Analysis of Financial Statements

Inter-corporate Investments
Small (minority) passive stakes
IFRS 9

Arthur Kraft

How do we measure the health of a firm?

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 Walmart’s Boundaries

What is the boundary of the “firm” that

we are talking about?

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 Firm Boundary

• Inter-corporate equity investments alters the

boundaries of the firm.

• Implications for understanding health of a firm

and financial ratios

Objectives
The objectives of this and next session are to:

• Discuss the different types of investments in other

firms’ equity securities
– Marketable securities
– Minority active investments under the equity method
– Consolidation and group accounts

• Basics of Goodwill and Non-Controlling Interests

(session 9)
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 Investments - Big Picture

Investment (financial):
An asset that is characterised by its ability to generate
future economic benefits in the form of distributions
and/or appreciation in value

• Investments in common and preferred shares, bonds,

or other securities

Investments - Big Picture (cont.)

The accounting of inter-corporate investments

depends on :

a) purpose of the investment and,

b) percentage of stock held (US GAAP) (or) the extent
of control (IFRS)
- “An investor controls an investee when it is exposed, or has
rights, to variable returns from its involvement with the investee
and has the ability to affect those returns through its power over
the investee.”
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 Investments - Big Picture (cont.)

• Why do firms invest in other corporations?

Investments - Big Picture (cont.)

Why do firms invest in other corporations?
Passive Investments
• Earn return on idle cash.
• Initial step in acquisition strategy.
Active Investments
• Increase efficiency of present operations (e.g., through purchase of company
in same line of business).
• Gain access to raw materials, distribution channels, or markets (e.g., vertical
integration).
• Exploit its expertise by improving operations of an inefficiently-run investee.

We are not talking about derivative instruments (hedging)

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 INVESTMENTS
The three primary categories

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Investments in Other Companies

1. Minority stakes
– Passive
– Investor has no ability to influence the company
– Active
– Investor has ability to influence the company

2. Majority stakes
– Passive
– N/A
– Active
– Investor has control over the operating, investing and financing
decisions of the investee
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 Investments in Other Companies
1. Minority, passive stakes in other companies
 Defining characteristic: Investor cannot significantly influence the operating and
financial policies of the investee (< 20% ownership).
 Accounting: Mark-to-market (fair value) or cost method
 Account for investments in a ‘passive’ manner and primarily record changes in value
(and dividends received).
2. Minority, active stakes in other companies
 Defining characteristic: Investor can significantly influence the operating and financial
policies of the investee (between 20% and 50% ownership).
 Accounting: Equity method
 Include a portion of income earned by company in which we invested as our own.
3. Majority, active stakes in other companies
 Defining characteristic: The investor controls the investee (> 50% ownership).
 Accounting: Consolidation
 Include all assets & liabilities of investee on our balance sheet in addition to our share
of their income
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Summary: Nature of Investment and Reporting Alternatives

Nature of Investment/Ownership

M
Minority Minority Active Majority
Passive Between 20% and More than 50%
Less than 20% 50% ownership ownership
ownership

Intend to sell soon Hold longer-term

Can influence mgt Effective control

Trading Available- Held-to- Equity Full

Securities for-sale maturity Method Consolidation
Mark-to- Securities Securities
Adjusted historical Historical cost with
market with Mark-to-market Historical cost purchase accounting
unrealized with unrealized amortized
gains/losses gains/losses to cost
to income stockholders’
equity
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 Basic Framework: Nature of Investment
and Reporting Alternatives
Nature of Investment/Ownership

Minority Minority Majority

Passive Active
Between 20% and More than 50%
50% ownership ownership

Can influence mgt Effective control

Equity Debt Equity Full

Investments Investments Method Consolidation
Less than 20%
equity ownership

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1. Minority, Passive Stakes in Other Companies

 Marketable securities
 Accounting (in IFRS & US) depends on how investment is
classified:
1. Trading Securities (“TS”) or Fair Value through P&L
 Debt/equity securities held principally for short-term trading profit.
 Management has every intention of turning the securities over  “WILL
SELL.”
2. Available-for-Sale Securities (“AFS”) or Fair Value through
OCI
 Held principally as investments.
 Management may respond to market opportunities  “MAY SELL.”
3. Held-to-Maturity Securities (“HTM”)
 Debt securities firm intends to hold to maturity.
 Management has no intention of selling the securities in response to market
opportunities  “WON'T SELL.”
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 Terminology:
US GAAP vs IFRS
Note on Terminology

US GAAP IFRS
Trading Securities Fair Value through P&L (FVPL)
Available-for-sale Fair Value through other
comprehensive income (FVOCI)
Held-to-maturity Held-to-maturity

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Minority Passive Investments NEW

• NOTE: Recently, the accounting for minority passive investments changed
under IFRS and US GAAP:
– The discussion in your textbook (HHTS) may be outdated and not reflect these
changes
• Simplified the accounting for equities
• Classify the investments according to intent:
– Objective is to hold the investment to collect contractual cash flows – mainly debt
securities (i.e., principal and interest)
– Objective is to hold the investment to collect contractual cash flows and sell it
(capital gains) – equity and debt securities
• Accounting, broadly speaking:
– Debt: Investment can be carried at fair value (with changes in value going to Other
Comprehensive Income) or historical amortized cost
– Debt and equity: investment is carried at fair value with changes in value going to
P&L
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 Minority Passive Investments:
Under the New Standards (cont.)
• In a nutshell:
– Equity investments are carried at fair values, with changes in
values charged to the P&L (not OCI)
– No substantial changes for debt investments

• NOTE: Under IFRS (but not US GAAP): if the investment is not held
for trading purposes, changes in the fair value of equity investments
may be charged to OCI (need to designate the security as FVOCI at
acquisition date and cannot reclassify)

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Minority Passive Investments:

Under the New Standards (cont.)
Minority Passive Investments

Equity Debt
Investments Investments
Less than 20%
ownership
Collect cash Intent to hold:
flows and sell Collect cash flows

Marketable Trading Available- Held-to-

Securities Securities for-sale maturity
Securities securities
Fair value Fair value
through through Fair value
P&L (FVPL) P&L through
(FVPL) OCI
(FVOCI)

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 Minority Passive Investments (cont.)

• Accounting depends on the classification

• Classification
– Management decides at the outset what type of investments
the firm has made
– Subsequent re-classification rules vary depending on US
GAAP or IFRS, type of instrument and the setting.
– Classification across categories allowed under U.S. GAAP only for
debt, equities must be Trading Securities.
– IFRS – is evolving. But in general tighter rules. Reclassification if and
only if the entity's business model objective for its financial assets
changes. Moreover, FVOCI equity securities can never be re-
classified.
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Investments – Accounting issue

Four aspects of the accounting for investments:

1) Valuation at acquisition
2) Valuation subsequent to acquisition as the securities
are held by the investor
3) Recognition of income – accounting both for
distributions receivable or received and for changes in
the market value of the securities subsequent to
acquisition.
4) Disposal
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 Minority Passive Investments: Financial
Reporting
1) Value at Acquisition

• Initially, record investment at cost on Balance Sheet

– Available-for-sale and Held-to-maturity securities  include transaction costs
– Trading securities  EXCLUDE transaction costs

2) Value Subsequent to Acquisition

• At each balance sheet date:

– Trading and Available-for-sale securities: report investment
at fair value (in some instances called “mark-to-market”)
– More on this later

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Minority Passive Investments: Financial

Reporting (cont.)
3) Recognition of Income (Capital gains)
• The changes in fair value are unrealized because the securities have
not been sold (yet).

• These unrealized gains/losses are reported in:

– P&L for Trading securities or FVPL securities.

– Other comprehensive income for Available-for-sale

securities or FVOCI securities (i.e., by-pass the income
statement)

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 Minority Passive Investments: Financial
Reporting (cont.)
3) Recognition of Income (Distributions)
• Dividends (or interest) are recorded in P&L when declared (or
earned). Reported as “Other Income”.

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Minority Passive Investments: Financial

Reporting (cont.)
4. On disposal/sale of the investment
• Balance Sheet: remove the carrying value of the asset at the time of
sale

• Income Statement: Report a gain if the selling price is greater than

the carrying value or a loss if the selling price is lower than the
carrying value on the balance sheet. Gain/loss reported as “Other
Income”.

• For available-for-sale securities, handle the cumulative unrealized

holding gains/losses in the Accumulated Unrealized Gains and
Losses.
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 Minority Passive Investments:
Financial Reporting - Summary
Investment < 20% of Shares (No Significant
Influence)

Trading Available-for-
Held-To-Maturity
or FVPL Sale or FVOCI

Fair Value in
Fair Value in
Asset Balance Amortized Cost
Balance Sheet
Sheet
In Other
∆s in Fair In Net
Comprehensive Ignored
Value Income
Income

Dividends or In Net
In Net Income Interest only
Interest Income

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Example
• On Jan. 1, 2021, company A purchased 10% of company B’s outstanding bonds for £10,000.
• In 2021, B has net income of £12,000 and pays £5,000 in interest to its bondholders.
• Jan. 1, 2021: Market value of B’s bonds is £100,000.
• Dec. 31, 2021: Market value of B’s bonds is £120,000.
• On Jan. 1, 2022, company A sells its entire investment in B for £13,000.

B Corp.’s balance sheet on Jan. 1, 2021:

ASSETS LIAB & SE
Current Assets 20,000 Liabilities 30,000
Non-Current Assets 50,000 Contributed Capital 15,000
Retained Earnings 25,000
Total Assets 70,000 Total L & SE 70,000

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 Example (cont.)
Record all the transactions relating to company A’s investment in B.

CASE 1: Assume that company A intends to hold its bonds purely for short-term,
speculative purposes  Trading Securities.

Assets S’E
Cash Investments P+L R’E AOCI

Buy bonds

Interest

Mark-to-market

CB/OB

Sell Bonds
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Example (cont.)
CASE 2: Assume A intends to hold the bonds for non-trading purposes, say to invest cash
that will be used for operating purposes  Securities Available for Sale.

Assets S’E
Cash Investments P+L R’E AOCI

Buy bonds (10,000) 10,000

Interest 500 500

Mark-to-market

CB/OB

Sell Bonds
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 Example (cont.)
CASE 3: Company A intends to hold the bond for the full 10 years 
Held-to-Maturity.

Assets S’E
Cash Investments P+L R’E AOCI

Buy bond (10,000) 10,000

Interest received 500 500

Note: If the bond had been issued at either a discount or premium, the net book value of the
investment would have been adjusted at year-end.
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Issues with Held-to-Maturity

investments
• Changes in value are not reflected on the financial statements  can
potentially obscure losses that could occur in the future (if sold) or
opportunity costs if held to maturity (earning below-market rates of
return).

• Issues with liquidity  many HTM investments are traded on active

markets so are very liquid. HOWEVER, the accounting discourages
selling these securities early due to tainting the entire HTM category.

• What if HTM securities make up the majority of a company’s assets and

those securities decline in value?
• What if HTM securities make up the majority of a company’s assets are
they are in need of liquidity?
• What if BOTH happen?

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 Silicon Valley Bank – Balance Sheet

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Silicon Valley Bank – Balance Sheet

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 Silicon Valley Bank

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Silicon Valley Bank

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 Silicon Valley Bank

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Silicon Valley Bank 2021

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 Silicon Valley Bank 2022

• The above table tells us how Silicon Valley’s net interest income would
change if interest rates changed
– Net interest income = interest revenue – interest expense
– Interest rates increasing would improve their income
– But how would interest rate changes affect the underlying fair values of their
assets and liabilities??  no information

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Comprehensive Income:
Basic Issues
• A basic concept in accounting is the following:
Shareholders’ Equitybeg + Profit – dividends ± net capital contributions =
Shareholders’ Equityend

• Till now we have thought of Profit as Net Income (NI) i.e. Revenue minus
Expense.

• But, there can be other events that do not directly relate to NI but are
nevertheless changes to shareholders’ equity.
– Re-evaluation of non-current assets
– Changes in exchange rates of foreign currency
– unrealized gains and losses on available-for-sale securities

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 Comprehensive Income (CI):
Basic Issues (cont.)
• Such wealth changes that are not reflected on the income statement
are instead reflected in a broader summary measure called
Comprehensive Income (“CI”).
• CI = NI ± other comprehensive income (“OCI”)
• IFRS suggests companies prepare and present income statement as a
part of a larger statement of comprehensive income.
• U.K. Companies currently provide two statements
– Income Statement
– Statement of Comprehensive Income beginning with NI and making
adjustments for OCI.

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CSL balance sheet

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 CSL AOCI

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OCI and AOCI are different accounts!

• Other Comprehensive Income (OCI) is the flow of

unrealized gains or losses over a given fiscal period.
– This is sometimes disclosed on a pre and post tax basis or just a
post tax basis.

• Accumulated Other Comprehensive Income (AOCI) is the

stock of unrealized gains and losses at a point in time.
– This will be disclosed on an after tax basis.

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 OCI and AOCI and Taxes

• When looking at the financial statements of a company be

careful when looking for OCI and AOCI amounts!
– Balance Sheet (Assets)
– Marketable Securities will reflect the fair value of all TS and AFS
securities. These amounts will be the cumulative gross unrealized
gains and losses.

– Balance Sheet (Equity)

– AOCI will reflect the cumulative net (or after tax) unrealized gains
and losses.
– The changes to AOCI attributable to AFS will be the net unrealized
gains/losses.

– If assets are pre-tax and equity is after-tax how does the

B/S balance?  Deferred Taxes!
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Example w/ Taxes
• On Jan. 1, 2021, company A purchased bonds of company Z for £10,000 plus 200 in
commissions.
• In 2021, Z pays £500 in interest to A.
• Dec. 31, 2021: Market value of Z’s bonds is £12,000.
• In 2022, Z pays £500 in interest to A.
• Dec. 31, 2022: Market value of Z’s bonds is £13,000.
• On Jan. 1, 2023, company A sells all of Z’s bonds for £13,500.
• Assume that over this entire period the firm faces a tax rate of 30% on all income.

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 Example (cont.)
Record all the transactions relating to company A’s investment in Z’s bonds.

CASE 1: Assume that company A intends to hold these bonds purely for short-term,
speculative purposes  Trading Securities.

Assets Liabs S’E

Cash Investments Def Tax P+L R’E AOCI

Buy bonds

Interest

Mark-to-
market
FYE 2021
CB/OB
2021/22 49

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Example (cont.)
Record all the transactions relating to company A’s investment in Z’s bonds.

CASE 2: Now assume that company A intends to hold these bonds for non-trading
purposes, say to invest cash that will be used for operating purposes  Securities
Available for Sale.

Assets Liabs S’E

Cash Investments Def Tax P+L R’E AOCI

Buy bonds

Interest

Mark-to-
market
FYE 2021
CB/OB
2021/22 50

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 Example (cont.)
Record all the transactions relating to company A’s investment in Z’s bonds.

CASE 3: Finally assume that company A intends to hold the bond for the full 10 years 
Held-to-Maturity.

Assets Liabs S’E

Cash Investments Def Tax P+L R’E AOCI

Buy bonds

Interest

Mark-to-
market
FYE 2016
CB/OB
2016/17 51

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Passive Investments in Securities:

Basic Accounting Issues

Investment < 20% of Shares O/S (No Significant Influence)

Trading Available for Sale
Or Or Held-To-Maturity
FV through PL FV through OCI

Asset Market Value Market Value Amortized Cost

In Other
∆s in Market Value In Net Income Ignored
Comprehensive Income

Income of Investee Dividends only Dividends only Interest only

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 Mini-Case
Coca-Cola Company

Investments 2019

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Learning objectives:
• To learn how investments are disclosed in the main financial
statements and notes
– Minority Passive Investments
– Minority Active Investments
– Majority Investments

• To understand these disclosures

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 Minority Passive Investments:
Under the New Standards
Minority Passive Investments

Equity Debt
Investments Investments
Less than 20%
ownership
Collect cash Intent to hold:
flows and sell Collect cash flows

Equity/ Trading Available- Held-to-

Marketabl Securities for-sale maturity
e Securities securities
Fair value
Securities
through Fair value
Fair value P&L through
through (FVPL) OCI
P&L (FVOCI)
(FVPL)
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Minority Passive Investments (cont.)

As of 31st of December 2019, what was the total value of Coca

Cola’s investments in equities?

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Minority Passive Investments (cont.)

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 Minority Passive Investments (cont.)

As of 31st of December 2019, what was the total value of Coca

Cola’s investments in equities?

Where are these investments presented in the balance sheet?

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Minority Passive Investments (cont.)

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Minority Passive Investments (cont.)

Gains and Losses on Equity Securities

What was the net unrealized gain/loss on equity securities

recognized during 2019 related to equity securities?

Of this amount, what was the net unrealized gain/loss on equity

securities recognized during 2019 related to equity securities
still held at the end of the year?

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 Minority Passive Investments

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 Debt Investments

As of 31st of December 2019, what was the total value of Coca

Cola’s investments in debt?

What was the original cost of these debt investments?

Where are these investments presented in the balance sheet?

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Debt Investments (cont.)

What is the cumulative value of the unrealized gains and losses

recognized by the Coca-Cola on debt securities still held at the
end of the year?

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In 2017, changes in FV of available-for-sale equity and debt securities

In 2018 and 2019, changes in FV of available-for-sale debt securities only
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 Purchases and Sales of Investments

How much did Coca-Cola pay to purchase debt investments

and minority passive equity investments in 2019?

How much did Coca-Cola receive from the sale of debt

investments and minority passive equity investments in 2019?

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Questions 13 - 21

We’ll cover next week when we discuss the equity method and
consolidation

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 Risk Management and
Accounting for investments

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Hedging
• Firms frequently purchase financial instruments in an
attempt to mitigate or eliminate an operational or financial
risk they face.
• The objective is not to earn excess gains, but instead to
reduce risk:
– The Qantas Group is subject to financial risks which are an
inherent part of operations of an airline. The Qantas Group
manages these risk exposures using various financial
instruments, governed by a set of policies approved by
the Board. The Qantas Group’s policy is not to enter into,
issue or hold derivative financial instruments for
speculative trading purposes.
• This is frequently accomplished through the purchase of
derivatives

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 Derivative Financial Instruments
• A derivative is an instrument whose value depends on the
value of an underlying variable.
– Interest rate or foreign exchange rate
– Index value such as a stock index value
– Commodity price
– Common stock
– Other
• Thus, the value of a derivative is ‘derived’ from another
variable.
• They frequently require little or no initial investment and
their value will subsequently change as the underlying
variable changes:
– Classified as a financial asset or liability depending on their
value

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Accounting for Derivatives

The standard accounting treatment for derivative instruments
is Fair Value through Profit and Loss (trading security)
• BS: recognised at fair value
– Typically, it reflects the present value of the expected cash
flows
• IS: changes in fair value recorded as gains/losses

Issue  If the purpose of the derivative is to reduce risk, is

this reflected in the accounting?
• How are we accounting for the item being hedged? Let’s
look at hedging….

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 Hedging
• In a hedge transaction, a hedging instrument is used to protect the hedged
item from a certain risk
– Hedging instrument: most often (but not always) a derivative
instrument
– Hedged item: often an asset, liability, or future cash flow
• Example: A firm enters a forward contract (hedging instrument) to fix the
payment amount (hedged item) of a future purchase
• Illustration of company disclosure:

Extract from Rolls Royce’s accounts

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Accounting for Derivatives

The standard accounting treatment for derivative instruments
is Fair Value through Profit and Loss (trading security)
• BS: recognised at fair value
– Typically, it reflects the present value of the expected cash
flows
• IS: changes in fair value recorded as gains/losses

Issue  If the purpose of the derivative is to reduce risk, is

this reflected in the accounting?
• How are we accounting for the item being hedged? Let’s
look at hedging….

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 Accounting Problems with Hedging
• When the standard accounting rules are applied to hedging transactions, a
perverse effect sometimes results: the volatility of earnings increases
– This consequence can be problematic
• Example:
– A firm enters a forward contract (hedging instrument) to protect their fuel
inventories (hedged item) from price risk
– Inventories are accounted at the lower of cost and net realisable value
– The gains or losses on the derivative are recorded in the IS
– Result: the hedge is likely to increase the earnings volatility (see
numbers below and real example on following slides)
• Fair value Earnings
Beginning + 1 month Change impact
Inventories 100 110 10 zero
Derivative 0 -9 -9 -9

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Accounting Problems with Hedging

Example – Rolls Royce 2009

What caused
these huge swings
in financing
income/expense?

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 Accounting Problems with Hedging
Example – Rolls Royce 2009 (cont.)

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Accounting Problems with Hedging

Example – Rolls Royce 2009 (cont.)

Rolls-Royce says that the reported earnings are distorted.

The adjusted PBT is £915m (from £2,957m reported).
Application of hedge accounting may have mitigated
that distortion.

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 Accounting Problems with Hedging
Rolls Royce 2021

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IAS 39 \ IFRS 9

Hedging

Hedged item Hedging instrument

An asset, liability, firm commitment, Designated derivative or other

highly probable forecast transaction financial asset or liability whose fair
or net investment in a foreign value or cash flows are expected to
operation that exposes the entity to offset changes in the fair value of the
risks of changes in fair value or designated hedged item
future cash flows and is designated
as being hedged Most often a derivative

Gains and losses on hedged items and hedged instruments

can be accounted for under hedge accounting rules provided
the hedging relationship is formally designated &
documented and expected to be highly effective.

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 Hedge Accounting

• A special set of accounting rules applying to the hedging

instrument or to the hedged item
• Designed to recognise the gains/losses on the hedging instrument
and on the hedged item (as long as they are caused by the hedged
risk) in the same time period
• Main principles of hedge accounting :
– The effective portion of the hedge should not impact the
earnings (because of the offsetting caused by the hedge)
– Only the non-effective portion of a hedge should impact
the earnings
• Hedge accounting can only be applied if certain conditions are met

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IAS 39 \ IFRS 9

Hedging types
Hedge of fair value
Fair Value Hedge of a recognised
asset or liability

Cash Flow Hedge Hedge of cash flow

volatility associated
with a recognised
asset or liability

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 IAS 39 \ IFRS 9

Hedging types
Hedge of fair value
Fair Value Hedge of a recognised
asset or liability or
unrecognised firm
commitment

Cash Flow Hedge Hedge of cash flow

volatility associated
with a recognised
asset or liability or
highly probable
forecast transaction

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IAS 39 \ IFRS 9

Hedging types
Hedge of fair value Hedged item &
Fair Value Hedge of a recognised hedging instrument
asset or liability or re-measured to fair
unrecognised firm value via profit or
commitment loss

Cash Flow Hedge Hedge of cash flow Effective gain or

volatility associated loss on hedging
with a recognised instrument to
asset or liability or equity until hedged
highly probable item affects profit
forecast transaction or loss

Outcome is that gains & losses on hedged item and hedged instrument matched
in P/L in same period

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 Cash Flow Hedge vs. Fair Value Hedge

• Fair value hedges are used to hedge the exposure to

changes in the fair value of a recognized asset or liability or
of an unrecognized commitment.
• e.g., the FV of a fixed-rate loan asset varies with the
fluctuation of market interest rate
• The exposure to changes in the FV can be hedged by a fixed- to-
floating interest rate swap

• Cash flow hedges are used to hedge exposures to cash

flow risk, which results from the variability in cash flows.
• e.g., future contracts can be used to fix the future cash flows from
selling products

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Cash Flow Hedge vs. Fair Value Hedge

• Many hedges can be classified as either a fair value or
cash flow hedge.
• Think of a farmer with a large inventory of grain that they
will take to market next month.
– If the farmer is concerned with changing grain prices over
the next month  FV hedge
– If the farmer is concerned about changes in the cash flow
they will receive from selling the grain  CF hedge
• So why the 2 type of hedges? It affects how we do hedge
accounting.
– FV Hedge  change how we account for the underlying
item being hedged (mark-to-market)
– CF Hedge  change how we account for the hedging
instrument (delay recognising changes in fair value)

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 IAS 39 \ IFRS 9

Hedging a recognised asset – fair value hedge

XYZ plc owns stocks of 28,000 gallons of oil which cost

$500,000 on 1 December, 2019.
In order to hedge the fluctuation in the market value of the
oil the company signs a futures contract to deliver 28,000
gallons of oil on 31, March 2020 at the futures price of $20
per gallon.
The market price of oil on 31 December, 2019 is $21 per
gallon and the futures price for 31 March, 2020 delivery is
$23 per gallon.
How would this be accounted for if the derivative did not
qualify for hedge accounting?
What if it did qualify for hedge accounting?

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IAS 39 \ IFRS 9

Hedging a recognised asset – fair value hedge

Inventory – no hedge accounting

Measure at cost Mismatch
Gain recognised when sold

Gain

Loss 31.12.20

Derivative
Re-measure to fair value
Loss of 28,000 * (23-20) = $84,000

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 IAS 39 \ IFRS 9

Hedging a recognised asset – fair value hedge

Inventory – hedge accounting

Re-measure to fair value
Gain of (28,000 * 21) – 500,000 = $88,000

Gain

Loss 31.12.20
Net profit or loss
Derivative impact is $4,000.
Re-measure to fair value
Loss of 28,000 * (23-20) = $84,000

99

IAS 39 \ IFRS 9

Hedging a highly probable forecast transaction – cash flow

hedge

An entity expects to have to undertake repairs to a ship next year due to

changing regulations. It is uncommitted to this transaction but it is
highly probable that the work will be undertaken.
The repair work will be undertaken in Singapore at a cost of S$60 million and
therefore the entity is exposed to movements in the exchange rate. It therefore
enters into a futures contract, buying forward S$60 million at a rate of US$1 =
S$3.

The futures price on 31.12.20 (the company’s year end) is S$3.25.

How would this be accounted for if the derivative did not qualify for hedge
accounting?
What if it did qualify for hedge accounting?

100
 IAS 39 \ IFRS 9
Hedging a highly probable forecast transaction – cash flow
hedge

Highly probable forecast transaction

Not on statement of financial position Mismatch
“Gain” recognised when paid

Gain

Loss 31.12.20

Derivative
Re-measure to fair value
Loss of S$60m/3.00 - S$60m/3.25 = US$1,538,462

101

IAS 39 \ IFRS 9

Hedging a highly probable forecast transaction – cash flow

hedge
Gain and loss
Highly probable forecast transaction recognised in the
Not on balance sheet same accounting
“Gain” recognised when paid period.

Gain

Loss 31.12.20

Derivative – hedge accounting

Re-measure to fair value but gain or loss deferred in equity
Loss of S$60m/3.00 - S$60m/3.25 = US$1,538,462

102
 Income Statement Presentation
• When hedge accounting is applied:
 Effective portion is typically recorded in the same line as the
underlying item, resulting in offsetting
 Ineffective portion usually recorded in financial
income/expense or in residual line
• When hedge accounting is not applied:
 Gains/losses on derivatives usually recorded in financial
income/expense or in residual line
• Speculative derivatives: gains and losses are typically
recorded in a separate line (e.g. "Trading Income")

103

1
0 Hedging and the Income Statement
4

Extract from Qantas’ 2022 accounts

104
 1
0
5 Hedging and the Statement of
Comprehensive Income

Extract from Qantas’ 2022 accounts

105

1
0
6 Hedging and the IS
Example

Extract from Qantas’ 2022 accounts

106
 Conclusion
1. Investments: A brief overview
2. Investments: The three primary categories
– Small, passive stakes
– Small, active stakes
– Large, active stakes
3. Trading, Available-for-Sale, Held-to-Maturity
4. Comprehensive Income
5. Investments and Deferred Taxes
6. Hedge Accounting

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