Fair value hedges with swaps: accounting practice under IFRS

Abstract

The paper reveals the accounting treatment for hedging against the interest rate risk and the foreign exchange rate risk arising from operations with financial instruments of banks using interest and currency swaps. The economic essence of hedging transactions, the concept and mechanism for the implementation of swap agreements are considered. The article analyses the requirements of IFRS 9 on fair value hedge accounting including qualifying criteria for hedge accounting, hedge effectiveness and ineffectiveness determination, accounting requirements for fair value hedges. The author provides the calculation of the fair value of the floating-for-fixed interest rate swap. The fair value of swaps is measured in terms of bond prices: the fair value is calculated as the difference between the present value of fixed rate bonds of all future periods and the present value of floating-rate bonds for a current period. The results received explain how the change in the fair value of a hedged item is compensated with the reverse change in the fair value of a hedging instrument. The paper covers the accounting practice for fair value hedges of the fixed rate financial liability measured at fair value through profit or loss, with interest rate swap as a hedging instrument. The author introduces the accounting treatment for the fair value hedge of the fixed rate financial liability denominated in foreign currency with the use of currency swap as a hedging instrument. For both hedging procedures any gains or losses on a hedging instrument as well as on a hedged item are recognized in profit or loss. The suggested accounting procedures completely respond to the requirements of IFRS and can be applied by Ukrainian banks.

Keywords

• hedge accounting interest rate swap
• hedge accounting
• currency swap
• fair value hedge