CFM24400 - Accounting for corporate finance: derivative contracts: accounting for derivatives under Old UK GAAP (excluding FRS 26)
This following guidance covers Old UK GAAP (applied before 2015) and where FRS 26 was not applied.
Historic cost accounting for derivatives
Prior to the introduction of New UK GAAP, the great majority of UK companies used the historic cost model for accounting for financial instruments. Under this model, derivatives were recorded at their historic cost, although this was subject to the familiar ‘lower of cost or net realisable value’ principle.
In practice this often meant that derivatives were recognised at their historic cost of nil.
For contracts such as interest rate swaps, the holders of such instruments would accrue the periodic cashflows due under the contract, usually as an adjustment to interest income/expense.
For contracts without such periodic payments (e.g. a forward), typically no accounting entries would be made until the transaction under the forward takes place.
Under Old UK GAAP (excluding FRS 26) it was also common in some circumstances to treat a financial instrument and hedging derivative as a “synthetic” single instrument. For example, a company with floating rate borrowings and a receive floating/pay fixed interest rate swap used to hedge the loan might have accounted for the loan as a synthetic fixed rate loan.
For contract rate accounting and the use of foreign currency contracts see the guidance on SSAP 20 at CFM26000+.
If derivatives are being used for speculative purposes, other considerations will apply (see CFM24440). In general, however, it is likely that the derivatives you will encounter will be used in connection with risk management activities.
As with many other aspects of derivatives, if you are in any doubt you should contact your local HMRC advisory accountant.