CFM96100 - Interest restriction: group-interest: derivative contracts: example 1 (designated cash flow hedge)

MN plc is the ultimate parent of worldwide group.

MN plc takes out an interest rate swap to hedge the cash flows on a floating rate bank loan. The swap is designated as a cash flow hedge in the group accounts.

Consolidated financial statements: Interest and other financing costs:

Interest on bank loan	£10m
Accrual of periodic payments on swap \n(transfer from Cash Flow Hedging Reserve)	£4m
Fair value movements on swap - hedge ineffectiveness	£(0.5)m
	£13.5m

The application of the Disregard Regulation to the group financial statements would be as follows:

• Regulation 9 would apply as there is an interest rate contract that is hedging risks arising in respect of the interest cost on the bank loan (the hedged item) and the fair value profits and losses in respect of the hedged item are not recognised in the group accounts.
• As a result, all of the profits and losses on the swap are disregarded for the period. Instead, the amounts are brought into account on an ‘appropriate accruals basis’ which is likely to follow the accrual of the periodic payments made under the swap.
• The group will therefore have a net group-interest expense of £14m for the period. This is calculated by excluding the hedge ineffectiveness in the income statement.
• Note that the group’s financial statements are assumed to have been prepared on the basis of the application of the Disregard Regulations for both group-interest and group-EBITDA. As a result, the hedge ineffectiveness is completely disregarded - it does not appear in any of the group-interest or group-EBITDA amounts.