Fair Value Hedge Research Articles

Хеджування справедливої вартості із використанням свопів: облік за МСФЗ

The paper reveals the accounting treatment for hedging against the interest rate risk and the foreign exchange rate risk arising from operations with financial instruments of banks using interest and currency swaps. The economic essence of hedging transactions, the concept and mechanism for the implementation of swap agreements are considered. The article analyses the requirements of IFRS 9 on fair value hedge accounting including qualifying criteria for hedge accounting, hedge effectiveness and ineffectiveness determination, accounting requirements for fair value hedges. The author provides the calculation of the fair value of the floating-for-fixed interest rate swap. The fair value of swaps is measured in terms of bond prices: the fair value is calculated as the difference between the present value of fixed rate bonds of all future periods and the present value of floating-rate bonds for a current period. The results received explain how the change in the fair value of a hedged item is compensated with the reverse change in the fair value of a hedging instrument. The paper covers the accounting practice for fair value hedges of the fixed rate financial liability measured at fair value through profit or loss, with interest rate swap as a hedging instrument. The author introduces the accounting treatment for the fair value hedge of the fixed rate financial liability denominated in foreign currency with the use of currency swap as a hedging instrument. For both hedging procedures any gains or losses on a hedging instrument as well as on a hedged item are recognized in profit or loss. The suggested accounting procedures completely respond to the requirements of IFRS and can be applied by Ukrainian banks.

The Effect of Applying Hedge Accounting in Reducing Future Financial Risks in Jordanian Commercial Banks

The Effect of Applying Hedge Accounting in Reducing Future Financial Risks in Jordanian Commercial Banks
 
 The study aimed to identify the effect of applying hedge accounting on reducing the future financial risks of the Jordanian commercial banks by using financial ratios to find a practical method of calculating the hedge with its three categories and to address the future financial risks of commercial banks in Jordan.
 
 The researchers used both the descriptive and analytical methods based on the financial statements and reports of the Jordanian commercial banks for the period (2012-2017), in addition of using financial indicators. The study community included the published financial statements of the Jordanian commercial banks before applying hedge accounting and after in accordance with the amendments to IFRS Standard No. 9, as well as the banks listed in the Amman Exchange Market for the period of study. The sample of the study included all Jordanian commercial banks that disclosed the application of hedge accounting in their annual financial statements.
 
 The study concluded that there is a strong correlation between cash flow hedges and reducing the financial risks of Jordanian commercial banks after the application of hedge accounting for the period (2012-2017), and that there is a strong correlation between fair value hedges and reducing the financial risks.
 
 The fair value hedges have an explanatory capacity to reduce the financial risk by 27.4%. This has been derived from the R2 value. There is a weak correlation between the net investments in foreign currencies and the financial risks. The study recommended the importance of maintaining the use of hedge accounting to achieve fairness and honest representation in the final financial statements to the benefit of internal and external users.

Hedging and Hedge Accounting in a Multiperiod World: A Cash Flow-Centered View

Although there are many aspects to be considered for a full understanding of hedge accounting as an exceptional rule to fair value accounting, we focus on: what rationale exists behind the dichotomy of fair value and cash flow hedges; and whether it is justifiable on a solid theoretical foundation of accounting measurement.Furthermore, in order to fully understand the theoretical as well as practical significance of hedge accounting, we should broaden our perspective beyond the scope of a usual measurement-oriented argument in the accounting literature. To be more concrete, we will argue that reexamining the meaning of being risk-free from a viewpoint of multiperiod dynamic optimization is absolutely necessary, albeit not sufficient, to comprehend the essence of hedging.

Accounting for Derivative Instruments and Hedging Activities

The goal of this research was to investigate the reasons behind the plethora of amendments of the FASB Accounting Pronouncements for Financial Instruments from 2002 to 2008. Entities have communicated their apprehensions that the existent disclosure requirements in SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, do not furnish sufficient input about how derivative and hedging activities influence an entity’s financial position, financial performance, and cash flows. Correspondently, in 2008 the FASB issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133”. The purpose of the study was to investigate the extent to which the thirty companies that comprise the Dow Jones Industrial Average complied with the new qualitative and quantitative disclosure requirements for derivative financial instruments of SFAS No. 161. Following the theoretical framework of corporate risk management, the quarterly financial statements (10Qs) of the thirty companies that comprise the Dow Jones Industrial Average were examined to determine whether companies complied with the qualitative requirements of SFAS No.161 to disclose their objectives for holding or issuing derivative financial instruments and their risk management policy as well as a description of the items being hedged. A surprising finding was that most companies failed with the requirements of SFAS No. 161 to disclose the required information about cash flow hedges, net investments in foreign operations and, fair value hedges. These findings suggest that although the FASB issued SFAS No. 161 to enhance derivative disclosures to enable users of financial statements to evaluate the success and significance of derivative instruments and hedging transactions on an entity’s financial statements, companies might need additional time to implement the standard.

Information content and the contractual nature of hedging derivative incomes

In a sample of 87 banks representing 631 bank-years for the period 1996–2003, we examine whether information content of hedging derivative incomes is predicated on the contractual nature of the derivative. Of particular interest are the different abnormal trading volume reactions to incomes arising from executory contracts (i.e., cash flow and net investment hedges) and incomes arising from nonexecutory contracts (i.e., fair value hedges). We find a positive and significant relationship between two alternative measures of abnormal trading volume and incomes arising from cash flow and net investment hedges. The results are robust in an equity valuation framework. Our findings suggest that derivative incomes are informative, notably those incomes that are related to executory contracts. An implication for standard setters is that the complex rules for disaggregating incomes on hedging derivatives provide valuable information to the market.

Reducing reporting risk: Designating foreign currency forward contracts as cash flow hedges

Abstract We present an example that compares the effects on earnings of designating a foreign currency forward contract as either a cash-flow or fair-value hedge of a foreign currency denominated receivable. Entities engaging in exchange transactions not denominated in their functional currency frequently enter into foreign currency forward contracts in order to mitigate their foreign exchange rate risk exposure. The aggregate effect on earnings of the transaction gain or loss on the foreign currency receivable and the gain or loss on the forward contract is known on the date the forward contract is initiated. The effect on each period’s earnings during the term of a forward contract designated as a cash-flow hedge is also known on the date the contract is initiated; whereas the effect on each periods’ earnings from a fair-value hedge cannot be determined until the respective balance sheet dates. Therefore, designating forward contracts as cash-flow hedges may suppress volatility in reported earnings compared to designating forward contracts as fair-value hedges. In addition, the reporting risk (the amount of uncertainty surrounding the pending measure of an item to be reported in the financial statements) is lower when a forward contract is designated as a cash-flow hedge relative to designating it as a fair-value hedge. This suggests foreign currency forward contracts designated as cash-flow hedges are more consistent with the purpose of hedge accounting: to mitigate the effects on earnings of applying different measurement criteria for the hedge and the hedged item.

Financial Statement Outcomes When Alternative Derivative Hedging Designations Exist

<p class="MsoBlockText" style="margin: 0in 0.5in 0pt;"><span style="font-style: normal;"><span style="font-size: x-small;"><span style="font-family: Times New Roman;">When alternate reporting methods exist, financial statement preparers tend to select methods that provide more favorable results.<span style="mso-spacerun: yes;">  </span>Certain hedging transactions may be designated as either a fair value hedge or a cash flow hedge.<span style="mso-spacerun: yes;">  </span>Both designations achieve the objective of matching the gain <loss> on the derivative with the loss <gain> on the hedged item in the same reporting period.<span style="mso-spacerun: yes;">  </span>However, the cash flow hedge accounting tends to create a greater appearance of equity volatility.<span style="mso-spacerun: yes;">  </span></span></span></span></p>

Accounting for Derivatives and Hedging Activities: Comparison of Cash Flow versus Fair Value Hedge Accounting

Warfield Company is considering hedging the risk associated with (1) an available-for-sale (AFS) security portfolio and (2) an anticipated purchase of oil. Warfield's Board of Directors has limited experience in this area and has requested that you summarize the accounting and reporting implications if these items are hedged. The hedged risk in these two transactions can be either the risk associated with the cash flow or the risk associated with changes in the fair value. The two risks are discussed in separate parts of the case.

Accounting for Derivatives and Hedging Activities: Comparison of Cash Flow versus Fair Value Hedge Accounting

Accounting for Derivatives and Hedging Activities: Comparison of Cash Flow versus Fair Value Hedge Accounting

DOES ALLOWING ALTERNATIVE HEDGE DESIGNATIONS AFFECT FINANCIAL STATEMENT COMPARABILITY?

The comparability of hedge accounting disclosures between companies increases the informational value of financial statements. In order to eliminate inconsistency in the reporting of hedging activities, the FASB issued SFAS No. 133, which was intended to provide comprehensive guidance for all derivatives reporting and disclosure. The fact that SFAS No. 133 allows some hedging transactions to be designated as either a fair value hedge or a cash flow hedge might suggest a lack of comparability for similar transactions. This paper identified several of these transactions and provides the comparative accounting. Even though fair value and cash flow hedges are accounted for differently, there was little difference in their net effect on reported earnings while other comprehensive income did fluctuate somewhat for cash flow hedges.

FAS 133 Option Fair Value Hedges: Financial Engineering and Financial Accounting Perspectives

FAS 133 Option Fair Value Hedges: Financial Engineering and Financial Accounting Perspectives

Accounting and Reporting for Derivatives and Hedging Transactions

Corporate use of derivatives (and occasional misuses) created quite a stir in the 1990s, prompting the Financial Accounting Standards Board (FASB) to issue Statement of Financial Accounting Standard (SFAS) No. 133. What differentiates SFAS No. 133 from previous FASB guidelines is its definition of a derivative and an embedded derivative and its treatment of fair value hedges, cash flow hedges, and exchange rate or investment in foreign operations hedges.

Comparative analysis of accounting treatments for derivatives

This paper provides educators with a classroom example or a self-study tutorial to teach Statement of Financial Accounting Standards No. 133 (FAS 133), Accounting for Derivative Instruments and Hedging Activities . The example can be used in courses such as intermediate or advanced accounting that discuss derivative instruments or investments topics or in a training program that focuses on implementing FAS 133. This teaching material can help students gain technical knowledge of FAS 133. It can also help develop critical thinking skills in analyzing the impact of an accounting standard on a firm's operation. A scenario based on a futures contract used by a natural gas company to hedge price fluctuations of its gas inventory is applied across four cases to show the impact of derivative designation on the accounting treatment and to provide a comparative analysis of the economic results from using different accounting treatments for the derivative. Case 1 and Case 2 demonstrate hedge accounting under FAS 133 by designating the derivative as a fair value hedge and a cash flow hedge, respectively. Case 3 illustrates accounting for a derivative that is not designated as a hedge. Case 4 demonstrates the impact of not entering or using a derivative to mitigate market risk. A downloadable spreadsheet on the author's website can be customized for use in the classroom.

Alternative Approaches to Testing Hedge Effectiveness under SFAS No. 133

INTRODUCTION Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities--An Amendment of FASH Statement No. 133, prescribes comprehensive new rules for accounting for derivative instruments (FASB 1998,2000). SFAS No. 133 (para. 3) standardizes the accounting treatment for derivative instruments by requiring all entities to report their derivatives as assets and liabilities on the balance sheet and to measure them at fair value. Reporting changes in the fair value of a derivative in earnings each quarter could create a matching problem. If the derivative is being used as an economic hedge, changes in the value of the derivative might increase (or decrease) reported earnings one period while the opposite change in the value of the hedged item affects earnings in a later period. To avoid distorting earnings, SFAS No. 133 (paras. 3, 20, and 28) permits firms to match the timing of the gains and losses of hedged items and their hedging derivatives, provided the derivative qualifies as a hedge. For a fair-value hedge, SFAS No. 133 (para. 22) permits the hedger to record the change in the fair value of the hedged item concurrently with the gain or loss on the hedging derivative. In the case of a cash-flow hedge, the effective portion of any changes in the hedging derivative's fair value is recorded in other comprehensive income until the change in the value of the hedged item is recognized in earnings (SFAS No. 133, para . 30). (1) In principle, a hedge is highly effective if the changes in fair value or cash flow of the hedged item and the hedging derivative offset each other to a significant extent. Hedged item refers to an asset or a liability or a prospective cash inflow or outflow. Derivative refers to any derivative or combination of derivatives used to hedge changes in fair value or cash flow. Hedged position refers to the combined hedged item and derivative. The hedged item can be a designated portion of an asset or liability or a designated expected future cash flow that is attributable to a particular risk (SFAS No. 133, paras. 21 and 28, and Derivatives Implementation Group [DIG] Issue E10 [FASB 2000]). To qualify a derivative position for hedge accounting, the hedging entity must specify the hedged item, identify the hedging strategy and the derivative, and document by statistical or other means the basis for expecting the hedge to be in offsetting the designated risk exposure. The documentation step is c alled prospective testing, and it must be done before entering into the hedge and on an ongoing basis to justify continuing hedge accounting. The hedger must also regularly perform retrospective testing to determine how effective the hedging relationship has been in actually achieving offsetting fair values or cash flows. This article examines the test choices that firms must make. Section 2 of Appendix A of SFAS No. 133 requires the use of statistical or other numerical tests for hedge effectiveness, unless a specific exception applies, but SFAS No. 133 does not endorse any specific testing methodology. The hedger must select the methodology, such as regression analysis, choose the measurement period, and specify an appropriate test statistic like adjusted [R.sup.2] along with the critical value to distinguish a hedge from one that is not, for example, an adjusted [R.sup.2] above 0.8. The article describes four existing methods of testing hedge effectiveness: (1) the Dollar-Offset Method, (2) the Relative-Difference Method, (3) the Variability-Reduction Method, and (4) the Regression Method. We refine the Variability-Reduction Method and the Regression Method to correct their potential to accept poorly performing hedges. …

Comparing Alternative Hedge Accounting Standards: Shareholders' Perspective

We study the economic consequences of alternative hedge accounting rules in terms of managerial hedging decisions and wealth effects for shareholders. The rules we consider include the “fair-value” and “cash-flow” hedge accounting methods prescribed by the recent SFAS No. 133. We illustrate that the accounting method used influences the manager's hedge decision. We show that under no-hedge accounting, the hedge choice is different from the optimal economic hedge the firm would make under symmetric and public information. However, under a certain definition of fair-value hedge accounting, the hedging decision preserves the optimal economic hedge. We then demonstrate that long-term and future shareholders prefer a certain definition of fair-value hedge accounting to no-hedge accounting, while short-term shareholders prefer either approach depending on risk preferences and the level of uncertainty. We speculate about circumstances in which a manager would choose not to adopt fair-value hedge accounting when he has the option not to do so.

Comparing Alternative Hedge Accounting Standards: Shareholders? Perspective

We study the economic consequences of alternative hedge accounting rules in terms of managerial hedging decisions and wealth effects for shareholders. The rules we consider include the and cash-flow hedge accounting methods prescribed by the recent SFAS No. 133. We illustrate that the accounting method used influences the manager's hedge decision. We show that under no-hedge accounting, the hedge choice is different from the optimal economic hedge the firm would make under symmetric and public, information. However, under a certain definition of fair-value hedge accounting, the hedging decision preserves the optimal economic hedge. We then demonstrate that long-term and future shareholders prefer a certain definition of fair-value hedge accounting to no-hedge accounting, while short-term shareholders prefer either approach depending on risk preferences and the level of uncertainty. We speculate about circumstances in which a manager would choose not to adopt fair-value hedge accounting when he has the option not to do so.