HKAS 39 - Financial Instruments - Recognition and Measurement
1. INTRODUCTION AND SCOPE
1.1 Background and Context
HKAS 39 *Financial Instruments: Recognition and Measurement* has been largely replaced by HKFRS 9 *Financial Instruments*. However, HKAS 39 remains effective for hedge accounting purposes because HKFRS 9 permits an entity to choose as its accounting policy either to apply the hedge accounting requirements of HKFRS 9 or to continue to apply the hedge accounting requirements in HKAS 39.
Key Point: HKAS 39 now contains only its requirements for hedge accounting. All other sections (recognition, measurement, derecognition, impairment) have been superseded by HKFRS 9.
1.2 Scope (Paragraph 2)
This Standard shall be applied by all entities to all financial instruments within the scope of HKFRS 9 if, and to the extent that:
(a) HKFRS 9 permits the hedge accounting requirements of this Standard to be applied; and
(b) the financial instrument is part of a hedging relationship that qualifies for hedge accounting in accordance with this Standard.
Critical Rule: An entity applying HKFRS 9 that has not chosen to apply HKAS 39 hedge accounting must apply the hedge accounting requirements in Chapter 6 of HKFRS 9. However, for a fair value hedge of the interest rate exposure of a portion of a portfolio of financial assets or financial liabilities, an entity may apply HKAS 39 hedge accounting requirements instead of HKFRS 9.
2. DEFINITIONS (Paragraphs 8-9)
2.1 Terms Defined in Other Standards
The following terms are defined in HKFRS 13, HKFRS 9 and HKAS 32 and are used in HKAS 39 with those meanings:
| Term | Source |
|---|---|
| Amortised cost of a financial asset or financial liability | HKFRS 9 |
| Derecognition | HKFRS 9 |
| Derivative | HKFRS 9 |
| Effective interest method | HKFRS 9 |
| Effective interest rate | HKFRS 9 |
| Equity instrument | HKAS 32 |
| Fair value | HKFRS 13 |
| Financial asset | HKAS 32 |
| Financial instrument | HKAS 32 |
| Financial liability | HKAS 32 |
2.2 Definitions Relating to Hedge Accounting (Paragraph 9)
Firm commitment: A binding agreement for the exchange of a specified quantity of resources at a specified price on a specified future date or dates.
Forecast transaction: An uncommitted but anticipated future transaction.
Hedging instrument: A designated derivative or (for a hedge of the risk of changes in foreign currency exchange rates only) a designated non-derivative financial asset or non-derivative financial liability whose fair value or cash flows are expected to offset changes in the fair value or cash flows of a designated hedged item.
Hedged item: An asset, liability, firm commitment, highly probable forecast transaction or net investment in a foreign operation that:
(a) exposes the entity to risk of changes in fair value or future cash flows; and
(b) is designated as being hedged.
Hedge effectiveness: The degree to which changes in the fair value or cash flows of the hedged item that are attributable to a hedged risk are offset by changes in the fair value or cash flows of the hedging instrument.
3. HEDGING INSTRUMENTS (Paragraphs 72-77)
3.1 Qualifying Instruments (Paragraphs 72-73)
General Rule: This Standard does not restrict the circumstances in which a derivative may be designated as a hedging instrument, provided the conditions in paragraph 88 are met.
Exceptions:
External Party Requirement: Only instruments that involve a party external to the reporting entity can be designated as hedging instruments. Intragroup transactions are eliminated on consolidation and therefore do not qualify for hedge accounting in consolidated financial statements. However, they may qualify in individual or separate financial statements.
Key Principle: An entity's own equity instruments are not financial assets or financial liabilities and therefore cannot be designated as hedging instruments (AG97).
3.2 Designation of Hedging Instruments (Paragraphs 74-77)
General Rule: A hedging relationship is designated for a hedging instrument in its entirety. There is normally a single fair value measure for a hedging instrument.
Permitted Exceptions:
(a) Separating the intrinsic value and time value of an option contract and designating only the change in intrinsic value as the hedging instrument
(b) Separating the interest element and the spot price of a forward contract
Proportion Designation: A proportion of the entire hedging instrument (e.g., 50% of the notional amount) may be designated. However, a hedging relationship may not be designated for only a portion of the time period during which a hedging instrument remains outstanding.
Multiple Risks: A single hedging instrument may be designated as a hedge of more than one type of risk provided that:
(a) the risks hedged can be identified clearly;
(b) the effectiveness of the hedge can be demonstrated; and
(c) it is possible to ensure specific designation of the hedging instrument and different risk positions.
Combination of Instruments: Two or more derivatives may be viewed in combination and jointly designated as the hedging instrument. However, an interest rate collar or other derivative that combines a written option and a purchased option does not qualify as a hedging instrument if it is, in effect, a net written option.
4. HEDGED ITEMS (Paragraphs 78-84)
4.1 Qualifying Items (Paragraphs 78-80)
A hedged item can be:
Group Designation: A group of assets, liabilities, firm commitments, highly probable forecast transactions or net investments in foreign operations with similar risk characteristics may be designated as hedged items.
External Party Requirement: Only assets, liabilities, firm commitments or highly probable forecast transactions that involve a party external to the entity can be designated as hedged items.
Exception for Intragroup Items:
Important: A firm commitment to acquire a business in a business combination cannot be a hedged item, except for foreign exchange risk (AG98).
4.2 Designation of Financial Items as Hedged Items (Paragraphs 81-81A)
Portion Hedging: If the hedged item is a financial asset or financial liability, it may be a hedged item with respect to the risks associated with only a portion of its cash flows or fair value (such as one or more selected contractual cash flows or portions of them or a percentage of the fair value) provided that effectiveness can be measured.
Portfolio Hedge of Interest Rate Risk: In a fair value hedge of the interest rate exposure of a portfolio of financial assets or financial liabilities, the portion hedged may be designated in terms of an amount of a currency rather than as individual assets (or liabilities). Designation of a net amount including assets and liabilities is not permitted.
Separately Identifiable Requirement: To be eligible for hedge accounting, the designated risks and portions must be separately identifiable components of the financial instrument, and changes in the cash flows or fair value of the entire financial instrument arising from changes in the designated risks and portions must be reliably measurable (AG99F).
Example: For a fixed rate financial instrument hedged for changes in fair value attributable to changes in a risk-free or benchmark interest rate, the risk-free or benchmark rate is normally regarded as both a separately identifiable component and reliably measurable.
4.3 Designation of Non-Financial Items as Hedged Items (Paragraph 82)
If the hedged item is a non-financial asset or non-financial liability, it shall be designated as a hedged item:
(a) for foreign currency risks; or
(b) in its entirety for all risks
This restriction exists because of the difficulty of isolating and measuring the appropriate portion of the cash flows or fair value changes attributable to specific risks other than foreign currency risks.
4.4 Designation of Groups of Items as Hedged Items (Paragraphs 83-84)
Similar Risk Requirement: Similar assets or similar liabilities shall be aggregated and hedged as a group only if the individual assets or individual liabilities in the group share the risk exposure that is designated as being hedged.
Proportionality Requirement: The change in fair value attributable to the hedged risk for each individual item in the group shall be expected to be approximately proportional to the overall change in fair value attributable to the hedged risk of the group of items.
No Net Position Hedging: Comparing a hedging instrument with an overall net position (e.g., the net of all fixed rate assets and fixed rate liabilities with similar maturities), rather than with a specific hedged item, does not qualify for hedge accounting.
5. HEDGE ACCOUNTING (Paragraphs 85-102)
5.1 Types of Hedging Relationships (Paragraphs 85-87)
Hedge accounting recognises the offsetting effects on profit or loss of changes in the fair values of the hedging instrument and the hedged item.
Three Types of Hedging Relationships:
| Type | Description |
|---|---|
| Fair Value Hedge | A hedge of the exposure to changes in fair value of a recognised asset or liability or an unrecognised firm commitment, or an identified portion of such an asset, liability or firm commitment, that is attributable to a particular risk and could affect profit or loss |
| Cash Flow Hedge | A hedge of the exposure to variability in cash flows that (i) is attributable to a particular risk associated with a recognised asset or liability or a highly probable forecast transaction and (ii) could affect profit or loss |
| Hedge of a Net Investment | A hedge of a net investment in a foreign operation as defined in HKAS 21 |
Note: A hedge of the foreign currency risk of a firm commitment may be accounted for as a fair value hedge or as a cash flow hedge.
5.2 Conditions for Hedge Accounting (Paragraph 88)
A hedging relationship qualifies for hedge accounting if, and only if, all of the following conditions are met:
(a) Formal Designation and Documentation: At the inception of the hedge there is formal designation and documentation of:
(b) Expected High Effectiveness: The hedge is expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk, consistently with the originally documented risk management strategy.
(c) Highly Probable Forecast Transaction (for cash flow hedges): A forecast transaction that is the subject of the hedge must be highly probable and must present an exposure to variations in cash flows that could ultimately affect profit or loss.
(d) Reliable Measurement: The effectiveness of the hedge can be reliably measured, i.e., the fair value or cash flows of the hedged item that are attributable to the hedged risk and the fair value of the hedging instrument can be reliably measured.
(e) Ongoing Assessment: The hedge is assessed on an ongoing basis and determined actually to have been highly effective throughout the financial reporting periods for which the hedge was designated.
5.3 Assessing Hedge Effectiveness (AG105-AG113A)
Definition of Highly Effective (AG105): A hedge is regarded as highly effective only if both of the following conditions are met:
(a) Prospective Test: At the inception of the hedge and in subsequent periods, the hedge is expected to be highly effective in achieving offsetting changes in fair value or cash flows attributable to the hedged risk during the period for which the hedge is designated.
(b) Retrospective Test: The actual results of the hedge are within a range of 80-125 per cent.
Example of Retrospective Test: If actual results are such that the loss on the hedging instrument is CU120 and the gain on the hedged item is CU100, offset can be measured by 120/100 = 120%, or by 100/120 = 83%. Both are within the 80-125% range, so the hedge would be considered highly effective.
Timing of Assessment: Effectiveness is assessed, at a minimum, at the time an entity prepares its annual or interim financial statements (AG106).
Methods of Assessment: This Standard does not specify a single method for assessing hedge effectiveness. The method depends on the entity's risk management strategy (AG107).
Perfect Effectiveness Indicators (AG108): If the principal terms of the hedging instrument and the hedged item are the same, the changes in fair value and cash flows attributable to the risk being hedged may be likely to offset each other fully. For example:
Discontinuation of Hedge Accounting (AG113): If an entity does not meet hedge effectiveness criteria, the entity discontinues hedge accounting from the last date on which compliance with hedge effectiveness was demonstrated.
5.4 Fair Value Hedges (Paragraphs 89-94)
Accounting Treatment (Paragraph 89):
If a fair value hedge meets the conditions in paragraph 88 during the period, it shall be accounted for as follows:
(a) Hedging Instrument: The gain or loss from remeasuring the hedging instrument at fair value (for a derivative) or the foreign currency component of its carrying amount (for a non-derivative) shall be recognised in profit or loss.
(b) Hedged Item: The gain or loss on the hedged item attributable to the hedged risk shall:
Portfolio Hedge Presentation (Paragraph 89A):
For a fair value hedge of the interest rate exposure of a portion of a portfolio of financial assets or financial liabilities, the gain or loss attributable to the hedged item may be presented:
Discontinuation of Fair Value Hedge Accounting (Paragraph 91):
An entity shall discontinue prospectively the hedge accounting if:
(a) The hedging instrument expires or is sold, terminated or exercised (with specific exceptions for replacement/rollover as part of documented hedging strategy and novation to a central counterparty)
(b) The hedge no longer meets the criteria for hedge accounting in paragraph 88
(c) The entity revokes the designation
Amortisation of Fair Value Adjustments (Paragraph 92):
Any adjustment arising from paragraph 89(b) to the carrying amount of a hedged financial instrument for which the effective interest method is used shall be amortised to profit or loss. Amortisation may begin as soon as an adjustment exists and shall begin no later than when the hedged item ceases to be adjusted for changes in its fair value attributable to the risk being hedged.
Firm Commitment as Hedged Item (Paragraphs 93-94):
When an unrecognised firm commitment is designated as a hedged item:
5.5 Cash Flow Hedges (Paragraphs 95-101)
Accounting Treatment (Paragraph 95):
If a cash flow hedge meets the conditions in paragraph 88 during the period, it shall be accounted for as follows:
(a) Effective Portion: The portion of the gain or loss on the hedging instrument that is determined to be an effective hedge shall be recognised in other comprehensive income (OCI)
(b) Ineffective Portion: The ineffective portion of the gain or loss on the hedging instrument shall be recognised in profit or loss
Detailed Accounting (Paragraph 96):
(a) The separate component of equity associated with the hedged item is adjusted to the lesser of (in absolute amounts):
(b) Any remaining gain or loss on the hedging instrument (that is not an effective hedge) is recognised in profit or loss
(c) If the entity's documented risk management strategy excludes a specific component from the assessment of hedge effectiveness, that excluded component is recognised in accordance with paragraph 5.7.1 of HKFRS 9
Reclassification to Profit or Loss - Financial Items (Paragraph 97):
If a hedge of a forecast transaction subsequently results in the recognition of a financial asset or a financial liability, the associated gains or losses that were recognised in OCI shall be reclassified from equity to profit or loss as a reclassification adjustment in the same period or periods during which the hedged forecast cash flows affect profit or loss.
Basis Adjustment Option - Non-Financial Items (Paragraph 98):
If a hedge of a forecast transaction subsequently results in the recognition of a non-financial asset or a non-financial liability, the entity shall adopt either:
(a) Reclassification Approach: Reclassify the associated gains and losses from OCI to profit or loss in the same period or periods during which the asset acquired or liability assumed affects profit or loss
(b) Basis Adjustment Approach: Remove the associated gains and losses from OCI and include them in the initial cost or other carrying amount of the asset or liability
Important: An entity shall adopt either (a) or (b) as its accounting policy and shall apply it consistently to all hedges to which paragraph 98 relates (Paragraph 99).
Discontinuation of Cash Flow Hedge Accounting (Paragraph 101):
An entity shall discontinue prospectively the hedge accounting in the following circumstances:
| Circumstance | Treatment of Cumulative Gain/Loss in OCI |
|---|---|
| (a) Hedging instrument expires, sold, terminated or exercised | Remain separately in equity until forecast transaction occurs |
| (b) Hedge no longer meets criteria | Remain separately in equity until forecast transaction occurs |
| (c) Forecast transaction is no longer expected to occur | Reclassified from equity to profit or loss immediately |
| (d) Entity revokes the designation | Remain separately in equity until forecast transaction occurs or is no longer expected to occur |
5.6 Hedges of a Net Investment (Paragraph 102)
Hedges of a net investment in a foreign operation shall be accounted for similarly to cash flow hedges:
(a) The portion of the gain or loss on the hedging instrument that is determined to be an effective hedge shall be recognised in OCI
(b) The ineffective portion shall be recognised in profit or loss
The gain or loss on the hedging instrument relating to the effective portion that has been recognised in OCI shall be reclassified from equity to profit or loss as a reclassification adjustment in accordance with paragraphs 48-49 of HKAS 21 on the disposal or partial disposal of the foreign operation.
6. INTEREST RATE BENCHMARK REFORM - TEMPORARY EXCEPTIONS (Paragraphs 102A-102Z3)
6.1 Scope and Application (Paragraphs 102A-102C)
These paragraphs apply only to hedging relationships directly affected by interest rate benchmark reform. A hedging relationship is directly affected if the reform gives rise to uncertainties about:
(a) The interest rate benchmark (contractually or non-contractually specified) designated as a hedged risk; and/or
(b) The timing or the amount of interest rate benchmark-based cash flows of the hedged item or of the hedging instrument
Definition: 'Interest rate benchmark reform' refers to the market-wide reform of an interest rate benchmark, including the replacement of an interest rate benchmark with an alternative benchmark rate (e.g., IBOR reform).
6.2 Temporary Exceptions (Paragraphs 102D-102I)
Highly Probable Requirement (Paragraph 102D):
For the purpose of applying the requirement that a forecast transaction must be highly probable, an entity shall assume that the interest rate benchmark on which the hedged cash flows are based is not altered as a result of interest rate benchmark reform.
Reclassification of Cumulative Gain/Loss (Paragraph 102E):
For the purpose of determining whether the forecast transaction is no longer expected to occur, an entity shall assume that the interest rate benchmark on which the hedged cash flows are based is not altered as a result of interest rate benchmark reform.
Effectiveness Assessment (Paragraphs 102F-102G):
Designation of Financial Items (Paragraphs 102H-102I):
6.3 End of Application (Paragraphs 102J-102O)
An entity shall prospectively cease applying the temporary exceptions when the uncertainty arising from interest rate benchmark reform is no longer present.
6.4 Phase 2 Amendments - Changes Required by Reform (Paragraphs 102P-102Z3)
Amending Hedge Designations (Paragraph 102P):
As and when the temporary exceptions cease to apply, an entity shall amend the formal designation of the hedging relationship to reflect changes required by interest rate benchmark reform. The hedge designation shall be amended only to make one or more of these changes:
(a) Designating an alternative benchmark rate as a hedged risk
(b) Amending the description of the hedged item, including the description of the designated portion of the cash flows or fair value being hedged
(c) Amending the description of the hedging instrument
(d) Amending the description of how the entity will assess hedge effectiveness
Timing of Amendment (Paragraph 102S):
An entity shall amend a hedging relationship by the end of the reporting period during which a change required by interest rate benchmark reform is made.
Nature of Amendment (Paragraph 102S):
Such an amendment to the formal designation constitutes neither the discontinuation of the hedging relationship nor the designation of a new hedging relationship.
Retrospective Effectiveness Assessment (Paragraph 102V):
For the purpose of assessing retrospective effectiveness on a cumulative basis, an entity may elect to reset to zero the cumulative fair value changes of the hedged item and hedging instrument when ceasing to apply the temporary exception.
Cash Flow Hedges - Deemed Basis (Paragraph 102W):
When an entity amends the description of a hedged item, the cumulative gain or loss in OCI shall be deemed to be based on the alternative benchmark rate on which the hedged future cash flows are determined.
Groups of Items (Paragraph 102Y):
When applying the amendments to groups of items, the entity shall allocate the hedged items to subgroups based on the benchmark rate being hedged and designate the benchmark rate as the hedged risk for each subgroup.
24-Month Separately Identifiable Deeming Provision (Paragraph 102Z1):
An alternative benchmark rate designated as a non-contractually specified risk portion that is not separately identifiable at the date it is designated shall be deemed to have met that requirement if, and only if, the entity reasonably expects the alternative benchmark rate will be separately identifiable within 24 months.
7. EFFECTIVE DATE AND TRANSITION (Paragraphs 103-108K)
7.1 General Effective Date (Paragraph 103)
An entity shall apply this Standard for annual periods beginning on or after 1 January 2005. Earlier application is permitted.
7.2 Transition Provisions (Paragraph 104)
Prospective Application: For transactions entered into before the beginning of the financial year in which this Standard is initially applied that the entity did previously designate as hedges, the recognition, derecognition, and measurement provisions shall be applied prospectively.
Fair Value Hedges: At the beginning of the financial year in which this Standard is initially applied, any balance sheet positions in fair value hedges of existing assets and liabilities should be accounted for by adjusting their carrying amounts to reflect the fair value of the hedging instrument.
Cash Flow Hedges: If an entity's hedge accounting policies prior to initial application had included deferral of gains or losses on cash flow hedges, those deferred gains and losses should be reclassified as a separate component of equity to the extent that the transactions meet the criteria in paragraph 88.
No Retrospective Designation: Transactions entered into before the beginning of the financial year in which this Standard is initially applied should not be retrospectively designated as hedges.
7.3 Interest Rate Benchmark Reform Transition (Paragraphs 108G-108K)
Phase 1 Amendments (Paragraph 108G):
Phase 2 Amendments (Paragraph 108H):
Reinstatement of Discontinued Hedging Relationships (Paragraph 108I):
An entity shall reinstate a discontinued hedging relationship if, and only if:
(a) The entity had discontinued that hedging relationship solely due to changes required by interest rate benchmark reform and the entity would not have been required to discontinue if the amendments had been applied at that time; and
(b) At the beginning of the reporting period in which an entity first applies these amendments, that discontinued hedging relationship meets the qualifying criteria for hedge accounting
8. PORTFOLIO HEDGE OF INTEREST RATE RISK - APPLICATION GUIDANCE (AG114-AG132)
8.1 Procedures for Portfolio Fair Value Hedge (AG114)
For a fair value hedge of interest rate risk associated with a portfolio of financial assets or financial liabilities, an entity would meet the requirements of this Standard if it complies with the following procedures:
(a) Identify Portfolio: Identify a portfolio of items whose interest rate risk it wishes to hedge. The portfolio may comprise only assets, only liabilities or both.
(b) Analyse into Repricing Time Periods: Analyse the portfolio into repricing time periods based on expected, rather than contractual, repricing dates.
(c) Determine Hedged Amount: Decide the amount to hedge. Designate as the hedged item an amount of assets or liabilities (but not a net amount) from the identified portfolio.
(d) Designate Hedged Risk: Designate the interest rate risk being hedged (e.g., a benchmark interest rate such as LIBOR).
(e) Designate Hedging Instruments: Designate one or more hedging instruments for each repricing time period.
(f) Assess Effectiveness: Assess at inception and in subsequent periods whether the hedge is expected to be highly effective.
(g) Measure Change in Fair Value of Hedged Item: Periodically measure the change in the fair value of the hedged item attributable to the hedged risk and recognise it in profit or loss and in a separate line item in the statement of financial position.
(h) Measure Change in Fair Value of Hedging Instrument: Measure the change in fair value of the hedging instrument and recognise it in profit or loss.
(i) Recognise Ineffectiveness: Any ineffectiveness will be recognised in profit or loss as the difference between the change in fair value of the hedged item and the hedging instrument.
8.2 Expected Repricing Dates (AG117)
The expected repricing date of an item is determined as the earlier of the dates when that item is expected to mature or to reprice to market rates. Expected repricing dates are estimated at the inception of the hedge and throughout the term of the hedge, based on historical experience and other available information.
8.3 Designation Example (AG118)
If in a particular repricing time period an entity estimates that it has fixed rate assets of CU100 and fixed rate liabilities of CU80 and decides to hedge all of the net position of CU20, it designates as the hedged item assets in the amount of CU20 (a portion of the assets).
8.4 Sources of Ineffectiveness (AG124)
Ineffectiveness may arise from:
(a) Actual repricing dates being different from those expected, or expected repricing dates being revised
(b) Items in the hedged portfolio becoming impaired or being derecognised
(c) Payment dates of the hedging instrument and the hedged item being different
(d) Other causes (e.g., when some hedged items bear interest at a rate below the benchmark rate)
9. KEY TAKEAWAYS SUMMARY
| Topic | Key Point |
|---|---|
| Scope of HKAS 39 | Only hedge accounting requirements remain; all other aspects superseded by HKFRS 9 |
| Hedging Instruments | Derivatives generally qualify; non-derivatives only for foreign currency risk; written options generally do not qualify |
| Hedged Items | Can be recognised assets/liabilities, firm commitments, highly probable forecast transactions, or net investments in foreign operations |
| Three Types of Hedges | Fair value hedge, cash flow hedge, hedge of net investment |
| Qualification Conditions | Formal documentation, expected high effectiveness, highly probable forecast transaction (for cash flow hedges), reliable measurement, ongoing assessment |
| Effectiveness Range | 80-125% for retrospective test |
| Fair Value Hedge Accounting | Both hedging instrument and hedged item changes recognised in profit or loss |
| Cash Flow Hedge Accounting | Effective portion in OCI; ineffective portion in profit or loss |
| Basis Adjustment | Optional for non-financial items; mandatory reclassification for financial items |
| Portfolio Hedges | Only for fair value hedge of interest rate risk; designated as amount of currency, not net position |
| Interest Rate Benchmark Reform | Temporary exceptions from certain requirements; Phase 2 allows amendment of hedge designations |
| Non-Financial Items | Can only be hedged in entirety or for foreign currency risk |
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