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In November 2013, the IASB added a new Hedge Accounting chapter to its financial instruments Standard (IFRS 9 Financial Instruments). It is a major overhaul of hedge accounting. The new model more closely aligns accounting for hedging activities with a company’s risk management strategies, and provides improved information about those strategies.
The new hedge accounting model can be applied when a company adopts IFRS 9. Because the IASB is still finalising amendments to the classification and measurement chapter in IFRS 9 and completing a chapter on expected credit losses, the effective date of IFRS 9 has been revised to 1 January 2018. However, companies may choose to apply it now. The IASB expects companies that will be significantly affected by changes to accounting for the classification, measurement and impairment of financial instruments to postpone adopting IFRS 9 until its effective date. However, companies whose primary exposure to financial instruments is derivatives used for risk management may adopt it sooner to take advantage of the improved hedge accounting model.
Not all risk management activities are reflected in the financial statements through hedge accounting. The risk management activities represented by hedge accounting are those risks that management chooses to manage with financial instruments such as derivatives, and for which they elect to use hedge accounting. In addition, because hedge accounting is elective it does not need to be applied even if a company is engaging in hedging activities. Because of IAS 39’s onerous record-keeping requirements some companies simply chose not to make use of hedge accounting for some or all of their hedging activities. In addition, because of the rule-based nature of IAS 39, there are instances in which companies cannot apply hedge accounting even though they are using financial instruments to mitigate risk.
When a company enters into derivatives for risk management purposes but hedge accounting cannot or is not applied, the derivatives are accounted for as if they were trading instruments. This creates volatility in profit and loss that is inconsistent with the economics of the related risk management strategy. As a result, the hedging relationship is not apparent to investors. A company that has reduced its risk by entering into the derivatives for risk management purposes may paradoxically appear more risky.