By Graeme Tosen
Graeme Tosen, the executive for technical accounting at HBOS Treasury providers in London, has written a step by step consultant to figuring out and enforcing the hugely technical accounting principles of the overseas monetary Reporting criteria (IFRS) that observe to derivatives and dependent finance.
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Extra info for A Practical Guide to IFRS for Derivatives and Structured Finance
32 Embedded derivatives Practical implementation Example 1: Embedded derivative linked to an inflation index Entity A granted two loans, both with interest rate payments plus a margin based on inflation indices. Loan 1 was made based on the inflation rate index published for the area in which the loans were granted and used. The purpose of this was to protect the lender in the short term from inflation (before base interest rates are adjusted accordingly). Loan 2 was issued to a UK company with expansion prospects in South America and was linked to an average inflation rate index for developing countries, although the loan was issued locally in the United Kingdom.
When you apply hedge accounting, you will either remove something from the income statement that would have been there under regular rules, or add something to the income statement that would not have been there under regular accounting rules, all with the aim of limiting volatility in the income statement. There are a few basic questions that need to be addressed. • • • • • Is an entity allowed to designate a particular asset or liability as a hedged item? Is an entity allowed to use a specific financial instrument as a hedging instrument?
Under IFRS, no transfers into or out of the ‘at fair value through profit or loss’ category are allowed. Under US GAAP, however, an entity may transfer assets both into and out of this category, a position that provides an entity with an opportunity to follow a change in the initial intent with an asset (however, remember that intent is not a test under IFRS). This also opens the door for profit manipulation, however, as an entity can switch between fair value and amortised cost accounting when necessary for other reasons than a true change in intent, while it would be very hard to prove that the move was not bona fide.
A Practical Guide to IFRS for Derivatives and Structured Finance by Graeme Tosen