IFRIC 16 Hedges of a Net Investment in a Foreign Operation

The International Financial Reporting Interpretations Committee (IFRIC) issued IFRIC 16 Hedges of a Net Investment in a Foreign Operation, to provide guidance on accounting for the hedge of a net investment in a foreign operation in an entity’s consolidated financial statements. Why? Many differences practice were in place based on different views on which risks are eligible for hedge accounting. International Financial Reporting Standards (IFRSs) made this seem vague and easily interpreted differently.

Clarification was provided for in the following three areas:

1. Risks in foreign currency exposure. This can be from functional currencies of the foreign operation and the parent entity. It can also be risk from the foreign currency exposure to the functional currency of the foreign operation, including presenting the currency of the parent’s consolidated financial statements.

2. Which member of the group can hold the hedge when hedging a net investment in a foreign operation. Particularly, whether the parent entity holding the net investment in a foreign operation must also hold the hedging instrument.

3. How to determine the amounts to be reclassed from equity to the income statement for both the hedging instrument and the hedged item, when the investment is disposed of.

How was this solved?

IFRIC 16 states that? the presentation currency does not create an exposure to which an entity may apply hedge accounting. As a result, a parent entity can only hedged risk the risk of foreign exchange differences that come up as the result of a difference between the functional currency it operates in and that of its foreign operation.

IFRIC 16 concludes that while IAS 39 must be applied to determine the amount that needs to be reclassified to profit or loss from the foreign currency translation reserve in respect of the hedging instrument, IAS 21 must be applied in respect of the hedged item.