Telstra 2007 Annual Report Download - page 134

Telstra Corporation Limited and controlled entities
131
Notes to the Financial Statements (continued)
2.22 Derivative financial instruments
We use derivative financial instruments such as forward exchange
contracts, cross currency swaps and int erest rate swaps to hedge risks
associat ed with foreign currency and interest rate fluctuations.
The use of hedging instruments is governed by the guidelines set by
our Board of Directors.
Derivatives are init ially recognised at fair value on the date a
derivative contract is entered into and are subsequently remeasured
to fair value. The method of recognising the result ing remeasurement
gain or loss depends on whether the derivative is designated as a
hedging instrument, and if so, the nature of the item being hedged.
Where we hold derivative financial instruments that are not
designated as hedges, they are categorised as 'held for trading'
financial instruments. All of our derivative financial inst ruments are
stated at fair value.
The carrying value of our cross currency and int erest rate swaps refers
to the fair value of our receivable or payable under the swap contract,
recorded as a hedge receivable or hedge payable in our balance sheet.
We do not offset the hedge receivable or hedge payable with the
underlying financial asset or financial liability being hedged, as the
transactions are generally with different counterparties and are not
generally sett led on a net basis.
Where we have a legally recognised right to set off the financial asset
and the financial liability, and we intend to settle on a net basis or
simultaneously, we record this position on a net basis in our balance
sheet. Where we enter into master netting arrangements relating to a
number of financial instruments, have a legal right of set off, and
intend to do so, we also include this position on a net basis in our
balance sheet.
Our derivat ive instruments that are held to hedge exposures can be
classified into three different types, depending on the reason we are
holding them - fair value hedges, cash flow hedges and hedges of net
investment in foreign operations.
Hedge accounting can only be utilised where effectiveness tests are
met on both a prospective and retrospective basis. Ineffectiveness
may result in significant volatility in the income statement.
We formally designate and document at the incept ion of a
transaction the relat ionship between hedging instruments and
hedged items, as well as our risk management objective and strategy
for undertaking various hedge transactions. We also document our
assessment, both at hedge inception and on an ongoing basis, of
whether the hedging instruments that are used in hedging
transactions have been, and will continue to be, highly effective in
offsetting changes in fair values or cash flows of hedged items.
Purchases and sales of derivat ive financial instruments are recognised
on trade date being the date on which we commit to purchase or sell
an asset.
(i) Fair value hedges
We use fair value hedges to mitigate the risk of changes in the fair
value of our foreign currency borrowings from foreign currency and
interest rate fluctuations over the hedging period.
Where a fair value hedge qualifies for hedge accounting, gains or
losses from remeasuring the fair value of the hedging instrument are
recognised in the income statement, together with gains and losses in
relation to the hedged item where those gains or losses relate t o the
risks intended to be hedged. This will increase volatility of reported
profits due to the inclusion of some ineffectiveness arising from the
application of hedge accounting.
(ii) Cash flow hedges
We use cash flow hedges to mitigat e the risk of variability of future
cash flows attributable to foreign currency fluctuations over the
hedging period. Cash flow hedges are used for our foreign currency
borrowings and our ongoing business activities, predominantly where
we have highly probable purchase or settlement commitments in
foreign currencies.
Where a cash flow hedge qualifies for hedge accounting, the effective
portion of gains or losses on remeasuring the fair value of the hedging
instrument are recognised directly in equity in the cash flow hedging
reserve until such time as the hedged item affects profit or loss, then
the gains or losses are transferred to the income statement. However,
in our hedges of forecast transactions, when the forecast transaction
that is hedged results in the recognit ion of a non-financial asset (for
example, inventory or fixed asset), the gains and losses previously
deferred in equity are transferred from equity and included in the
measurement of the initial cost or carrying amount of the asset. Gains
or losses on any portion of the hedge determined to be ineffective are
recognised immediately in the income statement. The application of
hedge accounting will create some volatility in equit y reserve
balances.
When a hedging instrument expires or is sold or terminated, or when
a hedge no longer meets the criteria for hedge accounting, any
cumulative gain or loss existing in equity at that time remains in
equity and is recognised when the hedged item is ult imately
recognised in the income statement.
If a forecast hedged transaction is no longer expected to occur, the
cumulative gains or losses on the hedging instrument that were
reported in equit y are transferred immediately to the income
statement.
2. Summary of accounting policies (continued)