Barclays 2005 Annual Report Download - page 143

Barclays PLC
Annual Report 2005 141
3.5
To the extent that the changes in the fair value of the hedging
derivative differ from changes in the fair value of the hedged risk in the
hedged item; or the cumulative change in the fair value of the hedging
derivative differs from the cumulative change in the fair value of
expected future cash flows of the hedged item, the hedge is deemed
ineffective. The amount of ineffectiveness, provided it is not so great as
to disqualify the entire hedge for hedge accounting, is recorded in the
income statement, in net interest income.
Fair value hedge accounting
Changes in fair value of derivatives that qualify and are designated as
fair value hedges are recorded in the income statement, together with
changes in the fair value of the hedged asset or liability that are
attributable to the hedged risk.
If the hedge no longer meets the criteria for hedge accounting, the fair
value hedging adjustment cumulatively made to the carrying value of
the hedged item is, for items carried at amortised cost, amortised over
the period to maturity of the previously designated hedge relationship
using the effective interest method. For available for sale items this fair
value hedging adjustment remains in equity until the hedged item
affects profit or loss.
If the hedged item is sold or repaid, the unamortised fair value
adjustment is recognised immediately in the income statement.
Cash flow hedges
For qualifying cash flow hedges, the fair value gain or loss associated
with the effective portion of the cash flow hedge is recognised initially
in shareholders’ equity, and recycled to the income statement in the
periods when the hedged item will affect profit or loss. Any ineffective
portion of the gain or loss on the hedging instrument is recognised in
the income statement immediately.
When a hedging instrument expires or is sold, 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 forecast transaction is ultimately recognised in the income
statement. When a forecast transaction is no longer expected to
occur, the cumulative gain or loss that was recognised in equity
is immediately transferred to the income statement.
Hedges of net investments
Hedges of net investments in foreign operations, including monetary
items that are accounted for as part of the net investment, are
accounted for similarly to cash flow hedges; the effective portion of the
gain or loss on the hedging instrument is recognised directly in equity
and the ineffective portion is recognised immediately in the income
statement. The cumulative gain or loss previously recognised in equity
is recognised in the income statement on the disposal or partial
disposal of the foreign operation.
Hedges of net investments may include non-derivative liabilities as well
as derivative financial instruments although for a non-derivative liability
only the foreign exchange risk is designated as a hedge.
Derivatives that do not qualify for hedge accounting
Derivative contracts entered into as economic hedges that do not
qualify for hedge accounting are held at fair value through profit
or loss.
Hedge accounting is not generally applied to credit derivatives that
are purchased to reduce credit risk for large portfolios of loans
and receivables.
Prior to 1st January 2005
Derivatives used for hedging purposes are measured on an accruals
basis consistent with the assets, liabilities, positions or future cash
flows being hedged. The gains and losses on these instruments
(arising from changes in fair value) are not recognised in the income
statement immediately as they arise. Such gains are either not
recognised in the balance sheet or are recognised and carried forward.
When the hedged transaction occurs, the gain or loss is recognised
in the income statement at the same time as the hedged item.
The criteria required for a derivative instrument to be classified as
a designated hedge are that:
(i) the transaction must be reasonably expected to match or eliminate
a significant proportion of the risk inherent in the assets, liabilities,
other positions or cash flows being hedged and which results from
potential movements in market rates and credit risk; and
(ii) adequate evidence of the intention to hedge and linkage with the
underlying risk inherent in the assets, liabilities, other positions
or cash flows being hedged, must be established at the outset of
the transaction.
Designated hedges are reviewed for effectiveness by regular tests
to determine that the hedge is closely negatively correlated to the
designated hedged position in each and every identified time band
in the maturity profile.
Profits and losses on interest rate swaps and options entered into for
hedging purposes are measured on an accrual accounting basis,
included in the related category of income and expense and reported
as part of the yield on the hedged transaction. Amounts paid or
received over the life of futures contracts are deferred until the contract
is closed; accumulated deferred amounts on futures contracts and
settlement amounts paid or received on forward contracts are
accounted for as elements of the carrying value of the associated
instrument, affecting the resulting yield.
A premium paid or received in respect of a credit derivative hedging an
asset or liability is amortised over the life of the protection purchased
or sold against either interest payable or interest receivable. Where a
credit event occurs which triggers a recovery under the credit
derivative, then the recovery will be offset against the profit and loss
charge on the underlying asset or liability.
Foreign exchange contracts which qualify as hedges of foreign
currency exposures, including positions relating to investments the
Group makes outside the UK, are retranslated at the closing rate with
any forward premium or discount recognised over the life of the
contract in net interest income.
Profits and losses related to qualifying hedges, including foreign
exchange contracts, of firm commitments and probable anticipated
transactions are deferred and recognised in income or as adjustments
to carrying amounts when the hedged transactions occur.
Hedging transactions that are superseded or cease to be effective
are measured at fair value. Any profit or loss on these transactions,
together with any profit or loss arising on hedging transactions that
are terminated prior to the end of the life of the asset, are deferred and
amortised into interest income or expense over the remaining life of
the item previously being hedged. When the underlying asset, liability
position or cash flow is terminated prior to the hedging transaction,
or an anticipated transaction is no longer likely to occur, the hedging
transaction is measured on the fair value accounting basis, as