Audit Firms in Dubai Rundown IFRS 9 and IAS 39 - EXPLAINOPEDIA
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Audit Firms in Dubai Rundown IFRS 9 and IAS 39

by Raja Mehar

Audit Firms in Dubai Rundown IFRS 9 and IAS 39 On Affected Hedging Relationships

IASB’s proposal to amend the hedge accounting requirements in IAS 39 Financial Instruments:. Recognition and Measurement (“IAS 39”) and IFRS 9 Financial Instruments (“IFRS 9”) has been prompted by the ongoing reform of short-term interest rate benchmarks and potential future uncertainties. The body released a draft of the Interest rate Benchmark Reform. How do the reform impact hedge accounting requirements for audit firms in Dubai & UAE, and why is the exposure draft issued?

Understanding the Exposure Draft

The Financial Stability Board (“FSB”) issued a report in 2014 questioning the reliability of short-term Interbank Offered Rates (“IBOR”). Such as LIBOR, following the 2008 liquidity crisis. In response to these events, a report recommends improving the governance of existing reference rates (such as IBOR and EONIA) and establishing alternative risk-free interest rates.

Several large-scale reforms have been launched in response to these recommendations. However, none have been adequately implemented across national and transnational jurisdictions. Other jurisdictions have left room for existing and new benchmark rates or kept the older ones. Different countries have different timetables for implementing reforms and different rates of reform implementation.

As a result, These reference rates introduce uncertainty in the timing and amount of future cash flows. Changes to existing rates may involve amending affected contracts. Which can be pretty demanding, particularly when the counterparties must agree and sign off and be time-consuming. In practice, the effective dates of these changes can be spread over months or even years.

The IASB launched a review to examine the impact of the reform on accounting. This project is divided into two phases:

Phase I

  •   Identifying and correcting accounting issues before replacing an existing interest rate benchmark.

Phase II

  •   Replacing the interest rate benchmark with the new bar.

Phase I of the exposure draft proposes amendments to IAS 39 and IFRS 9 hedge accounting requirements. It was published in May 2019. The amendments are therefore proposed because the reform is likely to have implications. That may cause some hedging relationships to be terminated, including:

  •   The disappearance (or the change in the probability of occurrence of interest rate risk components or hedged cash flows) of a benchmark component.
  •   Derecognition may result from the amendment of hedged contracts.
  •   Due to the reform, the relationship between the hedging instrument and the hedged item is ineffective.

Proposed Amendments To The Hedging Requirements

It was proposed that the IAS 39 and IFRS 9 eligibility requirements for interest rate hedging relationships be relaxed. This avoids situations where hedging relationships are discontinued or become ineligible. Simply because of uncertainty caused by benchmark rates for future contractual cash flows. The proposed relief relates to the prospective assessment criteria as a first step.

The hedging relationship must make sense if the hedged item is a future transaction that is “highly probable” according to IAS 39 and IFRS 9. Investing in this prospective transaction would result in cash flows based on the existing interest rate benchmarks.

However,

Since the current reference rate could be replaced by a new one. Its “highly probable” nature may be challenged. When assessing whether such a future transaction is “highly probable,”. The IASB proposes not to consider the effects of the ongoing interest rate reform.

Moreover, the IASB proposes audit firms in Dubai & UAE to overlook the impact of the reform on the perspectives on cash flow hedges and fair value hedges:

According to IAS 39, the future value changes of the hedging instrument and the hedged item should be offset. The hedge is “highly effective” for its entire life.

Hedging instruments must demonstrate an economic relationship with hedged items under IFRS 9. In other words, the value of a hedging instrument moves in opposite directions due to the same risk. The hedged risk). A different procedure is being proposed for a case in which the reform affects an interest rate risk component. That is not contractually specified.

A fair value hedging relationship occurs, for instance. When an entity sets up a 2-year fixed-rate liability at 4 percent against a benchmark interest rate.

It is permissible to hedge a designated risk component of an item rather than the entire item. Provided that the hedging relationship is both established and measurable from the beginning.

According to the exposure draft,  audit services in Dubai & UAE would be expected to apply the standard only at the onset of a hedging relationship rather than continuously.

Hedging Instrument

Indicator of the instrument’s carrying amount. As a result of ineffective hedge relationships, the fair value of the instrument used to determine the hedge relationship ineffectiveness changes.

  •   Instrument value as a nominal amount.
  •   Hedged item.

Fair value hedges:

  •   Calculating the hedged amount.
  •   Hedged item’s fair value adjustment reserve is reflected in the statement of financial position.

Hedge Of Cash Flow From Foreign Operations or Hedge Of Net Investment:

  •   Hedge reserves for continuing hedges in cash flow hedges / foreign exchange reserves.
  •   There are no balances in the foreign currency translation reserve or the cash flow hedge reserve for any hedging relationships no longer hedged.

All hedges:

  •   As a basis for recognizing hedge ineffectiveness, change in the hedged item’s fair value.

Mandatory Application

  •   According to the IASB, audit specialists in Dubai & UAE must apply this amendment retrospectively to interim results beginning 1 January 2020 but could be used earlier.
  •   A limited period would apply to the amendment, ending either:
  •   The interest rate benchmark-based cash flows will cease to be uncertain based on their timing and amount.

If the hedging relationship ends, it may be reclassified to profit or loss. Alternatively, It may be reclassified to profit or loss if all cash flow hedge reserves related to the hedging relationship are reclassified to profit or loss.

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