E.4.6 Impairment: excess losses
Does IAS 39 permit an entity to recognise impairment or bad debt losses in excess of impairment losses that are determined on the basis of objective evidence about impairment in identified individual financial assets or identified groups of similar financial assets?
No. IAS 39 does not permit an entity to recognise impairment or bad debt losses in addition to those that can be attributed to individually identified financial assets or identified groups of financial assets with similar credit risk characteristics (IAS 39.64) on the basis of objective evidence about the existence of impairment in those assets (IAS 39.58). Amounts that an entity might want to set aside for additional possible impairment in financial assets, such as reserves that cannot be supported by objective evidence about impairment, are not recognised as impairment or bad debt losses under IAS 39. However, if an entity determines that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, it includes the asset in a group of financial assets with similar credit risk characteristics (IAS 39.64).
E.4.7 Recognition of impairment on a portfolio basis
IAS 39.63 requires that impairment be recognised for financial assets carried at amortised cost. IAS 39.64 states that impairment may be measured and recognised individually or on a portfolio basis for a group of similar financial assets. If one asset in the group is impaired but the fair value of another asset in the group is above its amortised cost, does IAS 39 allow non-recognition of the impairment of the first asset?
No. If an entity knows that an individual financial asset carried at amortised cost is impaired, IAS 39.63 requires that the impairment of that asset should be recognised. It states: ‘the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective interest rate’ (emphasis added). Measurement of impairment on a portfolio basis under IAS 39.64 may be applied to groups of small balance items and to financial assets that are individually assessed and found not to be impaired when there is indication of impairment in a group of similar assets and impairment cannot be identified with an individual asset in that group.
E.4.8 Impairment: recognition of collateral
If an impaired financial asset is secured by collateral that does not meet the recognition criteria for assets in other Standards, is the collateral recognised as an asset separate from the impaired financial asset?
No. The measurement of the impaired financial asset reflects the fair value of the collateral. The collateral is not recognised as an asset separate from the impaired financial asset unless it meets the recognition criteria for an asset in another Standard.
E.4.9 Impairment of non-monetary available-for-sale financial asset
If a non-monetary financial asset, such as an equity instrument, measured at fair value with gains and losses recognised in equity becomes impaired, should the cumulative net loss recognised in equity, including any portion attributable to foreign currency changes, be recognised in profit or loss?
Yes. IAS 39.67 states that when a decline in the fair value of an available-for-sale financial asset has been recognised directly in equity and there is objective evidence that the asset is impaired, the cumulative net loss that had been recognised directly in equity should be removed from equity and recognised in profit or loss even though the asset has not been derecognised. Any portion of the cumulative net loss that is attributable to foreign currency changes on that asset that had been recognised in equity is also recognised in profit or loss. Any subsequent losses, including any portion attributable to foreign currency changes, are also recognised in profit or loss until the asset is derecognised.
E.4.10 Impairment: whether the available-for-sale reserve in equity can be negative
IAS 39.67 requires that gains and losses arising from changes in fair value on available-for-sale financial assets are recognised directly in equity. If the aggregate fair value of such assets is less than their carrying amount, should the aggregate net loss that has been recognised directly in equity be removed from equity and recognised in profit or loss?
Not necessarily. The relevant criterion is not whether the aggregate fair value is less than the carrying amount, but whether there is objective evidence that a financial asset or group of assets is impaired. An entity assesses at each balance sheet date whether there is any objective evidence that a financial asset or group of assets may be impaired, in accordance with IAS 39.59-61. IAS 39.60 states that a downgrade of an entity’s credit rating is not, of itself, evidence of impairment, although it may be evidence of impairment when considered with other available information. Additionally, a decline in the fair value of a financial asset below its cost or amortised cost is not necessarily evidence of impairment (for example, a decline in the fair value of an investment in a debt instrument that results from an increase in the basic, risk-free interest rate).
Section F Hedging
F.1 Hedging instruments
F.1.1 Hedging the fair value exposure of a bond denominated in a foreign currency
Entity J, whose functional currency is the Japanese yen, has issued 5 million five-year US dollar fixed rate debt. Also, it owns a 5 million five-year fixed rate US dollar bond which it has classified as available for sale. Can Entity J designate its US dollar liability as a hedging instrument in a fair value hedge of the entire fair value exposure of its US dollar bond?
No. IAS 39.72 permits a non-derivative to be used as a hedging instrument only for a hedge of a foreign currency risk. Entity J’s bond has a fair value exposure to foreign currency and interest rate changes and credit risk.
Alternatively, can the US dollar liability be designated as a fair value hedge or cash flow hedge of the foreign currency component of the bond?
Yes. However, hedge accounting is unnecessary because the amortised cost of the hedging instrument and the hedged item are both remeasured using closing rates. Regardless of whether Entity J designates the relationship as a cash flow hedge or a fair value hedge, the effect on profit or loss is the same. Any gain or loss on the non-derivative hedging instrument designated as a cash flow hedge is immediately recognised in profit or loss to correspond with the recognition of the change in spot rate on the hedged item in profit or loss as required by IAS 21.
F.1.2 Hedging with a non-derivative financial asset or liability
Entity J’s functional currency is the Japanese yen. It has issued a fixed rate debt instrument with semi-annual interest payments that matures in two years with principal due at maturity of 5 million US dollars. It has also entered into a fixed price sales commitment for 5 million US dollars that matures in two years and is not accounted for as a derivative because it meets the exemption for normal sales in paragraph 5. Can Entity J designate its US dollar liability as a fair value hedge of the entire fair value exposure of its fixed price sales commitment and qualify for hedge accounting?
No. IAS 39.72 permits a non-derivative asset or liability to be used as a hedging instrument only for a hedge of a foreign currency risk.
Alternatively, can Entity J designate its US dollar liability as a cash flow hedge of the foreign currency exposure associated with the future receipt of US dollars on the fixed price sales commitment?
Yes. IAS 39 permits the designation of a non-derivative asset or liability as a hedging instrument in either a cash flow hedge or a fair value hedge of the exposure to changes in foreign exchange rates of a firm commitment (IAS 39.87). Any gain or loss on the non-derivative hedging instrument that is recognised in equity during the period preceding the future sale is recognised in profit or loss when the sale takes place (IAS 39.95).
Alternatively, can Entity J designate the sales commitment as the hedging instrument instead of the hedged item?
No. Only a derivative instrument or a non-derivative financial asset or liability can be designated as a hedging instrument in a hedge of a foreign currency risk. A firm commitment cannot be designated as a hedging instrument. However, if the foreign currency component of the sales commitment is required to be separated as an embedded derivative under IAS 39.11 and IAS 39.AG33(d), it could be designated as a hedging instrument in a hedge of the exposure to changes in the fair value of the maturity amount of the debt attributable to foreign currency risk.
F.1.3 Hedge accounting: use of written options in combined hedging instruments
Issue (a) - Does IAS 39.AG94 preclude the use of an interest rate collar or other derivative instrument that combines a written option component and a purchased option component as a hedging instrument?
It depends. An interest rate collar or other derivative instrument that includes a written option cannot be designated as a hedging instrument if it is a net written option, because IAS 39.AG94 precludes the use of a written option as a hedging instrument unless it is designated as an offset to a purchased option. An interest rate collar or other derivative instrument that includes a written option may be designated as a hedging instrument, however, if the combination is a net purchased option or zero cost collar.
Issue (b) - What factors indicate that an interest rate collar or other derivative instrument that combines a written option component and a purchased option component is not a net written option?
The following factors taken together suggest that an interest rate collar or other derivative instrument that includes a written option is not a net written option.
(a) No net premium is received either at inception or over the life of the combination of options. The distinguishing feature of a written option is the receipt of a premium to compensate the writer for the risk incurred.
(b) Except for the strike prices, the critical terms and conditions of the written option component and the purchased option component are the same (including underlying variable or variables, currency denomination and maturity date). Also, the notional amount of the written option component is not greater than the notional amount of the purchased option component.
F.1.4 Internal hedges
Some entities use internal derivative contracts (internal hedges) to transfer risk exposures between different companies within a group or divisions within a single legal entity. Does IAS 39.73 prohibit hedge accounting in such cases?
Yes, if the derivative contracts are internal to the entity being reported on. IAS 39 does not specify how an entity should manage its risk. However, it states that internal hedging transactions do not qualify for hedge accounting. This applies both (a) in consolidated financial statements for intragroup hedging transactions, and (b) in the individual or separate financial statements of a legal entity for hedging transactions between divisions in the entity. The principles of preparing consolidated financial statements in IAS 27.24 require that ‘intragroup balances, transactions, income and expenses shall be eliminated in full’.
On the other hand, an intragroup hedging transaction may be designated as a hedge in the individual or separate financial statements of a group entity, if the intragroup transaction is an external transaction from the perspective of the group entity. In addition, if the internal contract is offset with an external party the external contract may be regarded as the hedging instrument and the hedging relationship may qualify for hedge accounting.
The following summarises the application of IAS 39 to internal hedging transactions.
• IAS 39 does not preclude an entity from using internal derivative contracts for risk management purposes and it does not preclude internal derivatives from being accumulated at the treasury level or some other central location so that risk can be managed on an entity-wide basis or at some higher level than the separate legal entity or division.
• Internal derivative contracts between two separate entities within a consolidated group can qualify for hedge accounting by those entities in their individual or separate financial statements, even though the internal contracts are not offset by derivative contracts with a party external to the consolidated group.
• Internal derivative contracts between two separate divisions within the same legal entity can qualify for hedge accounting in the individual or separate financial statements of that legal entity only if those contracts are offset by derivative contracts with a party external to the legal entity.
• Internal derivative contracts between separate divisions within the same legal entity and between separate entities within the consolidated group can qualify for hedge accounting in the consolidated financial statements only if the internal contracts are offset by derivative contracts with a party external to the consolidated group.
• If the internal derivative contracts are not offset by derivative contracts with external parties, the use of hedge accounting by group entities and divisions using internal contracts must be reversed on consolidation.
To illustrate: the banking division of Entity A enters into an internal interest rate swap with the trading division of the same entity. The purpose is to hedge the interest rate risk exposure of a loan (or group of similar loans) in the loan portfolio. Under the swap, the banking division pays fixed interest payments to the trading division and receives variable interest rate payments in return.
If a hedging instrument is not acquired from an external party, IAS 39 does not allow hedge accounting treatment for the hedging transaction undertaken by the banking and trading divisions. IAS 39.73 indicates that only derivatives that involve a party external to the entity can be designated as hedging instruments and, further, that any gains or losses on intragroup or intra-entity transactions should be eliminated on consolidation. Therefore, transactions between different divisions within Entity A do not qualify for hedge accounting treatment in the financial statements of Entity A. Similarly, transactions between different entities within a group do not qualify for hedge accounting treatment in consolidated financial statements.
However, if in addition to the internal swap in the above example the trading division enters into an interest rate swap or other contract with an external party that offsets the exposure hedged in the internal swap, hedge accounting is permitted under IAS 39. For the purposes of IAS 39, the hedged item is the loan (or group of similar loans) in the banking division and the hedging instrument is the external interest rate swap or other contract.
The trading division may aggregate several internal swaps or portions of them that are not offsetting each other and enter into a single third party derivative contract that offsets the aggregate exposure. Under IAS 39, such external hedging transactions may qualify for hedge accounting treatment provided that the hedged items in the banking division are identified and the other conditions for hedge accounting are met. It should be noted, however, that IAS 39.79 does not permit hedge accounting treatment for held-to-maturity investments if the hedged risk is the exposure to interest rate changes.
F.1.5 Offsetting internal derivative contracts used to manage interest rate risk
If a central treasury function enters into internal derivative contracts with subsidiaries and various divisions within the consolidated group to manage interest rate risk on a centralised basis, can those contracts qualify for hedge accounting in the consolidated financial statements if, before laying off the risk, the internal contracts are first netted against each other and only the net exposure is offset in the marketplace with external derivative contracts?
No. An internal contract designated at the subsidiary level or by a division as a hedge results in the recognition of changes in the fair value of the item being hedged in profit or loss (a fair value hedge) or in the recognition of the changes in the fair value of the internal derivative in equity (a cash flow hedge). There is no basis for changing the measurement attribute of the item being hedged in a fair value hedge unless the exposure is offset with an external derivative. There is also no basis for including the gain or loss on the internal derivative in equity for one entity and recognising it in profit or loss by the other entity unless it is offset with an external derivative. In cases where two or more internal derivatives are used to manage interest rate risk on assets or liabilities at the subsidiary or division level and those internal derivatives are offset at the treasury level, the effect of designating the internal derivatives as hedging instruments is that the hedged non-derivative exposures at the subsidiary or division levels would be used to offset each other on consolidation. Accordingly, since IAS 39.72 does not permit designating non-derivatives as hedging instruments, except for foreign currency exposures, the results of hedge accounting from the use of internal derivatives at the subsidiary or division level that are not laid off with external parties must be reversed on consolidation.
It should be noted, however, that there will be no effect on profit or loss and equity of reversing the effect of hedge accounting in consolidation for internal derivatives that offset each other at the consolidation level if they are used in the same type of hedging relationship at the subsidiary or division level and, in the case of cash flow hedges, where the hedged items affect profit or loss in the same period. Just as the internal derivatives offset at the treasury level, their use as fair value hedges by two separate entities or divisions within the consolidated group will also result in the offset of the fair value amounts recognised in profit or loss, and their use as cash flow hedges by two separate entities or divisions within the consolidated group will also result in the fair value amounts being offset against each other in equity. However, there may be an effect on individual line items in both the consolidated income statement and the consolidated balance sheet, for example when internal derivatives that hedge assets (or liabilities) in a fair value hedge are offset by internal derivatives that are used as a fair value hedge of other assets (or liabilities) that are recognised in a different balance sheet or income statement line item. In addition, to the extent that one of the internal contracts is used as a cash flow hedge and the other is used in a fair value hedge, the effect on profit or loss and equity would not offset since the gain (or loss) on the internal derivative used as a fair value hedge would be recognised in profit or loss and the corresponding loss (or gain) on the internal derivative used as a cash flow hedge would be recognised in equity.
Question F.1.4 describes the application of IAS 39 to internal hedging transactions.
F.1.6 Offsetting internal derivative contracts used to manage foreign currency risk
If a central treasury function enters into internal derivative contracts with subsidiaries and various divisions within the consolidated group to manage foreign currency risk on a centralised basis, can those contracts be used as a basis for identifying external transactions that qualify for hedge accounting in the consolidated financial statements if, before laying off the risk, the internal contracts are first netted against each other and only the net exposure is offset by entering into a derivative contract with an external party?
It depends. IAS 27 Consolidated and Separate Financial Statements requires all internal transactions to be eliminated in consolidated financial statements. As stated in IAS 39.73, internal hedging transactions do not qualify for hedge accounting in the consolidated financial statements of the group. Therefore, if an entity wishes to achieve hedge accounting in the consolidated financial statements, it must designate a hedging relationship between a qualifying external hedging instrument and a qualifying hedged item.
As discussed in Question F.1.5, the accounting effect of two or more internal derivatives that are used to manage interest rate risk at the subsidiary or division level and are offset at the treasury level is that the hedged non-derivative exposures at those levels would be used to offset each other on consolidation. There is no effect on profit or loss or equity if (a) the internal derivatives are used in the same type of hedge relationship (ie fair value or cash flow hedges) and (b), in the case of cash flow hedges, any derivative gains and losses that are initially recognised in equity are recognised in profit or loss in the same period(s). When these two conditions are met, the gains and losses on the internal derivatives that are recognised in profit or loss or in equity will offset on consolidation resulting in the same profit or loss and equity as if the derivatives had been eliminated. However, there may be an effect on individual line items, in both the consolidated income statement and the consolidated balance sheet, that would need to be eliminated. In addition, there is an effect on profit or loss and equity if some of the offsetting internal derivatives are used in cash flow hedges, while others are used in fair value hedges. There is also an effect on profit or loss and equity for offsetting internal derivatives that are used in cash flow hedges if the derivative gains and losses that are initially recognised in equity are recognised in profit or loss in different periods (because the hedged items affect profit or loss in different periods).
As regards foreign currency risk, provided that the internal derivatives represent the transfer of foreign currency risk on underlying non-derivative financial assets or liabilities, hedge accounting can be applied because IAS 39.72 permits a non-derivative financial asset or liability to be designated as a hedging instrument for hedge accounting purposes for a hedge of a foreign currency risk. Accordingly, in this case the internal derivative contracts can be used as a basis for identifying external transactions that qualify for hedge accounting in the consolidated financial statements even if they are offset against each other. However, for consolidated financial statements, it is necessary to designate the hedging relationship so that it involves only external transactions.
Furthermore, the entity cannot apply hedge accounting to the extent that two or more offsetting internal derivatives represent the transfer of foreign currency risk on underlying forecast transactions or unrecognised firm commitments. This is because an unrecognised firm commitment or forecast transaction does not qualify as a hedging instrument under IAS 39. Accordingly, in this case the internal derivatives cannot be used as a basis for identifying external transactions that qualify for hedge accounting in the consolidated financial statements. As a result, any cumulative net gain or loss on an internal derivative that has been included in the initial carrying amount of an asset or liability (basis adjustment) or deferred in equity would have to be reversed on consolidation if it cannot be demonstrated that the offsetting internal derivative represented the transfer of a foreign currency risk on a financial asset or liability to an external hedging instrument.
F.1.7 Internal derivatives: examples of applying Question F.1.6
In each case, FC = foreign currency, LC = local currency (which is the entity’s functional currency), and TC = treasury centre.
Case 1 Offset of fair value hedges
Subsidiary A has trade receivables of FC100, due in 60 days, which it hedges using a forward contract with TC. Subsidiary B has payables of FC50, also due in 60 days, which it hedges using a forward contact with TC.
TC nets the two internal derivatives and enters into a net external forward contract to pay FC50 and receive LC in 60 days.
At the end of month 1, FC weakens against LC. A incurs a foreign exchange loss of LC10 on its receivables, offset by a gain of LC10 on its forward contract with TC. B makes a foreign exchange gain of LC5 on its payables offset by a loss of LC5 on its forward contract with TC. T C m ake s a loss of LC1 0 on its internal for ward contrac t w ith A, a gain of LC5 on its int erna l forward contract with B, and a gain of LC5 on its external forward contract.
At the end of month 1, the following entries are made in the individual or separate financial statements of A, B and TC. Entries reflecting intragroup transactions or events are shown in italics.
| A’s entries | | |
| Dr Foreign exchange loss | LC10 | |
| Cr Receivables | | LC10 |
| Dr Internal contract TC | LC10 | |
| Cr Internal gain TC | | LC10 |
| B’s entries | | |
| Dr Payables | LC5 | |
| Cr Foreign exchange gain | | LC5 |
| Dr Internal loss TC | LC5 | |
| Cr Internal contract TC | | LC5 |
| TC’s entries | | |
| Dr Internal loss A | LC10 | |
| Cr Internal contract A | | LC10 |
| Dr Internal contract B | LC5 | |
| Cr Internal gain B | | LC5 |
| Dr External forward contract | LC5 | |
| Cr Foreign exchange gain | | LC5 |
Both A and B could apply hedge accounting in their individual financial statements provided all conditions in IAS 39 are met. However, in this case, no hedge accounting is required because gains and losses on the internal derivatives and the offsetting losses and gains on the hedged receivables and payables are recognised immediately in the income statements of A and B without hedge accounting.
In the consolidated financial statements, the internal derivative transactions are eliminated. In economic terms, the payable in B hedges FC50 of the receivables in A. The external forward contract in TC hedges the remaining FC50 of the receivable in A. Hedge accounting is not necessary in the consolidated financial statements because monetary items are measured at spot foreign exchange rates under IAS 21 irrespective of whether hedge accounting is applied.
The net balances before and after elimination of the accounting entries relating to the internal derivatives are the same, as set out below. Accordingly, there is no need to make any further accounting entries to meet the requirements of IAS 39.
| | Debit | C redit |
| Receivables | - | LC10 |
| Payables | LC5 | - |
| External forward contract | LC5 | - |
| Gains and losses | - | - |
| Internal contracts | - | - |
Case 2 Offset of cash flow hedges
To extend the example, A also has highly probable future revenues of FC200 on which it expects to receive cash in 90 days. B has highly probable future expenses of FC500 (advertising cost), also to be paid for in 90 days. A and B enter into separate forward contracts with TC to hedge these exposures and TC enters into an external forward contract to receive FC300 in 90 days.
As before, FC weakens at the end of month 1. A incurs a ‘loss’ of LC20 on its anticipated revenues because the LC value of these revenues decreases. This is offset by a ‘gain’ of LC20 on its forward contract with TC.
B incurs a ‘gain’ of LC50 on its anticipated advertising cost because the LC value of the expense decreases. This is offset by a ‘loss’ of LC50 on its transaction with TC.
TC incurs a ‘gain’ of LC50 on its internal transaction with B, a ‘loss’ of LC20 on its internal transaction with A and a loss of LC30 on its external forward contract.
A and B complete the necessary documentation, the hedges are effective, and both A and B qualify for hedge accounting in their individual financial statements. A defers the gain of LC20 on its internal derivative transaction in a hedging reserve in equity and B defers the loss of LC50 in its hedging reserve in equity. TC does not claim hedge accounting, but measures both its internal and external derivative positions at fair value, which net to zero.
At the end of month 1, the following entries are made in the individual or separate financial statements of A, B and TC. Entries reflecting intragroup transactions or events are shown in italics.
| A’s entries | | |
| Dr Internal contract TC | LC20 | |
| Cr Equity | | LC20 |
| B’s entries | | |
| Dr Equity | LC50 | |
| Cr Internal contract TC | | LC50 |
| TC’s entries | | |
| Dr Internal loss A | LC20 | |
| Cr Internal contract A | | LC20 |
| Dr Internal contract B | LC50 | |
| Cr Internal gain B | | LC50 |
| Dr Foreign exchange loss | LC30 | |
| Cr External forward contract | | LC30 |
For the consolidated financial statements, TC’s external forward contract on FC300 is designated, at the beginning of month 1, as a hedging instrument of the first FC300 of B’s highly probable future expenses. IAS 39 requires that in the consolidated financial statements at the end of month 1, the accounting effects of the internal derivative transactions must be eliminated.
However, the net balances before and after elimination of the accounting entries relating to the internal derivatives are the same, as set out below. Accordingly, there is no need to make any further accounting entries in order for the requirements of IAS 39 to be met.
| | Debit | C redit |
| External forward contract | - | LC30 |
| Equity | LC30 | - |
| Gains and losses | - | - |
| Internal contracts | - | - |
Case 3 Offset of fair value and cash flow hedges
Assume that the exposures and the internal derivative transactions are the same as in cases 1 and 2. However, instead of entering into two external derivatives to hedge separately the fair value and cash flow exposures, TC enters into a single net external derivative to receive FC250 in exchange for LC in 90 days.
TC has four internal derivatives, two maturing in 60 days and two maturing in 90 days. These are offset by a net external derivative maturing in 90 days. The interest rate differential between FC and LC is minimal, and therefore the ineffectiveness resulting from the mismatch in maturities is expected to have a minimal effect on profit or loss in TC.
As in cases 1 and 2, A and B apply hedge accounting for their cash flow hedges and TC measures its derivatives at fair value. A defers a gain of LC20 on its internal derivative transaction in equity and B defers a loss of LC50 on its internal derivative transaction in equity.
At the end of month 1, the following entries are made in the individual or separate financial statements of A, B and TC. Entries reflecting intragroup transactions or events are shown in italics.
| A’s entries | | |
| Dr Foreign exchange loss | LC10 | |
| Cr Receivables | | LC10 |
| Dr Internal contract TC | LC10 | |
| Cr Internal gain TC | | LC10 |
| Dr Internal contract TC | LC20 | |
| Cr Equity | | LC20 |
| B’s entries | | |
| Dr Payables | LC5 | |
| Cr Foreign exchange gain | | LC5 |
| Dr Internal loss TC | LC5 | |
| Cr Internal contract TC | | LC5 |
| Dr Equity | LC50 | |
| Cr Internal contract TC | | LC50 |
| TC’s entries | | |
| Dr Internal loss A | LC10 | |
| Cr Internal contract A | | LC10 |
| Dr Internal loss A | LC20 | |
| Cr Internal contract A | | LC20 |
| Dr Internal contract B | LC5 | |
| Cr Internal gain B | | LC5 |
| Dr Internal contract B | LC50 | |
| Cr Internal gain B | | LC50 |
| Dr Foreign exchange loss | LC25 | |
| Cr External forward contract | | LC25 |
| TOTAL (for the internal derivatives) | A | B | Total |
| | LC | LC | TC |
| Income (fair value hedges) | 10 | (5) | 5 |
| Equity (cash flow hedges) | 20 | (50) | (30) |
| Total | 30 | (55) | (25) |
Combining these amounts with the external transactions (ie those not marked in italics above) produces the total net balances before elimination of the internal derivatives as follows:
| | Debit | Credit |
| Receivables | - | LC10 |
| Payables | LC5 | - |
| Forward contract | - | LC25 |
| Equity | LC30 | - |
| Gains and losses | - | - |
| Internal contracts | - | - |
For the consolidated financial statements, the following designations are made at the beginning of month 1:
• the payable of FC50 in B is designated as a hedge of the first FC50 of the highly probable future revenues in A. Therefore, at the end of month 1, the following entries are made in the consolidated financial statements: Dr Payable LC5; Cr Equity LC5;
• the receivable of FC100 in A is designated as a hedge of the first FC100 of the highly probable future expenses in B. Therefore, at the end of month 1, the following entries are made in the consolidated financial statements: Dr Equity LC10, Cr Receivable LC10; and
• the external forward contract on FC250 in TC is designated as a hedge of the next FC250 of highly probable future expenses in B. Therefore, at the end of month 1, the following entries are made in the consolidated financial statements: Dr Equity LC25; Cr External forward contract LC25.
In the consolidated financial statements at the end of month 1, IAS 39 requires the accounting effects of the internal derivative transactions to be eliminated.
However, the total net balances before and after elimination of the accounting entries relating to the internal derivatives are the same, as set out below. Accordingly, there is no need to make any further accounting entries to meet the requirements of IAS 39.
