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Hedge Accounting is supported by Agiblocks CTRM

Posted by Bart Kroon
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The importance of IFRS compliance Commodity Trade and Risk Management software (CTRM) is once more confirmed in 2018. Agiblocks CTRM software supports the agricultural and soft-commodity industries. In 2018 a large number of old and new clients choose to integrate their Agiblocks  CTRM platform to their accounting and/or ERP applications. The confidence of these companies motivates Agiboo introduce state of the art IFRS compliant integrations and to further develop IFRS related functionality. As from 2019 IFRS 9 and IFRS 15 Hedge Accounting is supported by Agiblocks CTRM.

 

IFRS (Hedge) Accounting Support in Agiblocks CTRM

 

IFRS is a set of International Financial Reporting Standards proposed and maintained by the International Accounting standards Board. IFRS-9 requires commodities companies to keep track of  their trading assets (contracts, inventories) and provides minimum standards for substantiation and record keeping for hedge accounting. In short, to be able to comply to IFRS 9, a company should maintain records of all its’ individual trading  assets from the inception until their de-recognition as a trading asset (“realisation “), and be able to record and record on the fair value changes of these trading assets over their life time.

The Agiblocks IFRS 9 functionality records the inception and valuation of commodity contracts until these trading assets are de-recogniszed (“realized”) and then represented under IFRS 15 as revenue and cost of goods sold. Effectively IFRS 9 functionality in a CTRM allows a company to either report the fair value movements their forward book as unrealised P&L or to have the fair value movements reported as Fair Value movements on the balance sheet (hedge accounting).

Under IFRS 15  a company needs to recognise revenues and cost of goods sold, and such at the transfer of economic ownership of the goods. A challenge for commodity companies is transfer of economic ownership under uncertain commercial conditions. One could imagine a transfer before all pricing have been fixed, or when the final settlement weight has not been established. Under IFRS 15 a commodities company needs to account for such uncertainties based on respectively market values and estimates. Adjustments to these estimates have to be recorded at final settlement, but also at an end of a reporting period before such a final settlement.

 

Agiblocks IFRS 9

Agiblocks offers near – real time and full permanence records for IFRS 9. During the “life-time” of a trading asset, Agiblocks keeps track of the 2 variables that together determine the fair value movements.

1. The Contract Value of each contractual and/or inventory quantity, and included all cost associated to the contract and/or inventory.

2. The Market Value of each contract or inventory quantity. This Market Value based on actual market data, differential and/or ratio curves and currency rates.

These two variables are updated near real time; whenever the status of the trading assets change and on any given moment in time a user requires an updated value, for example

1. when pricings take place
2. when quantities are split, e.g. by partial reservations or by splitting deliveries, reservations, or inventory
3. when cost items are changed (due to change of estimates, or allocation of cost invoices to contracts)
4. when the position/valuation period/reporting period of an asset is changed
5. when the system wide re-estimation is run, e.g. at month-end

Agiblocks advanced accrual accounting functionality supports the recording of these fair value changes and ensures that accumulative fair value changes is kept track of as well. When booking IFRS 9 accruals is activated on an Agiblocks installation, the fair value movements are transmitted as accrual messages to the financial accounting system. For this purpose, new IFRS-9 Fair Value posting profiles have been added to Agiblocks.

 

Agiblocks IFRS 15

Agiblocks offers near- real time and full permanence records for IFRS 15. At the transfer of economic ownership of trading asset, Agiblocks records a revenue and cost of goods sold transaction. At the same time Agiblocks reverses all Fair Value movements recorded for the trading asset and thus effectively the executed transaction creates a movement from the “unrealised” to the “realised” financial accounts.

In the case a revenue or cost of goods sold moment is based on uncertain conditions, Agiblocks records the initial revenue and cost of goods sold based on the most accurate information at execution and when final settlement information is available the initial revenues and cost of goods sold are reversed and replaced with final values. In the period between transfer of ownership and the final settlement values are updated whenever the transactions are influenced thereto, for example;

1. when pricings take place
2. when final quantities are determined
3. when cost items are changed (due to change of estimates, or allocation of cost invoices to contracts)
4. when the system wide re-estimation is run, e.g. at month-end

To ensure alignment with the financial reporting timelines, Agiblocks ensures that movements in revenues and cost of goods, after the moment of the actual transfer of ownership, are allotted to the financial reporting period they actually take place. This approach assures that the financial reporting and the trade reporting will always be synced and aligned.

 

We grow with our clients and our clients grow with us

Agiboo will further focus to support the agricultural and soft commodity industries in 2019. We aim to bring further efficiency in trading and operations of our clients, and to embed even more industry and commodity specific functionality to Agiblocks. We help our customers in achieving their challenges and enable them to capitalise on the benefits of information technology.

IFRS 9 replaces IAS39 as from 2018

Posted by Bart Kroon
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IFRS 9: As from 2018 the Economic Reality will be accounted for!

 

As from January 1st 2018 it will become mandatory to replace accounting standard IAS 39 (Revenue and Recognition) by IFRS 9   (Financial assets). IFRS 9 is predominantly applicable for banks and companies that focus is on financial assets. Such assets are loans and bonds and related hedging instruments of foreign exchange and interest rates. IFRS 9 offers also a new reality for companies that generate margin through buying, selling and/or processing physical commodities.

 

These commodity companies might consider replacing IAS39 Financial Assets by IFRS 9 an administrative burden. But actually it offers companies an opportunity to reflect the real economic practice and performance in their financial statements. More reporting value of the IFRS 9 can be obtained when applying hedge accounting in financial statements. As a consequence of IFRS 9  we expect more companies to adopt price/margin risk hedging techniques for their raw materials and/or sales portfolios. Finally the economic reality can be accounted for!

 

How IAS 39 limited “transforming” business in their hedging practices

 

An important part of a “transformation” business model is buying a certain complex of raw materials (physical commodities) and  transforming them into a consumable semi finished (B2B) or end product (B2B\B2C). Usually raw material sourcing markets and (end) product consumption markets are somewhat disconnected in terms of pricing and market price volatility.

 

So will a coffee roaster or a chocolate manufacturer buy respectively coffee or cocoa beans and transform these into end products. Since consumer prices have a rather flat character, consumer markets have no direct reflection of price movements in the commodity markets. Hence a margin risk is created due to the commodity markets price volatility. You will find similar patterns in textile, animal feeds, vegetable oils, rubber, beverages, etc.. Margins in a transformation business model are usually thin. So one would expect these companies to hedge their market exposure. And the most effective way of hedging price volatility is hedging through derivative markets.

 

Without Hedge Accounting the use of derivative instruments (despite economically viable and responsible) increases volatility of results in financial statements. This volatility originates from the non-symmetrical accounting treatment of physical and derivative contracts. In financial statements the movements in the value of physical stocks and contracts are only reflected upon transformation or sale of end products. Movements of the value of derivatives are reflected in financial statements as they occur.

 

Hedge Accounting

 

So under the previous guidance of the Financial Accounting Standards Board (FASB) hedge results from derivative instruments where not treated equally with volatility exposure from physical assets. The exemption offered under IAS 39 required the evidence of a strict hedge correlation between the hedged item (assuming an own use principle) and  each allocated hedge instrument (derivative). Upon sufficient substantiation (evidenced correlation) hedge results could be attributed to the the raw materials in the transformation process. Consequently one accounted then for the hedge results in parallel with the realisation of the physical transactions. The latter is called Hedge accounting.

 

Here the accounting reality limited companies in its economically sensible decision making. First of all companies did not accept the “accounting” volatility created by derivatives used for hedging. Hedge Accounting offered a solution. However the complex IAS39 rules and requirements withheld many Boards and CFO’s to pursue for hedge accounting. As a consequence, sourcing and sales management was discouraged (or even forbidden) to use commodity futures and/or options to manage market volatility related margin risk. And by this IAS39 influences the economic practice performance of business negatively, just for the sake of the accounting reality.

 

IFRS 9 enables to account for the economic reality

 

It took the FASB years to create a common agreement on an accounting treatment for hedge accounting that actually supports the economically sensible and responsible practice of hedging. The definition of hedge has been simplified. Also hedge effectiveness measurement is brought in line with economical practices. When a company has a professional price/margin risk management in place such a company would implicitly have the information available to substantiate hedge accounting. There is no longer a need to create a “2nd administrative reality” to substantiate hedge accounting. The accounting & disclosure requirements follow practice rather then accounting & disclosure requirements creating a practice.

 

For most commodity transforming companies, the application of IFRS 9 Hedge Accounting will more easily eliminate the non-symmetrical treatment of accounting for physical and derivative contracts. Thus would enable companies to define their price-risk management on economical grounds rather then on accounting standards.

 

The impact of IFRS 9 being mandatory as from January 1st, 2018

 

The FASB anticipated a gradual change of practice as from April 2014. Thus offered companies reporting under International Accounting Standards a three year transition period, including an early adoption period. Upon the EU endorsing the adoption of IFRS 9 as a standard in November 2016, the process of change became irreversible for EU based companies. One might expect that the new IFRS 9 will finds it’s way to many local accounting practices around the world coming years.

 

Companies are changing their accounting practices towards IFRS 9. Now, one may expect that companies will also gradually change their hedging practices back to economically sound and sensible practices.  Over last years many procurement portfolio’s of companies have been excused from commodity derivatives. We assume that derivatives will gradually come back in these portfolio’s. And so will then commodity derivative knowledge slowly return in these companies. With the knowledge also the need for professional tooling to manage a combined derivative and physical portfolio of commodity contracts will return. At Agiboo we are looking forward to the latter. Because there will be more opportunities to support clients in managing their price and margin risks.

 

 

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