Barclays 2006 Annual Report Download - page 160

valuation techniques, including discounted cash flow models and
option pricing models as appropriate. All derivatives are included in
assets when their fair value is positive, and liabilities when their fair
value is negative, unless there is the legal ability and intention to settle
net (as per accounting policy 11).
Embedded derivatives
Some hybrid contracts contain both a derivative and a non-derivative
component. In such cases, the derivative component is termed an
embedded derivative. Where the economic characteristics and risks of
the embedded derivatives are not closely related to those of the host
contract, and the host contract itself is not carried at fair value through
profit or loss, the embedded derivative is bifurcated and reported at fair
value with gains and losses being recognised in the income statement.
Profits or losses cannot be recognised on the initial recognition of
embedded derivatives unless the host contract is also carried at fair
value.
Hedge accounting
Where derivatives are held for risk management purposes, and when
transactions meet the criteria specified in IAS 39, the Group applies
fair value hedge accounting, cash flow hedge accounting, or hedging
of a net investment in a foreign operation as appropriate to the risks
being hedged.
When a financial instrument is designated as a hedge, the Group
formally documents the relationship between the hedging instrument
and hedged item as well as its risk management objectives and its
strategy for undertaking the various hedging transactions. The Group
also documents its assessment, both at hedge inception and on an
ongoing basis, of whether the derivatives that are used in hedging
transactions are highly effective in offsetting changes in fair values or
cash flows of hedged items.
The Group discontinues hedge accounting when:
(i) It is determined that a derivative is not, or has ceased to be, highly
effective as a hedge;
(ii) the derivative expires, or is sold, terminated, or exercised;
(iii)the hedged item matures or is sold or repaid; or
(iv)a forecast transaction is no longer deemed highly probable.
In certain circumstances, the Group may decide to cease hedge
accounting even though the hedge relationship continues to be highly
effective by no longer designating the financial instrument as a hedging
instrument. 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.
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 relationship no longer meets the criteria for hedge
accounting, it is discontinued. For fair value hedges of interest rate risk,
the fair value adjustment to the hedged item is amortised to the income
statement over the period to maturity of the previously designated
hedge relationship using the effective interest method.
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.
Prior to 1st January 2005
Derivatives entered into as trading transactions, together with any
associated hedging, are measured at fair value and the resultant profits
and losses are included in net trading income, along with interest and
dividends arising from long and short positions and funding costs
relating to trading activities. Assets and liabilities resulting from gains or
losses on derivative and foreign exchange contracts are reported gross
and reduced by the effects of qualifying netting agreements with
counterparties.
The fair value of derivatives is determined by calculating the expected
cash flows under the terms of each specific contract, discounted back
to a present value. The expected cash flows for each contract are
determined either directly by reference to actual cash flows implicit in
observable market prices or through modelling cash flows using
appropriate financial-markets pricing models.
The effect of discounting expected cash flows back to present value is
achieved by constructing discount curves derived from the market price
of the most appropriate observable interest rate products such as
deposits, interest rate futures and swaps. The calculation of fair value
for any financial instrument may also require adjustment of the quoted
price or model value to reflect the cost of credit risk (where not
embedded in underlying models or prices used), or to reflect hedging
costs not captured in pricing models (to the extent they would be taken
into account by a market participant in determining a price).
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
Consolidated accounts Barclays PLC
Accounting policies
Barclays PLC
Annual Report 2006
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