Hedge Accounting for FX Option IFRS - Overview
The Hedge Management and Hedge Accounting process helps you to mitigate profit and loss volatility from the use of derivatives.
Currently the scope item supports IFRS 9 and covers Cash Flow Hedge using European Style FX Option as Hedging Instruments.
The functionality helps you to automate labor-intensive processes, such as calculating net open exposure amount, creating hedging relationship for hedge item and hedge instrument, determining the key figures calculation (NPV, Intrinsic Value, Time Value, CCBS, CVA/DVA), performing the valuation of FX transactions, checking classification, processing balance sheet crossover, dealing with the de-designation, and generating posting journal reports.
The main process flows covered by the Hedge Accounting for FX Option supporting IFRS 9 include the definition of hedging areas based on the hedging policy. The scope item supports the upload and release of forecast and planning data as well as the determination of net open exposure to make hedging decisions.
You will be able to execute FX transactions and to prepare and release designation. Further functionality includes the determination of Net Present Value, executing valuation, and classification at period end plus the de-designation and reclassification at contract close and the accompanying postings.
Hedge Accounting for FX Option IFRS - Process
The Treasury department is responsible for executing a given hedging policy for hedging the risk of forecast cashflows in foreign currencies of future periods. The forecast itself is represented as exposures in the Hedge Management Cockpit. A snapshot is taken for the forecast exposures from Exposure Management. Based on the snapshot, the net open exposure amount, risk currency and period are detailed in the Hedge Management Cockpit. Based on rules of the hedging policy, the net open exposures are reduced by trading financial instruments such as a FX option.
In case of expected inflows of a risk currency, the resulting exposure shall be closed by a FX option whose underlying spot transaction sells the inflow currency and buys the local currency of the company code; where there are of expected outflows of risky currency, a FX option is traded whose underlying spot transaction buys the outflow currency and sells the local currency.
With the creation of the FX option contract, the financial transaction is automatically designated into a hedging relationship as a hedging instrument together with the exposure item of the Hedge Management Cockpit as the hedged item. The matching exposure item is determined based on characteristics of the hedging instrument, for example, hedging classification, foreign currency of underlying FX Spot Transaction, exercise of FX option. At the same time, the hypothetical derivative is created and all necessary mathematical evaluations necessary for the measurement of effectiveness are performed and stored.
At period end, the determination of NPVs, including the decomposition of market values for the hedging instrument and the hypothetical derivative is performed, and the key date valuation of the FX option transactions is executed. Meanwhile, the measurement and postings of the Hedging Reserve (OCI I), Cost of Hedging Reserve (OCI II) and ineffectiveness are executed on the exposure subitem level. The period end close can be executed using two different procedures: valuation and classification with reset or without reset.
At the balance sheet recognition date, the reclassification flows are automatically created; depending on the rule that was set in the hedging area definition, the reclassification flows are posted immediately or at the exposure subitem end date.
At the expiry date of the FX option transaction, the FX option can be exercised or expired. The cumulated hedging reserve and cost of hedging reserve amounts are classified as frozen. At the end date of the exposure subitem, the cumulated hedging reserve and cost of hedging reserve amounts are to be reclassified to profit or loss as a reclassification adjustment.
This section can be executed using the following product type as hedging instrument: 76A: OTC Currency Option.