Accounting for Derivatives Training Course

Equip yourself with the skills and information to master:

• The impact of all changes to IFRS, including IFRS 9 and convergence with US GAAP
• The implications of the IFRS framework principles for the recording and reporting of derivatives
• The pricing and risk characteristics of each of the main derivatives product groups, and how they feed through into the accounting and valuation processes
• Core accounting procedures for all standard derivatives types, ranging from the basic ‘building-block’ products such as FRAs and FX forwards, to swaps, futures and options
• Processes and issues associated with the hierarchy of valuation methods, including fair value, mark-to-market, and the construction of valuation models for illiquid derivatives and their underlying components
• The theory and practice of hedge accounting
• Presentation and disclosure of risks and risk management policies associated with derivatives activity

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Day 1

Key IFRS Principles and Concepts

• The central objective of accounting: supporting a wide range of economic decisions about the
  future
• Fair value versus historic cost
• The importance of the ‘Reliable Measurement’ principle
• Reporting risk ‘as seen through the eyes of management’

Overview of the Key Standards

• Definitions of financial instruments and derivatives
• Scoping issues including:
  – Financial guarantees
  – Derivatives on non-financial underlyings
  – Undrawn commitments
  – The distinction between equity and debt

Classification and Measurement: 1 - Based on Unamended IAS 39

• The four categories of assets
• The two categories of liabilities
• Embedded derivatives: identification and accounting treatment
• Permitted and forbidden classifications and transfers
• Amortised cost /effective interest rate method of accounting for income and expense

Classification and Measurement: 1 - Based on New IFRS 9

• This session will be devoted to a detailed study of such parts of the proposed new IFRS 9 that
  have been published (either in final form or as exposure drafts) as at the date of the course. Details of the content will be made available on enquiry, nearer to the start-date of the course itself.

Day 2

Derivatives Products: The Basics

• The three criteria for treatment as a derivative under IFRS:
  – The underlying
  – Low/no initial investment: leverage
  – Future settlement
• The two families of derivatives products:
  – Linear products (forwards, futures, FRAs and swaps)
  – Nonlinear products (options)
• Valuation principles:
  – Replication in the cash market
  – Arbitrage-free pricing
  – The importance of risk

Derivatives in Detail: Linear Products

• Cost-of-carry as the main determinant of the relationship to the underlying
• Understanding interest rates:
  – The term structure
  – Bootstrapping the zero curve
• Why linear derivatives always can be, and usually are, priced as fair bargains with no initial investment
• The products in detail:
  – The FRA as the basic building-block of all interest-rate derivatives
  – The forward FX contract as the basic building-block of forex derivatives
  – The swap as a chain of FRAs
• Specific pricing and valuation issues including:
  – Deriving the zero curve for swaps
  – Forward-start swaps
  – The imperfect match between FRAs and traded futures
• Accounting for linear derivatives:
  – At inception
  – On subsequent accounting dates
  – At derecognition
  – Special issues, including:
     > The ban on amortising forward FX points
     > Double-counting of accrued interest on swaps

Derivatives in Detail: Nonlinear Products

• Why options are always unfair bargains requiring initial or deferred investment by the buyer
• Understanding the main components of options pricing:
  – Intrinsic value
  – Time value
• Understanding the components of time value:
  – Volatility, historical and implied
  – Interest rates
  – Why time value is always greatest at-themoney
• The principal options products in practice:
  – FX options
  – Share options including options on indices and on index futures
  – Options on interest rate futures and swaps
  – Commodity options within the scope of IFRS
• Accounting for nonlinear derivatives:
  – At inception
  – On subsequent accounting dates
  – At derecognition
  – Special issues, including:
     > The ban on amortising option premiums

Day 3

Hedging Accounting Under IFRS (Subject to Change by New IFRS 9)

• Why hedge accounting?
  – To eliminate accounting mismatches
  – To provide more reliable and relevant information on performance and risk
  – To bring external and internal performance measurement into line with each other
• Three types of hedge accounting:
  – Fair value hedge
  – Cash flow hedge
  – Hedge of net investment in foreign operation
• Some special issues:
  – Detailed policies and procedures for hedge accounting
  – Documentation requirements
  – What is a ‘highly probable’ future transaction?

Hedge Accounting in Practice (Subject to Change by New IFRS 9)

• Permissible and impermissible instruments and combinations for:
  – The hedged item
  – The hedging instruments
  – Understanding the exceptions
• Designing an optimum hedge:
  – Aligning the risks of hedged item and hedging instrument
  – Minimising potential ineffectiveness
• Accounting for hedges in detail – procedures and pitfalls:
  – The fair value hedge
  – The cash flow hedge
  – The hedge of net investment in foreign operation

Measurement and Disclosure Issues Under IFRS

• Current issues in valuation, including:
  – Determining fair value in illiquid markets
  – The problem of disappearing benchmarks, e.g. LIBOR
  – Factoring counterparty risk into the valuation process post-Lehman
• Current issues in disclosure, including:
  – Basic and enhanced disclosures under IFRS 7
  – How to present risk ‘through the eyes of management’

Update on Current IFRS Projects

• IFRS convergence with US GAAP
• The simplification project: replacement of IAS 39 with IFRS 9
• Advances in fair value methodology
• Outstanding issues between IFRS and the EU

Coming hot on the heels of the mass changeover to IFRS (which is itself in a state of flux), the fallout from the credit crunch has also laid bare just how stretched the accounting and risk management functions of many organisations have become as they strive to keep up with accounting, reporting and regulatory developments.

You will get an understanding, not only of the accounting for derivatives but also of the products themselves,  and invaluable practical insight into the most accurate and effective derivatives accounting techniques currently in use. You will learn the essentials of current market practice and regulation and be prepared for their effects and implications on your systems and procedures.