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In case the COVID-19 outbreak reduces the probability of a hedged forecasted transaction, the hedge accounting relationship may need to be terminated prospectively. If a hedging relationship is terminated because a forecasted transaction is no longer highly probable, a company needs to determine whether the transaction is still expected to occur.

What’s the issue?

Companies frequently enter into hedges of forecasted transactions, such as purchases and sales of raw materials and inventories. A forecasted transaction can be designated as a hedged item only if it is highly probable. In case the COVID-19 outbreak reduces the probability of a hedged forecasted transaction or affects its timing, then the hedge accounting relationship may need to be terminated. In which case the question arises what the hedge accounting consequences are when a forecasted transaction is no longer highly probable.

Partner Department of Professional Practice

KPMG Nederland

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Getting into more detail

Dutch GAAP allows a forecasted transaction to be designated as a hedged item in a cash flow hedge or cost price hedge if that transaction is highly probable. In case the COVID-19 outbreak reduces the probability of a hedged forecasted transaction such that it can no longer be considered ‘highly probable’, the hedge accounting relationship needs to be terminated prospectively.
The hedge instrument will then prospectively be measured at fair value or cost, or at lower market value, respectively, in case of termination of cash flow hedge accounting or cost price hedge accounting.

Once a hedging relationship is terminated because a forecasted transaction is no longer highly probable, a company needs to determine whether the transaction is still expected to occur, as this will determine the accounting for the cumulative result on the hedge instrument until that moment. In this event, there are two possible scenarios:

1. The transaction is still expected to occur. The associated cumulative result on the hedge instrument – until it was no longer considered highly probable – that was recognised in the cash flow hedge reserve in equity or held off-balance (cost price hedge accounting) in the period in which the hedge was effective, shall remain:

(i) in equity in case of a cash flow hedge, or

(ii) off-balance in case of a cost price hedge,

(iii) until the expected forecasted transaction occurs.

2. When the transaction is no longer expected to occur, then the deferred cumulative results in equity or held off-balance shall be recognised immediately in the profit and loss account.

Example

 #

Recognition change in value of hedge instrument until termination

Cash flow hedge

Cost price hedge

1.

Hedge instrument value: +90

 

 

Cash flow hedge reserve (CFHR): 90 Derivative gain

 

1. 90 remains in CFHR until the expected transaction occurs.

2. 90 is recognised in P&L when the transaction is no longer expected to occur.

Off-balance: 90 Derivative gain

 

1. 90 remains off-balance until the expected transaction occurs.

2. 90 is recognised in P&L when the transaction is no longer expected to occur.

2.

Hedge instrument value: -90

 

 

Cash flow hedge reserve (CFHR): 90 Derivative loss

 

1. 90 remains in CFHR until the expected transaction occurs.*

2. 90 is recognised in P&L when the transaction is no longer expected to occur.

Off-balance: 90 Derivative loss

 

1. Derivative loss of 90 is recognised as an accrual (debit), as the hedging instrument is measured at lower market value, until the expected transaction occurs.

2. 90 is recognised in P&L when the transaction is no longer expected to occur.

 

* Except in case the cumulative loss on the hedging instrument is no longer expected to be recovered. See our article COVID-19: How to account for a cumulative loss on a hedging instrument which is no longer expected to be recovered?

Actions for management to take now

  • If, due to COVID-19, there are changes in the expectations of forecasted transactions, management may need to evaluate the hedge accounting consequences.