CFM96120 - Interest restriction: group-interest: derivative contracts: example 3 (undesignated cash flow hedge)

TIOPA10/S420-S421

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 not designated as a hedge in the group accounts.

Consolidated financial statements: Interest and other financing costs:

Interest on bank loan	£10m
Accrual of periodic payments on swap	£4m
Fair value movements on swap	£(3)m
	£11m

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 ‘clean’ fair value movement in the swap of £3m for the period.
• 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 clean fair value movement is completely disregarded - it does not appear in any of the group-interest or group-EBITDA amounts.

Undesignated fair value hedges

Undesignated fair value hedges are treated in a similar way to undesignated cash flow hedges.