5.3 Derivatives and Hedging

IFRS Accounting Standards and U.S. GAAP contain somewhat similar requirements related to derivatives and hedging. For example, both sets of standards require derivatives to be accounted for at fair value, and both distinguish between fair value hedges and cash flow hedges. However, the definition of a “derivative” is narrower under U.S. GAAP than it is under IFRS Accounting Standards and, as a result, more instruments may meet the definition under IFRS Accounting Standards. Further, although the base premise of hedge accounting is similar under IFRS Accounting Standards and U.S. GAAP, as the table below shows, there are numerous detailed differences in the requirements entities must follow under the two sets of standards to qualify for, document, and apply hedge accounting.

Topic	IFRS Accounting Standards (IFRS 9, IAS 32)	U.S. GAAP (ASC 815)
“Derivative” — definition	For an instrument to meet the definition of a derivative, the following characteristics must be present: Its value changes in response to an underlying (e.g., specified interest rate, commodity price, foreign currency rate, credit rating, and so forth, provided in the case of a nonfinancial variable that the variable is not specific to a party to the contract). It requires no or a small initial net investment. It is settled at a future date. Though the definition of a derivative under IFRS Accounting Standards does not include a net settlement characteristic, contracts to purchase or sell nonfinancial items are within the scope of IFRS 9 only if they can be settled net.	For an instrument to meet the definition of a derivative, the following characteristics must be present: It contains “[o]ne or more underlyings” and “[o]ne or more notional amounts or payment provisions or both” (ASC 815-10). It requires no or a small initial net investment. It requires or permits net settlement (i.e., via contractual terms or via means outside the contract), or it provides for delivery of an asset that is readily convertible to cash.
Derivatives — scope	While both IFRS Accounting Standards and U.S. GAAP provide scope exceptions for certain contracts to purchase or sell nonfinancial items that will be purchased, sold, or used in the normal course of business, under IFRS Accounting Standards, the own-use scope exception for qualifying contracts is not elective and does not require an entity to document its designation of a contract as “own-use.”	The normal purchases and normal sales scope exception for qualifying contracts to purchase or sell nonfinancial items is elective and requires the designation to be documented.
Embedded derivatives — initial recognition	While the overall criteria for bifurcation are similar to those under U.S. GAAP, the bifurcation requirements do not apply to financial assets within the scope of IFRS 9. Therefore, if a hybrid contract contains a host that is a financial asset within the scope of IFRS 9, the bifurcation requirements do not apply.	The bifurcation requirements apply to both assets and liabilities, including financial assets. In addition, the application guidance under U.S. GAAP is more detailed than that under IFRS Accounting Standards. Accordingly, an entity may not necessarily reach the same conclusion under IFRS Accounting Standards as under U.S. GAAP about whether the conditions for bifurcation are met.
Embedded derivatives — debt with embedded put or call option	A put, call, or prepayment option embedded in a debt contract liability is not considered closely related to a debt host contract unless (1) the exercise price is approximately equal on each exercise date to the debt host contract’s amortized cost (before the separation of any equity component) or (2) the exercise price results in reimbursement to the lender for an amount up to the approximate present value of lost interest for the remaining term.	A put, call, or prepayment option embedded in a debt contract is considered not clearly and closely related to a debt host contract if (1) it is indexed to an underlying other than interest rates, credit risk, or inflation; (2) the debt involves a substantial discount or premium and the option is contingent; or (3) the option is not contingent and the negative-yield or double-double test is passed.
Embedded equity components — initial recognition	Embedded equity-linked features that qualify as equity are separated from liabilities and accounted for as equity.	Embedded equity-linked features that qualify as equity are not separated from liabilities except in specified circumstances (see Section 2.4).
Embedded equity components — initial measurement	The with-and-without method is used for initial measurement of equity components. The liability component is measured first.	Different methods apply for initial measurement of equity components depending on the reason an amount is allocated to equity.
Contract on an entity’s own equity — exercise contingencies	Exercise contingencies are not specifically addressed by IAS 32. In practice, exercise contingencies that would preclude equity classification under U.S. GAAP may not do so under IFRS Accounting Standards.	Exercise contingencies must be evaluated to determine whether they preclude equity classification.
Contract on an entity’s own equity — settlement amount	A contract on an entity’s own equity must be fixed for fixed to qualify as equity. Unlike U.S. GAAP, IFRS Accounting Standards do not provide detailed guidance on contracts with adjustment provisions (e.g., antidilution provisions).	To qualify as equity, the contract must be a fixed-for-fixed forward or option on equity shares, or the only variables that can adjust the settlement amount are inputs to a fixed-for-fixed forward or option. Although the fixed-for-fixed concept under U.S. GAAP is similar to that under IFRS Accounting Standards, the application may differ in some respects (e.g., the accounting for instruments with down-round provisions).
Contract on an entity’s own equity — net cash settlement provisions	Equity classification is precluded. Unlike U.S. GAAP, IFRS Accounting Standards do not contain detailed guidance on how to evaluate whether an entity might be required to net cash settle a contract that specifies share settlement.	Equity classification is precluded if the entity could be forced to net cash settle the contract. There is detailed guidance on how to assess whether an entity is able to settle in shares (e.g., whether the entity has sufficient authorized and unissued shares available to share settle the contract).
Contract on an entity’s own equity — net share settlement provisions	Equity classification is precluded.	Equity classification is not precluded if the entity cannot be forced to net cash settle the contract.
Contract on an entity’s own equity — settlement alternatives	Equity classification is precluded (unless all settlement alternatives are consistent with equity classification).	Equity classification is not precluded if the entity cannot be forced to net cash settle the contract.
Hedge accounting — “highly effective” threshold to quality for hedge accounting	The concept of a highly effective threshold does not exist; instead, IFRS 9 requires that (1) there is an economic relationship between the hedging instrument and the hedged item, (2) credit risk does not dominate the value changes that result from the economic relationship, and (3) the hedging relationship’s hedge ratio reflects the hedge ratio of the actual quantities of the hedging instrument and the hedged item.	The hedging instrument must be highly effective at offsetting changes in fair value or cash flows.
Hedge documentation and initial prospective quantitative hedge effectiveness assessment	Entities are required to complete all hedge documentation at hedge inception.	Entities must complete most hedge documentation at hedge inception; however, they generally do not need to complete the initial prospective quantitative hedge effectiveness assessment until the first quarterly hedge effectiveness assessment date (i.e., up to three months), although earlier completion may be required in some circumstances. Private companies that are not financial institutions and certain not-for-profit entities do not need to perform and document the initial and subsequent quarterly effectiveness assessments until the date the next interim (if applicable) or annual financial statements are available to be issued (however, these entities must document certain aspects of the hedging relationship at hedge inception).
Hedge accounting — method for assessing effectiveness	IFRS Accounting Standards do not specify a method for assessing hedge effectiveness. Entities are required to make ongoing qualitative or quantitative assessments (at a minimum at each reporting date).	Entities are generally required to perform an initial quantitative prospective assessment of hedge effectiveness (unless the shortcut method is applied). However, if certain criteria are met, they can elect to subsequently perform prospective and retrospective effectiveness assessments qualitatively unless facts and circumstances change.
Hedge accounting — shortcut method	The shortcut method is not permitted.	The shortcut method is permitted for hedging relationships involving an interest rate swap and an interest-bearing financial instrument that meet specific requirements. If an entity elects the shortcut method and later determines that it was not or is no longer appropriate, it can apply the long-haul method as long as: The entity documented at hedge inception the quantitative method it would use to assess hedge effectiveness and measure hedging results if the shortcut method could not be applied. The hedge was highly effective for the periods in which the shortcut method criteria were not met. The qualifying criteria also enable partial-term fair value hedges to qualify for shortcut accounting.
Hedge accounting — dedesignation	An entity may dedesignate the hedging relationship only when the hedging relationship (or a part of the hedging relationship) ceases to meet the qualifying criteria.	An entity may voluntarily discontinue hedge accounting at any time by removing the designation of the hedging relationship.
Hedge accounting — basis adjustment in cash flow hedges	If a hedged forecasted transaction results in the recognition of a nonfinancial asset or nonfinancial liability, or if it becomes a firm commitment for which fair value hedge accounting is applied, the amounts that were included in the cash flow hedge reserve are removed and included directly in the initial cost or other carrying amount of the related asset or the liability.	Basis adjustments for the realized effective amounts associated with cash flow hedges are not permitted. Instead, amounts in AOCI must be reclassified into earnings in the same period(s) in which the hedged forecasted transaction affects earnings.
Hedge accounting — nonfinancial risk components in cash flow hedges	An entity may designate nonfinancial components as hedged items under the principle that a component may be designated as a hedged item if it is separately identifiable and reliably measurable. There is no requirement that the component be contractually specified.	An entity is prohibited from designating changes in cash flows of a component of a nonfinancial item as the hedged risk, with the exception of the risk of changes in the functional-currency-equivalent cash flows of a forecasted purchase or sale attributable to changes in the related foreign currency exchange rate.
Hedge accounting — measurement and recognition of hedge ineffectiveness in cash flow hedges	An entity must recognize and measure hedge ineffectiveness (other than that arising from cumulative cash flow underhedges) in each reporting period.	If the relationship between the hedged item and hedging instrument is highly effective at offsetting changes in the cash flows, an entity should record, in OCI, the entire change in the designated hedging instrument’s fair value that is included in the hedge effectiveness assessment.
Application of critical-terms-match method to a cash flow hedge of a group of forecasted transactions	No formal approach exists; however, entities may be able to qualitatively assess hedge effectiveness when the critical terms of the hedging instrument match those of the hedged item.	Entities may use the critical-terms- match method when hedging the cash flows of a group of forecasted transactions if (1) those transactions occur within the same 31-day period or the same fiscal month in which the hedging derivative matures and (2) all other method requirements are met.
Hedge accounting — eligible benchmark interest rates in fair value hedges	An entity may designate components that are separately identifiable and reliably measurable.	ASC 815 prescribes the eligible benchmark interest rates that may be designated in fair value hedges of interest rate risk. The only permissible U.S. benchmark interest rates are U.S. Treasury rates, London Interbank Offered Rate swap rates, the Fed Funds Effective Rate Overnight Index Swap Rate, the Securities Industry and Financial Markets Association Municipal Swap Rate, and the Secured Overnight Financing Rate Overnight Index Swap Rate.