February, Company A has a highly probable forecasted sale expected to occur on 31 July and cash will be collected on 31 August.

Company A takes out a forward contract of CU100,000 to cover this sale.

On 30 April the Company no longer thinks it is highly probable that the sale will happen however it is possible.

At 30 June it is no longer possible that the sale will go ahead.

The fair values at each date are:

Fair value of forward contract

28 February CU20,000

31 March CU25,000

30 April CU15,000

31 May CU10,000

31 july CU5,000 AND SETTLED

SEE ACCOUNTING FOR SAME BELOW

12 PE 6

Example 19: Forward Contracts

Company A entered into a forward contract to hedge against foreign exchange movements as the company engages in a significant volume of foreign currency sales. The year end is 31 December. It entered into a forward contract on 1 November 2013 to sell FC100,000 of FC in return for CU at a set rate of CU1:FC0.80 maturing on 31 March.

Assume the spot rate at 31 December 2013 and 31 December 2014 was CU1:FC0.70 and the date of transition is 1 January 2014. Assume deferred tax of 10%.

The forward rate quoted for sterling contract at 31 December 2013 by the bank for a contract that matures on 31 March is CU1:FC0.75.

Under old GAAP this forward contract was not accounted for; instead it was disclosed in the financial statements. However under FRS 102 this should be fair valued.

The transition adjustments as a result of entering into this forward contract at 31 December year end under FRS 102 assuming it does not meet the conditions for hedge accounting are as follows:

1 January 2014

	CU	CU
Dr Profit and Loss reserves	8,333
Cr Forward Contract Liability		8,333*

Being journal to reflect fair value of the forward contract at the year-end not accounted for under old GAAP.

	CU	CU
Dr Deferred Tax Asset (CU8,333*10%)	833
Cr Profit and Loss reserves		833

Being journal to reflect deferred tax on the above adjustment for the fact that this will be tax deductible in future years.

*Fair value of the forward contract:

Amount of CU’s that will be obtained on 31 March at contracted rate of CU1:FC0.80 is FC100,000/0.80= CU125,000

Note any FC balances in the balance sheet at 31 December should be retranslated to the year-end spot rate.

Amount of CU’s that could theoretically be obtained on 31 March at contracted rate of CU1:FC0.75 = FC100,000/0.75= CU133,333

Fair value loss at 31 December 2013/1 January 2014 is CU133,333-CU125,000 = CU8,333

Journals required for year ended 31 December 2014 assuming the above journals are brought forward)

	CU	CU
Dr Forward Contract Liability	8,333
Cr Foreign Exchange Gain		8,333

Being journal to derecognise the liability recognised on 1 January 2014 above on the contract maturing

	CU	CU
Dr Deferred Tax in P&L	833
Cr Deferred Tax Asset		833

Being journal to reverse deferred tax as this was taxed in the 2014 tax computation when the forward contract was settled.

Example 20: Forward contracts in existence after the date of transition

If we take the example above and this time assume that the forward contract was entered into on 1 November 2014 and it matured on 31 March with the same dates and fair values. The journals that would be required on transition is:

31 December 2014

	CU	CU
Dr Foreign Exchange Gain in P&L	8,333
Cr Forward Contract Liability		8,333

Being journal to reflect fair value of the forward contract at the year-end not accounted for under old GAAP.

	CU	CU
Dr Deferred Tax Asset (CU8,333*10%)	833
Cr Deferred Tax in P&L		833

Being journal to reflect deferred tax on the above adjustment for the fact that this will be tax deductible in future years

31 December 2015 assuming the above journals were posted to reserves

	CU	CU
Dr Forward Contract Liability	8,333
Cr Foreign Exchange Gain		8,333

Being journal to derecognise the liability recognised at 31 December on the contract maturing

	CU	CU
Dr Deferred Tax in P&L	833
Cr Deferred Tax Asset		833

Being journal to reverse deferred tax as this will be taxed in the 2015 tax computation when the forward contract was settled.

Note if a forward contract exists at 31 December 2015 no deferred tax will be required to be recognised on the adjustment as it will be taxed/tax deductible in the 2015 year assuming the entity does not elect into regulations 7,8 and 9 of the disregard regulations. Where an entity elects into these regulations, deferred tax will need to be recognized on the movement in the fair value of the derivatives year on year similar to what has been shown in the 31 December 2014 journals above.

Example 21: Interest rate swap – non hedge accounting

Company A gets a loan for CU100,000 on 1 January 2013 at a fixed rate of 5% which is repayable in 5 years.

At the same time Company A enters into an interest rate swap with a third party e.g. another bank for a 5 year period whereby Company A will pay the floating rate to the third party and the third party will pay the fixed rate to Company A. The notional amount hedged is CU100,000 Assume the current average variable interest rate was 6%.

Under old GAAP (for non-FRS 26 adopters) this interest rate swap was not accounted for, instead it was disclosed in the financial statements. However under FRS 102 this should have been fair valued.

Assume at the end 31 December 2013 and 2014, there was a loss of CU5,000 and profit of CU6,000 respectively on the interest rate swap.

The transition adjustments required are:

1 January 2014

	CU	CU
Dr Profit and Loss Reserves	5,000
Cr Interest Rate Swap Liability		5,000 (CU500*10%)

Being journal to recognise the fair value of the interest rate swap

	CU	CU
Dr Profit and Reserves with Deferred Tax	500
Cr Deferred Tax Liability		500

Being journal to reflect the deferred tax on the above adjustment.

Journals required for year ended 31 December 2014 assuming the above journals are brought forward)

	CU	CU
Dr Interest Rate Swap Liability	5,000
Cr Interest Expense		5,000

Being journal to reverse the fair value of the interest rate swap at the end of prior year.

	CU	CU
Dr Deferred Tax Liability	500
Cr Deferred Tax P&L		500

Being journal to reflect the deferred tax on the above adjustment.

	CU	CU
Dr Interest Rate Swap Liability	6,000
Cr Interest Expense		6,000

Being journal to recognise the fair value of the interest rate swap at 31 December 2014

	CU	CU
Dr Deferred Tax P&L	600
Cr Deferred Tax Liability		600

Being journal to reflect the deferred tax on the above adjustment as it was not taxed in 2014 tax computation.

Journals required for year ended 31 December 2015 (assuming the above journals are brought forward)

	CU	CU
Dr Interest Expense	6,000
Cr Interest Rate Swap Liability		6,000

Being journal to reverse the fair value of the interest rate swap at 31 December 2014.

Note that no deferred tax journals are required on the fair value of the interest rate swap adjustment in 31 December 2015 as this will be taxed/tax deductible in the 2015 year assuming the entity does not elect into regulations 7,8 and 9 of the disregard regulations. Where they elect into these regulations deferred tax will need to be recognized on the movement in the fair value of the derivatives year on year similar to what has been shown in the 31 December 2014 journals above. This journal is not illustrated below.

Example 22: Cash flow hedge example

On 1 December 2013 Company A whose functional currency is CU secured a highly probable contract with a foreign currency customer worth FC100,000. The sale is expected to happen on 31 March 2015 of the following year.

In contemplation of the sale Company A enters into a forward FX contract to sell FC100,000 at a rate of CU1:FC0.80.

Assume the spot rate at 31 December 2013 was CU1:FC0.70 and the date of transition is 1 January 2014. Assume deferred tax of 10%.

The forward rate quoted for the foreign currency contract at 31 December 2013 by the bank for a contract that matures on 31 March is CU1:FC0.75.

Under old GAAP this forward contract was not accounted for instead it was disclosed in the financial statements. However under FRS 102 this should have been fair valued. The contract also meets the hedge accounting requirement in 12.18 and the client wants to hedge account.

The transition adjustments as a result of entering into this forward contract and chosing to adopt hedge accounting is as follows:

1 January 2014

	CU	CU
Dr – Cash Flow Hedge Reserve	8,333
Cr Forward Contract Liability		8,333*

Being journal to reflect fair value of the forward contract at the year-end not accounted for under old GAAP and applying hedge accounting (i.e. posted to OCI as it meets the condition for hedging).

Dr Deferred Tax Asset

(CU8,333*10%)

833

Cr Deferred Tax in Cash Flow Hedge Reserve

833

Being journal to reflect deferred tax on the above adjustment

*Fair value of the forward contract:

Amount of CU that will be obtained on 31 March at contracted rate of CU1:FC0.80 is FC100,000/FC0.80= CU125,000.

Note any FC balances in the balance sheet at 31 December should be retranslated to the year-end spot rate.

Amount of euros that could theoretically be obtained on 31 March at contracted rate of CU1:FC0.75 is FC100,000/FC0.75 = CU133,333.

Fair value loss at 31 December 2013/1 January 2014 is CU133,333-CU125,000 = CU8,333.

Journals required for year ended 31 December 2014 assuming the above journals are brought forward)

	CU	CU
Dr Forward Contract Liability	8,333
Cr Other Comprehensive Income – Cash Flow Hedge Reserve		8,333

Being journal to reverse the journals posted at 1 January as the contract has now matured and the FX gain on the contract has already been posted to the P&L under old GAAP (i.e. contract settled for CU125,000 (FC100,000/FC0.80) less the FC100,000 at the spot rate at 31 March of CU1:FC0.84p i.e. (CU119,048)= CU5,952.

Dr Deferred Tax in OCI/Cash Flow Hedge Reserve

833

Cr Deferred Tax Asset

(CU8,333*10%)

833

Being journal to reflect reversal of deferred tax recognised on transition as the contract has now matured.

If another forward contract was entered into in 2014 and 2015, the same type of journals would be required

Example 23: Interest rate swap – cash flow hedge accounting

Company A gets a loan for CU100,000 on 1 January 2012 at a variable rate which is repayable in 5 years.

At the same time Company A enters into an interest rate swap with a third party e.g. another bank for a 5 year period whereby Company A will pay the fixed rate of 6% to the third party and the third party will pay the floating rate to Company A. The notional amount hedged is CU100,000 and the variable rate at inception such that the swap has a nil fair value is 6%. The expected average variable interest rate set in advance at the start of the year was 6%, 5% and 8% for 2012, 2013 and 2014 respectively. Interest is paid the following year.

Under old GAAP (for non-FRS 26 adopters) the fair value of the interest rate swap was not accounted for, instead it was disclosed in the financial statements. However under FRS 102 this should have been fair valued. The entity has also chosen to hedge account as it meets the hedge accounting requirements in Section 12.18.

Assume at the 31 December 2013, the fair value of the interest rate swap was a loss of CU5,000 up to that date. Under cash flow hedge rules assume CU1,000 of this would have been recognised in the profit and loss account if the due to this element being ineffective and the remaining CU4,000 would be recognised in the cash flow hedge reserve.

The transition adjustments required are:

1 January 2014

	CU	CU
Dr Cash Flow Hedge Reserve	4,000
Dr Profit and Loss Reserve	1,000
Cr Interest Rate Swap Liability		5,000

Being journal to recognise the fair value of the interest rate swap.

Dr Deferred Tax Asset

500

Cr Deferred Tax in Cash Flow Hedge Reserve

(CU4,000*10%)

Cr Profit and loss reserves Deferred Tax

400

100

Being journal required to reflect the deferred tax on the above adjustment.

The journals for 31 December 2014 assuming the above journals were brought forward are:

	CU	CU
Dr Deferred Tax in OCI/Cash Flow Hedge reserve	400
Dr Deferred Tax in P&L	100
Cr Deferred Tax in Asset		500

Fair value hedge

On transition, an adjustment will be required to recognise the fair value of the interest rate swap and the adjustment to reflect the carrying amount of the loan through profit and loss reserves. Under a fair value hedge, the fair value adjustments are recognised in the profit and loss. See example below

Example 24: Fair value hedge – Interest rate swap – fixed interest rate on a debt instrument (carried at amortised cost)

Company A gets a loan for CU100,000 at a fixed rate of 7% which is repayable in 5 years on 1 January 2013.

At the same time Company A enters into an interest rate swap with a third party (e.g. another bank) for a 5 year period whereby Company A will pay the floating rate to the third party and the third party will pay the fixed rate to Company A (i.e. receive fixed pay variable). The notional amount hedged is CU100,000. Assume the current average variable interest rate for the year was 6%.

At the end of 31 December 2013 the interest rate swap has a positive fair value of CU6,100 and the negative fair value of the loan attributable to the hedged interest rate risk is CU5,600. Assume for the simplicity these values are the same for 31 December 2014 and 2015 year end.

Assume the transition date is 1 January 2014 and that all conditions for hedge accounting in 12.18 have been met. Assume the deferred tax rate is 10%. Assume the disregard provisions in regulation 9 of the disregard regulation applies.

The transition adjustments required are:

1 January 2014

The accounting entries required assuming all other conditions for hedge accounting have been met and the interest has already been charged and paid/received:

	CU	CU
Dr Swap Fair Value on Balance Sheet	6,100
Dr Profit and Loss Reserves on Loan Fair Value Gain	5,600
Cr Loan Liability		5,600
Cr Profit and Loss Reserves on Swap FV loss		6,100

Being journal to reflect fair value of loan and swap at date of transition

	CU	CU
Dr Profit and Loss Reserves (CU6,100-CU5,600*10%)	50
Cr Deferred Tax Liability		50

Being journal to reflect deferred tax on the above adjustment

Journals required at 31 December 2014 assuming the above journals are brought forward

	CU	CU
Dr Swap FV Loss in P&L	6,100
Dr Loan Liability	5,600
Cr Loan Fair Value Gain in P&L		5,600
Cr Swap Fair Value on Balance Sheet		6,100

Being journal to reverse prior year fair value of loan and swap

Dr Deferred Tax Liability

Cr Deferred Tax in P&L

(CU6,100-CU5,600*10%)

Being journal to reverse prior year deferred tax

	CU	CU
Dr Swap Fair Value on Balance Sheet	6,100
Dr Loan Fair Value Gain in P&L	5,600
Cr Swap FV Loss in P&L		6,100
Cr Loan Liability		5,600

Being journal to reflect fair value of loan and swap at 31 December 2014

Dr Deferred Tax in P&L

(CU6,100-CU5,600*10%)

Cr Deferred Tax Liability

Being journal to reflect deferred tax on year end journal

The final balance sheet will look like the below at 31 December 2014:

12 PE 7

Note in accordance with 12.22 if the hedge is discontinued before the loan is repaid in 5 years time the CU5,600 would have to be credited as interest to the profit and loss at the effective interest rate from that date to bring the liability to CU100,000 by the end of year 5. The amortisation does not take place until the hedge is ceased, it just lies there any moves in line with the fair value adjustments year on year.

If the swap is in place for all 5 years then the movement in fair values year on year will bring it back to CU100,000.

Journals required at 31 December 2015 assuming the above journals are brought forward

	CU	CU
Dr Swap FV loss in P&L	6,100
Dr Loan Liability	5,600
Cr Swap Fair Value on Balance Sheet		6,100
Cr Loan Fair Value Gain in P&L		5,600

	CU	CU
Dr Deferred Tax Liability	50
Cr Deferred Tax in P&L		50

(CU50/5 years)

Being journal to reverse prior tax assuming the disregard provisions in regulation 9 of the disregard regulation applies

	CU	CU

Dr Swap Fair Value on Balance Sheet	6,100
Dr Loan Fair Value Gain in P&L	5,600
Cr Swap FV loss in P&L		6,100
Cr Loan Liability		5,600

Being journal to reflect fair value of loan and swap at 31 December 2015

It is evident that there are no deferred tax journal at 31 December 2015 for the 2015 contract entered into. The reason for same is that this adjustment will be included in the tax computation in 2015 assuming the entity does not elect into regulation 9 of the disregard regulations. Where an entity elects into these regulations, deferred tax will need to be recognised, on the movement each year similar to what has been shown in the 2014 journals above.

Example 25: Extract accounting policy notes

Financial instruments

The company has adopted Section 11 and Section 12 of FRS 102 when accounting for financial instruments.

a) Trade and other receivables.

Trade and other receivables including amounts owed to group companies are recognised initially at transaction price (including transaction costs) unless a financing arrangement in exists which case they are measured at the present value of future receipts discounted at a market rate. Subsequently these are measured at amortised cost less any provision for impairment. A provision for impairment of trade receivables is established when there is objective evidence that the company will not be able to collect all amounts due according to the original terms of receivables. The amount of the provision is the difference between the asset’s carrying amount and the present value of estimated future cash flows, discounted at the effective interest rate. All movements in the level of the provision required are recognised in the profit and loss.

b) Cash and cash equivalents.

Cash and cash equivalents include cash on hand, demand deposits and other short- term highly liquid investments with original maturities of three months or less. Bank overdrafts are shown within borrowings in current liabilities on the statement of financial position.

c) Other financial assets.

Other financial assets include investment which are not investments in subsidiaries, associates or joint ventures. Investments are initially measured at fair value which usually equates to the transaction price and subsequently at fair value where investments are listed on an active market or where non listed investments can be reliably measured. Movements in fair value is measured in the profit and loss.

Where fair value cannot be measured reliably or can no longer be measured reliably, investments are measured at cost less impairment.

d) Trade and other payables.

Accounts payable are classified as current liabilities if payment is due within one year or less. If not, they are presented as non-current liabilities. Trade payables, other payable and amounts due to group companies are recognised initially at the transaction price net of transaction costs and subsequently measured at amortised cost using the effective interest method.

e) Borrowings.

Borrowings are recognised initially at the transaction price (present value of cash payable to the bank, including transaction costs). Borrowings are subsequently stated at amortised cost. Interest expense is recognised on the basis of the effective interest method and is included in finance costs.

Borrowings are classified as current liabilities unless the Company has a right to defer settlement of the liability for at least 12 months after the reporting date.

Preference shares, which are mandatorily redeemable on a specific date, are classified as borrowings. The dividends on these preference shares are recognised in the income statement as a finance cost.

f) Derivatives.

Derivatives are initially measured recognised at fair value on the date the contract is entered into and subsequently re-measured at their fair value. Changes in the fair value are recognised in the profit and loss within finance costs or finance income as appropriate, unless they are included in a hedging arrangement.

Derivative financial instruments are not basic.

Hedge accounting is not applied.

OR WHERE HEDGE ACCOUNTING IS APPLIED

Derivative financial instruments are used to manage the Group’s exposure to foreign currency risk and interest rate risk through the use of forward currency contracts and interest rate swaps. These derivatives are generally designated as cash flow hedges in accordance with Section 12. The Group does not enter into speculative derivative transactions.

g) Derecognition.

Financial liabilities are derecognised when the liability is extinguished, that being when the contractual obligation is discharged.

h) Offsetting financial instruments.

Financial assets and liabilities are offset and the net amount reported in the balance sheet when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously.

i) Compound financial instruments.

Compound financial instruments issued by the company comprise of convertible preference shares which can be converted to a set amount of ordinary shares at a future date. The liability component of the compound instrument is initially recognised at the fair value of a similar liability where the conversion to equity option is not available. Subsequently this is measured at amortised cost using the effective interest rate method. The equity component is measured the difference between the fair value of the liability component and the fair value of the instrument as a whole. The equity component is not re-measured. Transaction costs are apportioned to the equity and liability component as a proportion that each type instrument is to the total fair value of the compound instrument.

j) Hedge accounting

Cash flow hedges

Subject to the satisfaction of certain criteria, relating to the documentation of the risk, objectives and strategy for the hedging transaction and the ongoing measurement of its effectiveness, cash flow hedges are accounted for under hedge accounting rules. In such cases, any unrealised gain or loss arising on the effective portion of the derivative instrument is recognised in the cash flow hedging reserve, a separate component of equity and posted to other comprehensive income. Unrealised gains or losses on any ineffective portion of the derivative are recognised in the income statement. When the hedged transaction occurs the related gains or losses in the hedging reserve are transferred to the Income Statement.

The company engages in hedge accounting for forward contracts in order to manage foreign currency fluctuations as well as interest rate swaps.

Changes in fair values of derivatives designated as cash flow hedges which meet the conditions for hedge accounting are recognised in directly in equity through other comprehensive income to the extent that they are effective. Any ineffectiveness is charged to the profit and loss. Any gain or loss recognised in OCI is transferred from equity to the profit and loss when the hedge relationship ends.

Cash flow hedges are those of highly probable forecasted future income or expenses. In order to qualify for hedge accounting, the Group is required to document the relationship between the item being hedged and the hedging instrument and demonstrate, at inception, that the hedge relationship will be highly effective on an ongoing basis. The hedge relationship must be tested for effectiveness on subsequent reporting dates.

There is no significant difference between the timing of the cash flows and income statement effect of cash flow hedges.

Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the profit and loss, together with any changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. If the hedge no longer meets the criteria for hedge accounting, the adjustment to the carrying amount of a hedged item for which the effective interest method is used is amortised to the profit and loss.

Example 26: Extract of notes to the financial statements – Financial instruments note disclosures

	2015	2014
Financial assets at fair value through profit or loss
Listed investments	2,000	3,000

Financial assets that are equity instruments measured at cost less impairment
Investments (see note 3)	10,000	10,000
Loan commitment carried at cost less impairment	1,000	500

Financial assets that are debt instruments measured at amortised cost
Intercompany loans	100,000	90,000
Loan notes	80,000	75,000
Other debtors including deposits receivable	40,000	41,000
Trade debtors	30,000	15,000
Cash and short term deposits	30,000	15,000

Financial liabilities at fair value through profit and loss
Derivative financial instruments – Forward foreign contracts (see note 2)	3,000	2,000
Derivative financial instruments – Interest rate swap	XXX	XXX

Financial liabilities measured at amortised cost
Trade creditors	20,000	10,000
Intercompany loans	20,000	10,000
Accounts payable	20,000	10,000
Finance leases	20,000	10,000
Bank loans and loan notes	20,000	10,000
Accruals for goods and services	20,000	10,000
Bank overdraft	20,000	10,000

Note 1: The company takes out foreign currency contracts to hedge against the risk of foreign exchange movements. At 31 December 2015, the company had forward contracts to purchase FC100,000 at a rate of CU1:FC.80. These contracts expire within 6 months of the year end. The fair value of these instruments at 31 December 2015 was CU10,000 (2014:CU2,000). This has been recognised in the profit and loss. The forward contracts are measured at fair value by utilising observable market date, more specifically quoted prices.

OR WHERE HEDGING IS APPLIED

Derivatives – forward foreign exchange contracts

Forward foreign exchange contracts are marked to market using quoted forward exchange rates at the reporting date.

The absolute principal amount of the outstanding forward foreign exchange contracts at 31 December 2015 was CUXXXX (2014: CUXXXXXXX).

The hedged highly probable forecast transactions denominated in foreign currency are expected to occur at various dates during the next 12 months. Gains and losses recognised in the hedging reserve in equity (note XX) on forward foreign exchange contracts as of 31 December 2015 are recognised in the profit and loss in the period or periods during which the hedged transaction affects the income statement. This is generally within 12 months of the end of the reporting period.

Derivatives – Interest Rate Swaps

The fair value of interest rate swaps is calculated as the present value of the expected future cash flows based on observable yield curves.

The notional principal amounts of the outstanding interest rate swap contracts at 31 December 2015 were CUxxxxx (2014: CUxxxxxx).

At 31 December 2015, the average fixed interest rate on the swap portfolio was X% (2014: X%). The main floating rates are EURIBOR and LIBOR. Gains and losses recognised in the hedging reserve in equity (note XX) on interest rate swap contracts as of December 2015 will be continually released to the income statement within finance cost until the maturity of the relevant interest rate swap.

Note 2: At the year end the fair value of certain equity investments could not be determined. As a result the carrying value prior to this date has now been deemed to be the cost of the investments.

Example 27: Extract of notes to the financial statements – interest disclosures

Note: Interest receivable and similar income	2015	2014
Bank interest receivable	10,000	5,000
Interest on intra-group loans	2,000	0
Economic benefits provided on inter-group loan (see (i) below)	200,000	0
Interest income on other financial assets	1,000	1,000
Total interest income on financial assets not measured at fair value through profit and loss i.e. on an amortised cost basis	13,000	6,000

Gain on derivative financial instruments	1,000	2,000
Total interest receivable and similar income	12,000	4,000

i) On XX March 2015, the Company provided a CU1,000,000 interest free loan to a fellow subsidiary company.

Section 11 requires that all Financial Assets and Liabilities are initially recognised at their fair value. The Company estimates the fair value of interest free loans issued by calculating the present value of all future cash receipts discounted using the prevailing rates of interest for a similar instrument. Upon initial recognition, the company recognised the loan for CU800,000. The difference between the nominal amount of the loan and the initial fair value is CU200,000. As this is not a financial asset, nor do the Company view this as a cost of an investment in a subsidiary, this amount is recognised as an expense upon initial recognition.

Note: Interest payable and similar expenses	2015	2014
Interest payable on bank loans and overdrafts	10,000	5,000
Preference share dividend	2,000	0
Finance lease interest	1,000	1,000
Interest on inter-group loan (see (ii) below)	10,000	0
Economic benefits transferred on inter-group loan (see (i) below)	200,000	0
Total interest payable on financial assets not measured at fair value through profit and loss i.e. on an amortised cost basis	13,000	6,000

Loss on derivative financial instruments	1,000	2,000
Total interest payable and similar expenses	12,000	4,000

i) On XX March 2015, the Company obtained a CU1,000,000 interest free loan from a fellow sister company. Section 11 requires that all Financial Assets and Liabilities are initially recognised at their fair value. The Company estimates the fair value of interest free loan issued by calculating the present value of all future cash receipts discounted using the prevailing rates of interest for a similar instrument. Upon initial recognition, the Company recognised the loan for CU700,000. The difference between the nominal amount of the loan and the initial fair value is CU300,000. As this is not a financial liability, nor do the Company view this as a capital contribution from a sister company, this amount is recognised as an income upon initial recognition.

ii) In accordance with Section 11 as the Company received loans as detailed above at non market rates, the Company recognised these loans at their estimated fair value at the issuance date as detailed in note X. At the year end the estimated fair value of the loan for CU1,000,000. The additional interest arising in the current year upon the application of a market interest rate is CU100,000.

Example 28: Extract of notes to the financial statements – debtors, creditors, financial asset disclosures incorporating financial instrument requirements

TRADE AND OTHER RECEIVABLES
	2015	2014
	CU	CU
Trade debtors	1,022,788	1,083,813
Other debtors	279,008	57,864
Amounts owed by group companies (see (i) below)	790,000	0
Prepayments Derivative financial instruments	20,795 xxx	12,710 xxx
Directors’ Loans	112,633	104,332
VAT	30,090	13,614
	2,225,224	1,272,333

The fair values of trade and other receivables approximate to their carrying amounts. Trade debtors are stated after provisions for impairments of CU105,000 (2014: CU113,000).

Amounts owed by directors are unsecured, interest free, have no fixed date of repayment and are repayable on demand.

Extract of notes to the financial statements – creditors disclosures incorporating financial instrument requirements TRADE AND OTHER PAYABLES
	2015	2014
	CU	CU
Trade creditors	669,675	475,652
Other creditors and accruals	186,051	178,139
Bank Loans and overdrafts	1,066,950	2,064,128
Amount due to group company (see (i) below)	688,000	0
Finance Lease	31,198	39,933
Derivative financial instruments	3,000	2,000
Corporation tax due	280,351	64,812
Other Taxation and Social Security	25,665	26,245
Deferred Tax	2,856	–
	2,953,746	2,850,909

(i)The company received loans totalling CU1,000,000 at non market rates from a fellow sister company. Section 11 requires that all Financial Assets and Liabilities are initially recognised at their fair value. The Company estimates the fair value of interest free loan issued by calculating the present value of all future cash receipts discounted using the prevailing rates of interest for a similar instrument. Upon initial recognition, the Company recognised the loan for CU700,000. The difference between the nominal amount of the loan and the initial fair value is CU300,000. As this is not a financial liability, nor do the Company view this as a capital contribution from a sister company, this amount is recognised as an income upon initial recognition.

BORROWINGS

	Within 1 year	Between 1 & 2 years	Between 2 & 5 years	After 5 years	Total
	CU	CU	CU	CU	CU
Repayable other than by installments
Bank Overdrafts	0	0	0	0	0
Repayable by installments
Term loan	13,740	–	1,053,210	–	1,066,950

The bank facilities are secured by a debenture incorporating fixed and floating charges over the assets of the company and personal guarantees from the Directors.

The facilities expiring within one year are annual facilities subject to review at various dates during 2015/2016. The rate of interest applied on these loans is 4%.

The loan outstanding within 2 to 5 years is repayable on 30 November 2015 and an interest rate of 5% is applied on this loan.

FINANCIAL ASSETS

	At fair value	At cost less impairment	Total
	CU	CU	CU
Costs
At beginning of year	200,000	100,000	300,000
Additions in year		30,000	30,000
Fair value adjustments	(20,000)	–	(20,000)
Disposals in year	–	(20,000)	(20,000)
At end of year	180,000	110,000	290,000

Amounts provided
At beginning of year	–	–	–
Movement	–	(10,000)	(10,000)
At end of year	–	(10,000)	(10,000)

Carrying amount
At 31 December 2015	180,000	100,000	280,000

The fair value of the listed investments at 31 December 2015 is CU180,000 (2014: CU200,000).

Other investments are not listed and are held at cost less impairment as fair value cannot be reliably measured.

Example 29: Extract from other comprehensive income showing activity on cash flow hedges

Consolidated Statement of Comprehensive Income

Pro Profit for the financial year	1,000,000	500,000
ExcExhange differences on retranslation of foreign operations	XXX	XXX
Ca Cash flow hedges
– – effective portion of changes in fair value to cash flow hedges	9 XXX	XXX
– – fair value of cash flow hedges transferred to income statement	10 XXX	XXX
Act Actuarial loss in respect of the defined pension scheme	11 (XXX)	(XXX)
Gai Gain/(loss) on revaluation of intangible assets	12 XXX	(XXX)
Gai Gain/(loss) on revaluation of property, plant and equipment	13 XXX	(XXX)
Gai Gain/(loss) on revaluation of subsidiaries, associates, etc.	14 XXX	(XXX)
Def Deferred tax on components of other comprehensive income	15 XXX	XXX

Total other comprehensive income for the year net of tax	200,000	(100,000)

To Total comprehensive income for the year	1,200,000	400,000

Total comprehensive income for the financial year attributable to: NNon-controlling interests	XXXX	XXXX

OOwners of the parent company	XXX	XXX
	1,200,000	400,000

Example 30: Extract from the Changes in Equity showing the movement on the cash flow hedge reserve in line with Section 12 disclosure requirements

	Equity Share Capital	Revaluation Reserve	Other Reserve	Retained Earnings	Cash flow hedge Reserve	Total attributable To the Parent	Non-controlling Interest	Total

								Equity
	CU	CU	CU	CU	CU	CU	CU	CU

Balance at 1 January 2014	100,000	225,000	115,375	115,375	1,000	331,375	100,000	441,375

Changes in ownership interests in subsidiaries which do not result in a loss of control							(100,000)	–
Profit for the year		10,000		83,818		91,818	2,000	93,818

Balance at 31 December 2014	100,000	225,000	0	209,193	1,000		2,000	535,193

Balance at 1 January 2015	100,000	225,000	0	209,193	1,000	0	0	535,193

Equity Shares issued net of issue costs	20,000							30,000
Profit for the year				1,005,772		1,005,772	10,000	1,005,772
Equity dividends paid (see note XX)				(9,900)		(9,900)	(100)	(10,000)
Capitalisation of shares			1,000	(1,000)	–			–
Other Comprehensive Income			(15,000)		(15,000)	(15,000)		(15,000)

Balance at 31 December 2015	109,000	225,000	(14,000)	1,214,965	(15,000)	XXXX	10,100	1,554,965

Cash flow hedge reserve

The hedging reserve comprises the effective portion of the cumulative net change in the fair value of cash flow hedging instruments related to hedged transactions that have not yet occurred since XXXXX.

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