IFRS 9 (2013), hedge accounting, IFRS 7 paras 22A-24G cash flow hedge disclosures

Qantas Airways Limited – Annual report – 30 June 2018

Industry: airlines

[Note in this example fair value hedges are not material]

29 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (extract)

(E) FINANCIAL INSTRUMENTS (extract)

Non-Derivative Financial Instruments

i. Recognition and Measurement of Non-Derivative Financial Assets

At initial recognition, the Group measures a financial asset at its fair value plus, in the case of a financial asset not at fair value through profit or loss, transaction costs. Transaction costs of financial assets carried at fair value through profit or loss are expensed.

The Group subsequently classifies its financial assets in the following measurement categories:

  • Those to be measured subsequently at fair value (either through the Consolidated Income Statement or the Consolidated Statement of Comprehensive Income)
  • Those to be measured at amortised cost

ii. Recognition and Measurement of Non-Derivative Financial Liabilities

At initial recognition, the Group measures a non-derivative financial liability at its fair value, less transaction costs.

The Group subsequently measures non-derivative financial liabilities at amortised cost, with any difference between cost and redemption value being recognised in the Consolidated Income Statement over the period of the borrowings on an effective interest basis. Non-derivative financial liabilities that are designated as hedged items are subject to measurement under the hedge accounting requirements.

Derivative Financial Instruments

Derivative financial instruments are recognised at fair value both initially and on an ongoing basis. The accounting for subsequent changes in fair value depends on whether the derivative is a designated hedging instrument, and if so, the nature of the item being hedged and the type of hedge relationship designated. The Group designates derivatives as either hedges of the fair value of recognised assets or liabilities or a firm commitment (fair value hedges), or as hedges of highly probable forecast transactions (cash flow hedges). At the inception of the transactions, the Qantas Group documents the relationship between hedging instruments and hedged items, including the risk management objective and strategy for undertaking each transaction. The Qantas Group also documents its assessment, both at hedge inception and on an ongoing basis, of whether the hedging instruments that are used in hedge transactions have been and will continue to be highly effective.

From time to time certain derivative financial instruments do not qualify for hedge accounting, notwithstanding that the derivatives are held to hedge identified exposures. Any changes in the fair value of a derivative instrument or part of a derivative instrument that do not qualify for hedge accounting are classified as ‘ineffective’ and recognised immediately in the Consolidated Income Statement.

i.  Fair Value Hedges

Changes in the fair value of derivative financial instruments that are designated and qualify as fair value hedges are recorded in the Consolidated Income Statement, together with any changes in the fair value of the hedged asset or liability or firm commitment attributable to the hedged risk.

ii. Cash Flow Hedges

Where a derivative is designated as a cash flow hedging instrument, the effective portion of changes in the fair value of the derivative is recognised in the Consolidated Statement of Comprehensive Income and accumulated in the hedging reserve. Any ineffective portion of changes in the fair value of the derivative is recognised immediately in the Consolidated Income Statement.

The amount accumulated in equity is retained in the Consolidated Statement of Comprehensive Income and reclassified to the Consolidated Income Statement in the same period or periods during which the hedged forecast cash flows affect profit or loss or the hedged item affects profit or loss. If the forecast transaction is no longer expected to occur, the hedge no longer meets the criteria for hedge accounting, the hedging instrument expires or is sold, terminated or exercised, or the designation is revoked, then hedge accounting is discontinued prospectively. If the forecast transaction is no longer expected to occur, then the amount accumulated in equity is reclassified to the Consolidated Income Statement. Where the hedged item is capital in nature, the cumulative gain or loss recognised in the hedge reserve is transferred to the carrying amount of the asset when the asset is recognised.

iii. Cost of Hedging

The time value of an option, the forward element of a forward contract and any foreign currency basis spread is excluded from the designation of a financial instrument and accounted for as a cost of hedging. The fair value changes of these elements are recognised in other comprehensive income and depending on the nature of the hedged item, will either be transferred to the Consolidated Income Statement in the same period that the underlying transaction affects the Consolidated Income Statement or be capitalised into the initial carrying value of the asset and reported as ineffectiveness.

iv. Fair Value Calculations

The fair value of financial instruments traded in active markets is based on quoted market prices at balance date. The fair value of financial instruments that are not traded in an active market is estimated using valuation techniques consistent with accepted market practice. The Qantas Group uses a variety of methods and input assumptions that are based on market conditions existing at balance date. The different methods of estimating the fair value of these items have been defined in the Consolidated Financial Statements as follows:

Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities

Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices)

Level 3: Inputs for the asset or liability that are not based on observable market data (unobservable inputs)

20 FINANCIAL RISK MANAGEMENT (extract 1)

(C) DERIVATIVES AND HEDGING INSTRUMENTS

The following section summarises derivative financial instruments in the Consolidated Financial Statements:

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The Group’s derivative assets and liabilities as at 30 June 2018 are detailed below:

qant2i. Offsetting

The Group enters into contractual arrangements such as the International Swaps and Derivatives Association (ISDA) Master Agreement where, upon the occurrence of a credit event (such as default), a termination value is calculated and only a single net amount is payable in settlement of all transactions that are capable of offset under the contractual terms. The ISDA agreements do not meet the criteria for offsetting in the Consolidated Balance Sheet and consequently financial assets and liabilities are recognised gross. This is because the Group does not have any current legal enforceable right to offset recognised amounts, because the right to offset is enforceable only on the occurrence of future events. The amounts shown as financial assets and financial liabilities would each have been $33 million lower (2017: $68 million lower) in the event of the right to offset being currently enforceable.

ii. Hedge Reserve

The effective portion of the cumulative net change in the fair value of derivative financial instruments designated as a cash flow hedge and the cumulative change in fair value arising from the time value of options are included in the hedge reserve. These options relate entirely to transaction-related hedged items. For further information on accounting for derivative financial instruments as cash flow hedges, refer to Note 29(E). For the year ended 30 June 2018, $251 million (2017: $81 million) of the related cash flows are expected to occur within one year and $50 million (2017: $19 million) after one year. Other financial assets and liabilities represent the fair value of derivative financial instruments recognised on the Consolidated Balance Sheet. Refer to Note 29(E) for a definition of the fair value hierarchy.

(D) HEDGE ACCOUNTING

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1 Hedging instruments are located within the Other Financial Assets and Other Financial Liabilities on the Consolidated Balance Sheet and include costs of hedging. The carrying amount of the hedged item equals the nominal amount of the hedging instrument.

20 FINANCIAL RISK MANAGEMENT (extract 2)

(A) RISKS

The Qantas Group is subject to financial risks which are an inherent part of the operations of an airline. The Qantas Group manages these risk exposures using various financial instruments, governed by a set of policies approved by the Board. The Qantas Group’s policy is not to enter into, issue or hold derivative financial instruments for speculative trading purposes.

The Qantas Group uses different methods to assess and manage different types of financial risk to which it is exposed. These methods include correlations between risk types, sensitivity analysis in the case of interest rate, foreign exchange and other price risks, and ageing analysis and sensitivity analysis for liquidity and credit risk. A summary of these risks has been presented below:

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20 FINANCIAL RISK MANAGEMENT (extract 3)

ii. Interest Rate Risk

Nature of the Risk:

Interest rate risk refers to the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Qantas Group has exposure to movements in interest rates arising from its portfolio of interest rate sensitive assets and liabilities which are predominantly in AUD and USD currencies. These principally include corporate debt, leases and cash.

Management of Interest Rate Risk:

The Qantas Group manages interest rate risk by using a floating versus fixed rate debt framework. The relative mix of fixed and floating interest rate funding is managed by using interest rate swaps, forward rate agreements and options. For the year ended 30 June 2018, interest-bearing liabilities amounted to $4,748 million (2017: $4,838 million). The fixed/floating split is 53 per cent and 47 per cent respectively (2017: 53 per cent and 47 per cent). For the year ended 30 June 2018, other financial assets and liabilities included derivative financial instruments relating to debt obligations and future interest payments totalling $26 million (liability) (2017: $41 million (liability)). These are recognised at fair value. 

Sensitivity to Interest Rate Risk:

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1 Sensitivity analysis assumes hedge designations as at 30 June 2018 remain unchanged and that all designations are effective.

iii. Foreign Exchange Risk

Nature of the Risk:

Foreign exchange risk is the risk that the fair value of future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates. The source and nature of this risk arises from operations, capital expenditure and translation risk.

Management of Foreign Exchange Risk:

Cross-currency swaps are used to convert long-term foreign currency borrowings to currencies in which the Qantas Group has forecast sufficient surplus net revenue to meet the principal and interest obligations under the swaps. Where long-term borrowings are held in foreign currencies in which the Qantas Group derives surplus net revenue, offsetting forward foreign exchange contracts have been used to match the timing of cash flows arising under the borrowings with the expected revenue surpluses. To the extent a foreign exchange gain or loss is incurred, and the cash flow hedge is deemed effective, this is deferred until the net revenue is realised. As at 30 June 2018, total unrealised exchange gains on hedges of net revenue designated to service long-term debt was nil (2017: nil).

Forward foreign exchange contracts and currency options are used to hedge a portion of remaining net foreign currency exposures in accordance with Qantas Group policy. Net foreign currency exposures, including foreign currency purchases and disposals of property, plant and equipment, may be hedged out to two years within specific parameters. Any hedging outside these parameters requires approval by the Board. For the year ended 30 June 2018, other financial assets and liabilities included derivative financial instruments relating to the hedging of future capital expenditure payments, totalling $13 million (net asset) (2017: $14 million (net liability)). These are recognised at fair value.

Sensitivity to Foreign Exchange Risk:

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1 Sensitivity analysis assumes hedge designations as at 30 June 2018 remain unchanged and that all designations are effective. Sensitivity analysis on foreign currency pairs of 20 per cent represent recent volatile market conditions.

iv. Fuel Price Risk

Nature of the Risk:

Exposure of future AUD fuel costs to unfavourable USD denominated price and foreign exchange movements. 

Management of Future AUD Fuel Costs Risk:

The Qantas Group uses options and swaps on jet kerosene, gasoil and crude oil to hedge exposure to movements in the USD price of aviation fuel. Qantas considers the crude component to be a separately identifiable and measurable component of aviation fuel. The foreign exchange risk in the total fuel cost is separately hedged using foreign exchange contracts and currency options. Hedging is conducted in accordance with Qantas Group policy. Fuel consumption out to two years may be hedged within specific parameters, with any hedging outside these parameters requiring approval by the Board. For the year ended 30 June 2018, other financial assets and liabilities included fuel and foreign exchange derivatives totalling $540 million (net asset) (2017: $72 million (net asset)). These are recognised at fair value.

Sensitivity to Foreign Exchange and Fuel Price Risk:

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1 Sensitivity analysis assumes hedge designations as at 30 June 2018 remain unchanged and that all designations are effective. Sensitivity analysis on foreign currency pairs and fuel indices of 20 per cent represent recent volatile market conditions. Sensitivity analysis assumes an offset between USD and fuel price indices based on observed market movements.

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1 These amounts were allocated to revenue of $nil million (2017: $1 million), fuel expenditure of $(329) million (2017: $(10) million), and income tax expense of $99 million (2017: $3 million) in the Consolidated Income Statement.

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1 Other Reserves includes the Defined Benefit Reserve and the Fair Value Reserve.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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