8.1.1 Background Information

On 15 July 20X0, ABC issued a USD-denominated floating rate bond. ABC's functional ­currency was the EUR. The bond had the following main terms:

Since ABC's objective was to raise EUR floating funding, on the issue date ABC entered into a CCS. Through the CCS, the entity agreed to receive a floating rate equal to the bond coupon and pay a Euribor floating rate plus a spread. The CCS had the following terms:

The mechanics of the CCS are described next. It can be seen that through the combination of the USD bond and the CCS, ABC synthetically obtained a EUR floating liability.

On the issue date at the start of the CCS, there was an initial exchange of nominal amounts through the CCS: ABC delivered the USD 100 million debt issuance proceeds and received EUR 80 million. The resulting EUR–USD exchange rate was 1.2500. The combination of the bond and CCS had the same effect as if ABC had issued a EUR-denominated bond, as shown in Figure 8.1.

An exchange of interest payments took place annually. ABC received USD Libor-linked interest on the USD nominal and paid Euribor-linked interest on the EUR nominal. ABC used the USD Libor cash flows it received under the CCS to pay the bond interest. Figure 8.2 shows the strategy's intermediate cash flows.

At maturity of the CCS and the debt, ABC re-exchanged the CCS nominals, using the USD 100 million it received through the CCS to redeem the bond issue, and delivering EUR 80 million to the CCS counterparty. Note that this final exchange was made at exactly the same rate used in the initial exchange (1.2500). Figure 8.3 shows the strategy's cash flows at maturity.

8.1.2 Determining Risk Components to Include in the Hedging Relationship

The aim of the CCS was to hedge the changes in fair value of the bond. There were three risks affecting the bond's fair value:

• Exchange rate risk. An appreciation of the USD relative to the EUR would increase the EUR value of the bond's USD cash outflows, increasing the bond's fair value. Conversely, a depreciation of the USD relative to the EUR would decrease the EUR value of the bond's USD flows to be paid by ABC, decreasing the bond's fair value.
• Interest rate risk. The bond coupons were linked to the USD Libor 12-month rate. An increase in USD Libor rates would decrease the present value of the future USD cash flows, decreasing the bond's fair value. Conversely, a decline in USD Libor rates would increase the present value of the future USD cash flows, increasing the bond's fair value.
• Credit risk. The bond was issued with a credit margin of 50 basis points. During the life of the bond, a narrowing of ABC's credit margin would increase the bond's fair value. Conversely, a widening of the credit margin would decrease the bond's fair value.

The CCS hedged the exposure of the bond's fair value to the first two risks (exchange risk and interest rate risk). However, to hedge the third element (credit risk) would have implied ABC buying protection on its own credit risk, which no counterparty would provide unless a proxy credit name was used. Therefore, the bond's credit risk was excluded from the hedging relationship. Fair valuations of the hedged item would assume that the initial 50 bps credit margin remained unchanged during the term of the hedge.

When assessing effectiveness and calculating effective and ineffective amounts, the helpful simplification of a hypothetical derivative could not be used for fair value hedges. Therefore ABC needed to fair value the hedged item.

8.1.3 Hedging Relationship Documentation

ABC documented the hedging relationship as follows:

8.1.4 Hedge Effectiveness Assessment

Hedge effectiveness will be assessed by comparing changes in the fair value of the hedging instrument to changes in the fair value of the hedged item. Changes in the fair value of the hedging instrument (i.e., the CCS) will be recognised as follows:

• The effective part of the gain or loss on the hedging instrument will be recognised in profit or loss, adjusting interest income/expense.
• The ineffective part of the gain or loss on the hedging instrument will be recognised in profit or loss, as other financial income/expenses.

Hedge effectiveness will be assessed prospectively at hedging relationship inception, on an ongoing basis at least upon each reporting date and upon occurrence of a significant change in the circumstances affecting the hedge effectiveness requirements.

The hedging relationship will qualify for hedge accounting only if all the following criteria are met:

1. The hedging relationship consists only of eligible hedge items and hedging instruments. The hedge item is eligible as it is an already recognised liability that exposes the entity to fair value risk, affects profit or loss and is reliably measurable. The hedging instrument is eligible as it is a derivative that does not result in a net written option.
2. At hedge inception there is a formal designation and documentation of the hedging relationship and the entity's risk management objective and strategy for undertaking the hedge.
3. The hedging relationship is considered effective.

The hedging relationship will be considered effective if the following three requirements are met:

1. There is an economic relationship between the hedged item and the hedging instrument.
2. The effect of credit risk does not dominate the value changes that result from that economic relationship.
3. The hedge ratio of the hedging relationship is the same as that resulting from the quantity of hedged item that the entity actually hedges and the quantity of the hedging instrument that the entity actually uses to hedge that quantity of hedged item. The hedge ratio should not be intentionally weighted to create ineffectiveness.

Whether there is an economic relationship between the hedged item and the hedging instrument will be assessed on a quantitative basis using the scenario analysis method for two scenarios:

• In a first scenario, USD Libor interest rates will be shifted upwards by 2%, the EUR–USD exchange rate increased by 10%, and the changes in fair value of the hedged item and the hedging instrument compared.
• In a second scenario, USD Libor interest rates will be shifted downwards by 2%, the EUR–USD exchange rate reduced by 10%, and the changes in fair value of the hedged item and the hedging instrument compared.

8.1.5 Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship

On 15 July 20X0 ABC performed a hedge effectiveness assessment which was documented as described next.

The hedging relationship was considered effective as the following three requirements were met:

1. There was an economic relationship between the hedged item and the hedging instrument. Based on the quantitative assessment performed, the entity concluded that the change in fair value of the hedged item was expected to be substantially offset by the change in fair value of the hedging instrument, corroborating that both elements had values that would generally move in opposite directions.
2. The effect of credit risk did not dominate the value changes resulting from that economic relationship as the credit ratings of both the entity and XYZ Bank were considered sufficiently strong.
3. The hedge ratio of the hedging relationship was the same as that resulting from the quantity of hedged item that the entity actually hedged and the quantity of the hedging instrument that the entity actually used to hedge that quantity of hedged item. The hedge ratio was not intentionally weighted to create ineffectiveness.

A quantitative assessment was performed to support the conclusion that the hedging instrument and the hedged item had values that would generally move in opposite directions. The quantitative assessment consisted of two scenario analyses as follows:

A parallel shift of +2% in the USD Libor interest rate and +10% in the EUR–USD spot rate, occurring simultaneously on the assessment date, was simulated. The fair values of the hedging instrument and the hedged item were calculated and compared to their initial fair values. As shown in the table below, the assessment resulted in a high degree of offset, corroborating that both elements had values that would generally move in opposite directions.

Similarly, a parallel shift of –2% in the USD Libor interest rate and –10% in the EUR–USD spot rate, occurring simultaneously on the assessment date was simulated. As shown in the table below, the assessment resulted in a high degree of offset, corroborating that both elements had values that would generally move in opposite directions.

The following potential sources of ineffectiveness were identified:

• a substantial deterioration in credit risk of either the entity or the counterparty to the hedging instrument; and
• a change in the timing or amounts of the hedged highly expected cash flows.

The hedge ratio was set at 1:1.

ABC also performed assessments at each reporting date, yielding similar conclusions. These assessments have been omitted to avoid unnecessary repetition.

8.1.6 Fair Valuations, Effective/Ineffective Amounts and Cash Flow Calculations

8.1.7 Accounting Entries

The required journal entries were as follows.

1. Journal entries on 15 July 20X0

   The bond was issued.

2. No entries were required to record the CCS as its initial fair value was zero.
3. Journal entries on 31 December 20X0

   The accrued interest of the bond was EUR <2,193,000>. The payable related to this accrued interest was EUR <2,164,000>.

4. The change in fair value of the hedged item for the risk being hedged produced a EUR 2,103,000 gain, of which EUR 1,836,000 was deemed to be effective and EUR 267,000 ineffective.
5. The accrual of the USD leg of the CCS was EUR 2,193,000. The receivable related to this accrued interest was EUR 2,164,000.
6. The accrual of the EUR leg of the CCS was EUR <1,874,000>.
7. The change in fair value of the CCS produced a EUR 1,836,000 loss, fully deemed to be effective.
8. Journal entries on 15 July 20X1

   The accrued interest of the bond was EUR <2,533,000>. The payable related to this accrued interest was EUR <2,590,000>.

9. The interest payable corresponding to the bond's previous accrued interest was retranslated, producing a EUR 70,000 loss.
10. The bond coupon was paid using the amount received under the USD leg of the CCS.
11. The accrued interest of the USD leg was EUR 2,533,000. The receivable related to this accrued interest was EUR 2,590,000.
12. The interest receivable corresponding to the USD leg's previous accrued interest was retranslated, producing a EUR 70,000 gain.
13. The interest receivable corresponding to the USD leg was received.
14. The accrual of the EUR leg was EUR <2,173,000>.
15. The interest payable corresponding to the EUR leg was paid.
16. Journal entries on 31 December 20X1

    The accrued interest of the bond was EUR <2,305,000>. The payable related to this accrued interest was EUR <2,328,000>.

17. The change in fair value of the hedged item for the risk being hedged produced a EUR 3,530,000 loss, fully deemed to be effective.
18. The accrual of the USD leg of the CCS was EUR 2,305,000. The receivable related to this accrued interest was EUR 2,328,000.
19. The accrual of the EUR leg was EUR <1,968,000>.
20. The change in fair value of the CCS produced a EUR 3,758,000 gain, of which EUR 3,530,000 was deemed to be effective and EUR 228,000 ineffective.
21. Journal entries on 15 July 20X2

    The accrued interest of the bond was EUR <2,707,000>. The payable related to this accrued interest was EUR <2,722,000>.

22. The interest payable corresponding to the bond's previous accrued interest was retranslated, producing a EUR 19,000 loss.
23. The bond coupon was paid using the USD amounts received under the USD leg of the CCS.
24. The accrued interest of the USD leg was EUR 2,707,000. The receivable related to this accrued interest was EUR 2,722,000.
25. The interest receivable corresponding to the USD leg's previous accrued interest was retranslated, producing a EUR 19,000 gain.
26. The interest receivable corresponding to the USD leg was received.
27. The accrual of the EUR leg was EUR <2,282,000>.
28. The interest payable corresponding to the EUR leg was paid.
29. Journal entries on 31 December 20X2

    The accrued interest of the bond was EUR <2,472,000>. The payable related to this accrued interest was EUR <2,510,000>.

30. The change in fair value of the hedged item for the risk being hedged produced a EUR 4,552,000 loss, fully deemed to be effective.
31. The accrual of the USD leg of the CCS was EUR 2,472,000. The receivable related to this accrued interest was EUR 2,510,000.
32. The accrual of the EUR leg was EUR <2,043,000>.
33. The change in fair value of the CCS produced a EUR 4,871,000 gain, of which EUR 4,552,000 was deemed to be effective and EUR 319,000 ineffective.
34. Journal entries on 15 July 20X3

    The accrued interest of the bond was EUR <2,979,000>. The payable related to this accrued interest was EUR <3,044,000>.

35. The interest payable corresponding to the bond's previous accrued interest was retranslated, producing a EUR 114,000 loss.
36. The bond coupon and principal were paid/repaid by using the amounts received under the USD leg of the CCS. The bond principal represented EUR 90,909,000 (= USD 100 mn/1.1000).
37. The accrued interest of the USD leg was EUR 2,979,000. The receivable related to this accrued interest was EUR 3,044,000.
38. The interest receivable corresponding to the USD leg's previous accrued interest was retranslated, producing a EUR 114,000 gain.
39. The interest receivable corresponding to the USD leg was received.
40. The accrual of the EUR leg was EUR <2,369,000>.
41. The interest payable corresponding to the EUR leg was paid.
42. The change in fair value of the hedged item for the risk being hedged produced a EUR 3,836,000 loss, fully deemed to be effective.
43. The change in fair value of the CCS produced a EUR 4,116,000 gain, of which EUR 3,836,000 was deemed to be effective and EUR 280,000 ineffective.
44. The CCS notionals were exchanged. ABC paid EUR 80 million and received USD 100 million (worth EUR 90,909,000). The difference was worth EUR 10,909,000 (=90,909,000 – 80,000,000).
45. The remaining EUR 1,094,000 fair value adjustments related to the bond were amortised to profit or loss.

The following table gives a summary of the accounting entries:

8.1.8 Concluding Remarks

ABC's objective when entering into the combination of the bond and the CCS was to incur an expense representing Euribor 12-month plus 0.49%.

During the first year of the term of the bond (and of the hedging relationship) the overall impact of the strategy on profit or loss was a EUR 3,780,000 expense. The target expense during the first year was EUR 4,047,000 (=80 mn × (4.50% + 0.49%) × 365/360), corresponding to a 4.50% Euribor 12-month rate. The difference was due to the EUR 267,000 ineffective part of the change in fair value of the hedged item. Nonetheless, the net cash outflow was exactly EUR 4,047,000.

During the second year the overall impact of the strategy on profit or loss was a EUR 4,022,000 expense. The target expense during the second year was EUR 4,250,000 (=80 mn × (4.75% + 0.49%) × 365/360), corresponding to a 4.75% Euribor 12-month rate. The difference was due to the EUR 228,000 ineffective part of the change in fair value of the CCS. However, the net cash outflow was exactly EUR 4,250,000.

During the third year the overall impact of the strategy on profit or loss was a EUR 4,907,000 expense. The target expense during the third year was EUR 4,412,000 (=80 mn × (4.95% + 0.49%) × 365/360), corresponding to a 4.95% Euribor 12-month rate. The EUR 495,000 (=1,094,000 – 599,000) difference was due to the EUR 599,000 ineffective part of the change in fair value of the CCS and the EUR 1,094,000 amortisation of the fair value. Nonetheless, the net cash outflow was exactly EUR 4,412,000.

The sum of the interest expense over the three years equalled the sum of the three expense targets. Therefore over the three years, both from a cash and expense perspective, ABC achieved its objective of funding itself at Euribor 12-month plus 0.49%.

Finally, note that in our case the basis of the CCS was included in the hedging relationship. The full fair value movement of the CCS, including the basis component, was taken into account in the calculation of the effective part of the hedge. As a consequence, a volatile behaviour of the basis could have created substantial ineffectiveness. Similarly to the treatment of forward components of forward contracts, when the basis component of a CCS is excluded from a hedging relationship, IFRS 9 allows the choice between:

• recognising in profit or loss the change in the basis element fair value; and
• recognising changes in the basis element fair value in OCI to the extent that it relates to the hedged item, while amortising the initial basis element in profit or loss.

8.2.1 Background Information

On 15 July 20X0, ABC issued a USD-denominated floating rate bond. ABC's functional currency was the EUR. The bond had the following main terms:

Since ABC's objective was to raise EUR floating funding, on the issue date ABC entered into a CCS. Through the CCS, the entity agreed to receive a USD fixed rate equal to the bond coupon and pay a Euribor floating rate plus a spread. The CCS had the following terms:

The mechanics of the CCS are described next. It can be seen that through the combination of the USD bond and the CCS, ABC synthetically obtained a EUR floating liability.

On the issue date at the start of the CCS, there was an initial exchange of nominal amounts through the CCS: ABC delivered the USD 100 million debt issuance proceeds and received EUR 80 million. The resulting EUR–USD exchange rate was 1.2500. The combination of the bond and CCS had the same effect as if ABC had issued a EUR-denominated bond, as shown in Figure 8.4.

An exchange of interest payments took place annually. ABC received USD 6.09% ­interest on the USD nominal and paid Euribor-linked interest on the EUR nominal. ABC used the USD fixed cash flows it received under the CCS to pay the bond interest. Figure 8.5 shows the strategy's intermediate cash flows.

On maturity of the CCS and the debt, ABC re-exchanged the CCS nominals, using the USD 100 million it received through the CCS to redeem the bond issue, and delivering EUR 80 million to the CCS counterparty. Note that this final exchange was made at exactly the same rate used in the initial exchange (1.2500). Figure 8.6 shows the strategy's cash flows at maturity.

ABC designated the CCS as the hedging instrument in a fair value hedge of the exchange rate and interest rate risks (see Section 8.1.2 for a discussion of the risk components of the bond). Credit risk was excluded from the hedging relationship. Therefore, fair valuations of the hedged item would assume that the initial credit margin of 50 basis points remained unchanged during the term of the hedge.

When assessing effectiveness and calculating effective and ineffective amounts, the helpful simplification of a hypothetical derivative could not be used for fair value hedges. Therefore ABC needed to fair value the hedged item.

8.2.2 Hedging Relationship Documentation

ABC documented the hedging relationship as follows:

8.2.3 Hedge Effectiveness Assessment

Hedge effectiveness will be assessed by comparing changes in the fair value of the hedging instrument to changes in the fair value of the hedged item. Changes in the fair value of the hedging instrument (i.e., the CCS) will be recognised as follows:

• The effective part of the gain or loss on the hedging instrument will be recognised in profit or loss, adjusting interest income/expense.
• The ineffective part of the gain or loss on the hedging instrument will be recognised in profit or loss, as other financial income/expenses.

Hedge effectiveness will be assessed prospectively at hedging relationship inception, on an ongoing basis at least upon each reporting date and upon occurrence of a significant change in the circumstances affecting the hedge effectiveness requirements.

The hedging relationship will qualify for hedge accounting only if all the following criteria are met:

1. The hedging relationship consists only of eligible hedge items and hedging instruments. The hedge item is eligible as it is an already recognised liability that exposes the entity to fair value risk, affects profit or loss and is reliably measurable. The hedging instrument is eligible as it is a derivative that does not result in a net written option.
2. At hedge inception there is a formal designation and documentation of the hedging ­relationship and the entity's risk management objective and strategy for undertaking the hedge.
3. The hedging relationship is considered effective.

The hedging relationship will be considered effective if the following three requirements are met:

1. There is an economic relationship between the hedged item and the hedging instrument.
2. The effect of credit risk does not dominate the value changes that result from that economic relationship.
3. The hedge ratio of the hedging relationship is the same as that resulting from the quantity of hedged item that the entity actually hedges and the quantity of the hedging instrument that the entity actually uses to hedge that quantity of hedged item. The hedge ratio should not be intentionally weighted to create ineffectiveness.

Whether there is an economic relationship between the hedged item and the hedging instrument will be assessed on a quantitative basis using the scenario analysis method for two scenarios:

• In a first scenario, USD Libor interest rates will be shifted upwards by 2%, the EUR–USD exchange rate increased by 10%, and the changes in fair value of the hedged item and the hedging instrument compared.
• In a second scenario, USD Libor interest rates will be shifted downwards by 2%, the EUR–USD exchange rate reduced by 10%, and the changes in fair value of the hedged item and the hedging instrument compared.

8.2.4 Hedge Effectiveness Assessment Performed at the Start of the Hedging Relationship

On 15 July 20X0 ABC performed a hedge effectiveness assessment which was documented as described next.

The hedging relationship was considered effective as the following three requirements were met:

1. There was an economic relationship between the hedged item and the hedging instrument. Based on the quantitative assessment performed, the entity concluded that the change in fair value of the hedged item was expected to be substantially offset by the change in fair value of the hedging instrument, corroborating that both elements had values that would generally move in opposite directions.
2. The effect of credit risk did not dominate the value changes resulting from that economic relationship as the credit ratings of both the entity and XYZ Bank were considered sufficiently strong.
3. The hedge ratio of the hedging relationship was the same as that resulting from the quantity of hedged item that the entity actually hedged and the quantity of the hedging instrument that the entity actually used to hedge that quantity of hedged item. The hedge ratio was not intentionally weighted to create ineffectiveness.

A quantitative assessment was performed to support the conclusion that the hedging instrument and the hedged item had values that would generally move in opposite directions. The quantitative assessment consisted of two scenario analyses performed as follows.

A parallel shift of +2% in the USD Libor interest rate and +10% in the EUR–USD spot rate, occurring simultaneously on the assessment date, was simulated. The fair values of the hedging instrument and the hedged item were calculated and compared to their initial fair values. As shown in the table below, the assessment resulted in a high degree of offset, corroborating that both elements had values that would generally move in opposite directions.

Similarly, a parallel shift of –2% the USD Libor interest rate and –10% in the EUR–USD spot rate, occurring simultaneously on the assessment date, was simulated. As shown in the table below, the assessment resulted in a high degree of offset, corroborating that both elements had values that would generally move in opposite directions.

The following potential sources of ineffectiveness were identified:

• a substantial deterioration in credit risk of either the entity or the counterparty to the hedging instrument; and
• a change in the timing or amounts of the hedged highly expected cash flows.

The hedge ratio was set at 1:1.

ABC also performed assessments at each reporting date, yielding similar conclusions. These assessments have been omitted to avoid unnecessary repetition.

8.2.5 Fair Valuations, Effective/Ineffective Amounts and Cash Flow Calculations

8.2.6 Accounting Entries

The required journal entries were as follows.

1. Journal entries on 15 July 20X0

   The bond was issued.

2. No entries were required to record the CCS as its initial fair value was zero.
3. Journal entries on 31 December 20X0

   The accrued interest of the bond was EUR <2,264,000>. The payable related to this accrued interest was EUR <2,234,000>.

4. The change in fair value of the hedged item for the risk being hedged produced a EUR 2,326,000 gain, of which EUR 2,045,000 was deemed to be effective and EUR 281,000 ineffective.
5. The accrual of the USD leg of the CCS was EUR 2,264,000. The receivable related to this accrued interest was EUR 2,234,000.
6. The accrual of the EUR leg of the CCS was EUR <1,874,000>.
7. The change in fair value of the CCS produced a EUR 2,045,000 loss, fully deemed to be effective.
8. Journal entries on 15 July 20X1

   The accrued interest of the bond was EUR <2,615,000>. The payable related to this accrued interest was EUR <2,674,000>.

9. The interest payable corresponding to the bond's previous accrued interest was retranslated, producing a EUR 72,000 loss.
10. The bond coupon was paid using the amount received under the USD leg of the CCS.
11. The accrued interest of the USD leg was EUR 2,615,000. The receivable related to this accrued interest was EUR 2,674,000.
12. The interest receivable corresponding to the USD leg's previous accrued interest was retranslated, producing a EUR 72,000 gain.
13. The interest receivable corresponding to the USD leg was received.
14. The accrual of the EUR leg was EUR <2,173,000>.
15. The interest payable corresponding to the EUR leg was paid.
16. Journal entries on 31 December 20X1

    The accrued interest of the bond was EUR <2,321,000>. The payable related to this accrued interest was EUR <2,343,000>.

17. The change in fair value of the hedged item for the risk being hedged produced a EUR 3,527,000 loss, fully deemed to be effective.
18. The accrual of the USD leg of the CCS was EUR 2,321,000. The receivable related to this accrued interest was EUR 2,343,000.
19. The accrual of the EUR leg of the CCS was EUR <1,968,000>.
20. The change in fair value of the CCS produced a EUR 3,754,000 gain, of which EUR 3,527,000 was deemed to be effective and EUR 227,000 ineffective.
21. Journal entries on 15 July 20X2

    The accrued interest of the bond was EUR <2,725,000>. The payable related to this accrued interest was EUR <2,740,000>.

22. The interest payable corresponding to the bond's previous accrued interest was retranslated, producing a EUR 19,000 loss.
23. The bond coupon was paid using the USD amounts received under the USD leg of the CCS.
24. The accrued interest of the USD leg was EUR 2,725,000. The receivable related to this accrued interest was EUR 2,740,000.
25. The interest receivable corresponding to the USD leg's previous accrued interest was retranslated, producing a EUR 19,000 gain.
26. The interest receivable corresponding to the USD leg was received.
27. The accrual of the EUR leg was EUR <2,282,000>.
28. The interest payable corresponding to the EUR leg was paid.
29. Journal entries on 31 December 20X2

    The accrued interest of the bond was EUR <2,448,000>. The payable related to this accrued interest was EUR <2,486,000>.

30. The change in fair value of the hedged item for the risk being hedged produced a EUR 4,743,000 loss, fully deemed to be effective.
31. The accrual of the USD leg of the CCS was EUR 2,448,000. The receivable related to this accrued interest was EUR 2,486,000.
32. The accrual of the EUR leg was EUR <2,043,000>.
33. The change in fair value of the CCS produced a EUR 5,058,000 gain, of which EUR 4,743,000 was deemed to be effective and EUR 315,000 ineffective.
34. Journal entries on 15 July 20X3

    The accrued interest of the bond was EUR <2,950,000>. The payable related to this accrued interest was EUR <3,015,000>.

35. The interest payable corresponding to the bond's previous accrued interest was retranslated, producing a EUR 113,000 loss.
36. The bond coupon and principal were paid/repaid using the amounts received under the USD leg of the CCS. The bond principal represented EUR 90,909,000 (= USD 100 mn/1.1000).
37. The accrued interest of the USD leg was EUR 2,950,000. The receivable related to this accrued interest was EUR 3,015,000.
38. The interest receivable corresponding to the USD leg's previous accrued interest was retranslated, producing a EUR 113,000 gain.
39. The interest receivable corresponding to the USD leg was received.
40. The accrual of the EUR leg was EUR <2,369,000>.
41. The interest payable corresponding to the EUR leg was paid.
42. The change in fair value of the hedged item for the risk being hedged produced a EUR 3,863,000 loss, fully deemed to be effective.
43. The change in fair value of the CCS produced a EUR 4,142,000 gain, of which EUR 3,863,000 was deemed to be effective and EUR 279,000 ineffective.
44. The CCS notionals were exchanged. ABC paid EUR 80 million and received USD 100 million (worth EUR 90,909,000). The difference was worth EUR 10,909,000 (=90,909,000 – 80 mn).
45. The remaining EUR 1,102,000 fair value adjustments related to the bond were amortised to profit or loss.

The following table gives a summary of the accounting entries:

8.2.7 Concluding Remarks

ABC's objective when entering into the combination of the bond and the CCS was to incur an expense representing Euribor 12-month plus 0.49%.

During the first year of the term of the bond (and of the hedging relationship) the overall impact of the strategy on profit or loss was a EUR 3,766,000 expense. The target expense during the first year was EUR 4,047,000 (=80 mn × (4.50% + 0.49%) × 365/360), corresponding to a 4.50% Euribor 12-month rate. The difference was due to the EUR 281,000 ineffective part of the change in fair value of the hedged item. Nonetheless, the net cash outflow was exactly EUR 4,047,000.

During the second year the overall impact of the strategy on profit or loss was a EUR 4,023,000 expense. The target expense during the second year was EUR 4,250,000 (=80 mn × (4.75% + 0.49%) × 365/360), corresponding to a 4.75% Euribor 12-month rate. The difference was due to the EUR 227,000 ineffective part of the change in fair value of the CCS. However, the net cash outflow was exactly EUR 4,250,000.

During the third year the overall impact of the strategy on profit or loss was a EUR 4,920,000 expense. The target expense during the third year was EUR 4,412,000 (=80 mn × (4.95% + 0.49%) × 365/360), corresponding to a 4.95% Euribor 12-month rate. The EUR 508,000 (=1,102,000 – 594,000) difference was due to the EUR 594,000 ineffective part of the change in fair value of the CCS and the EUR 1,102,000 amortisation of the fair value. Again, the net cash outflow was exactly EUR 4,412,000.

The sum of the interest expense over the three years equalled the sum of the three expense targets. Therefore over the three years, both from a cash and expense perspective, ABC achieved its objective of funding itself at Euribor 12-month plus 0.49%.

Finally, note that in our case the CCS basis was included in the hedging relationship. The full fair value movement of the CCS, including the basis component, was taken into account in the calculation of the effective part of the hedge. As a consequence, a volatile behaviour of the basis could have created substantial ineffectiveness. Similarly to the treatment of forward components of forward contracts, when the basis component of a CCS is excluded from a hedging relationship, IFRS 9 allows the choice between:

• recognising in profit or loss the change in the basis element fair value; and
• recognising changes in the basis element fair value in OCI to the extent that it relates to the hedged item, while amortising the initial basis element in profit or loss.