Companies have been able to apply hedge accounting under IAS 39, Financial Instruments: Recognition and Measurement, for more than 10 years. But many felt that it was difficult to apply due to some of the accounting standard’s onerous provisions. Some of these include restrictions on the types of hedging relationships that can qualify for hedge accounting and the need to perform periodic quantitative effectiveness assessments that evaluate how well the hedge has performed at hedging the intended risk.
The IASB heard the criticisms of IAS 39 and drafted a new standard, IFRS 9, Financial Instruments, which includes provisions that are aimed at simplifying the application of hedge accounting and bringing it more in line with a company’s risk management activities. The hedge accounting provisions in IFRS 9 were published in November 2013, and companies now need to begin to assess the impact on their hedging programmes, including what changes, if any, they will need to make over the coming years.
Although the standard has a mandatory effective date beginning 1 January 2018, companies currently have the choice of either early adopting IFRS 9, if permitted in their jurisdiction, or waiting until the mandatory effective date in 2018.
For companies that believe they will benefit significantly from the early adoption of IFRS 9, the benefits may outweigh the costs. Companies that do not perceive much benefit from adopting are likely to be better off deferring the cost of adoption to a later date
This article is the first in a series from Chatham that will provide practical insight to help companies evaluate the impact of adopting IFRS 9 and assist them with evaluating whether early adoption of the standard is a wise decision.
When it comes to making the decision to either early adopt IFRS 9 or continue to apply IAS 39, there are a few important issues that companies should consider.
One of the first things a company should consider is whether or not it is permitted to early adopt IFRS 9. Even though the standard has been issued by the IASB, not every company that applies IFRS will be able to early adopt IFRS 9. Some jurisdictions require regulatory approval before a new accounting standard can be applied. As a result, a first step in the process is to determine if your governing body permits early adoption.
In addition, IFRS 9 introduces the concept of hedging aggregated exposures. This feature will allow companies to hedge exposures that consist of a derivative and an exposure, something not permitted under IAS 39.
In addition, companies may not be required to perform quantitative analysis to demonstrate effectiveness. Companies are permitted to make qualitative assessments, and quantitative assessments are only required when necessary. As we will explore in a subsequent article in this series, however, performing quantitative effectiveness assessments may be required more often than expected.
Adopting IFRS 9 will force companies to evaluate the standard and make changes to their established practices. While these changes are inevitable (IFRS 9 will be required to be adopted eventually), each company must determine the optimal point at which it is desirable to expend the cost required to evaluate the impact of IFRS 9 on its existing practices, implement new practices and get its auditors comfortable with those changes. For companies that believe they will benefit significantly from the early adoption of IFRS 9, the benefits may outweigh the costs. Companies that do not perceive much benefit from adopting are likely to be better off deferring the cost of adoption to a later date.
Companies are likely to encounter higher implementation costs for areas affected by the above items since they are new. Not only that, as auditors gain additional experience auditing those new features of IFRS 9, there is a risk that previous conclusions are challenged, which could result in the need for companies to make additional changes. Again, if companies believe they will benefit significantly from adopting the new standard, such costs are likely to be outweighed by the benefits, while the opposite is likely to be true if companies perceive there is little to be gained.
Dan Gentzel is MD of hedge accounting and Zwi Sacho is director of hedge accounting at Chatham Financial