25 Jul 2014

Accounting Update: Amendments to FRS 102 – Financial Instruments and Hedge Accounting

The FRC has recently issued amendments to FRS 102 in respect of the classification conditions for the treatment of “basic” financial instruments and conditions of hedge accounting under sections 11 and 12.

The amendments come into effect for financial years beginning on or after 1 January 2015, so RPs will need to publish accounts under FRS 102 for the year ending 31 March 2016 (with restated comparatives). The latest changes are essentially a consolidation of the previously issued amendments, FRED 51 and FRED 54.

Section 11 – Basic Financial Instruments
Per the previous amendments in FRED 54, the aim was to allow a wider range of debt instruments to be classified as Basic and held at amortised cost (e.g. inflation linked debt and embedded inflation swaps). The only notable changes from the amendments in FRED 54 is the clarification around the treatment of LOBO’s and potentially embedded cancellables.

In the Accounting Council’s advice to the FRC, it specifically mentions: “After detailed consideration the Accounting Council advises that a loan cannot be classified as basic if it includes contractual terms giving the lender the unilateral option to change the terms of that loan, for example from a pre-determined fixed rate to a variable rate or to a different fixed rate chosen by the lender, even if the holder can avoid it by repaying the loan”

This suggests that LOBOs will definitely not meet the definition of “Basic” so will be need to be classified as “Other” and fair valued on the balance sheet. Arguably the wording is also wide enough to cover embedded cancellable swaps although this is less clear and we recommend this treatment is discussed and agreed with auditors.

Section 12 – Hedge Accounting
FRED 51 was issued at the end of last year and incorporated more relaxed criteria for hedge accounting, moving from a rules based to a principles based approach. This allowed for more hedging relationships to qualify for hedge accounting.

In the criteria to apply hedge accounting it is now not necessary to achieve a prescribed level of effectiveness, but an economic relationship between the hedged item and the hedging instrument has to exist.

The following areas were also clarified:
• Hedge accounting can be applied to transactions between entities in the same group in the individual financial statements when certain conditions are met.
• It provides clarity on allowing greater flexibility when allocating hedging instruments to hedged items, for example, allocating a portion of an interest rate swap to an underlying loan, or allocating a single swap to several loans.
• Documentation for hedge accounting does not need to be in place on transition date, but will need to be finalised by the time the first financial statements under FRS 102 are authorised for issue.

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