Answers / Corporate Treasury

A company has a net investment hedge in a foreign subsidiary using a USD-denominated loan. The USD strengthens by 5% against the EUR. How is this hedge accounted for under IAS 21? What is the impact on equity?

An advanced Corporate Treasury question — expect it in final rounds and case-heavy interviews (IB, PE, Big-4 Transaction Services).

THE SHORT ANSWER

Under IAS 21, a net investment hedge is accounted for similarly to a cash flow hedge. The effective portion of the gain or loss on the hedging instrument (the USD loan) is recognized in other comprehensive income (OCI) and accumulated in the translation reserve, offsetting the translation gain/loss on the net investment. The ineffective portion goes to profit or loss. When the subsidiary is disposed of, the cumulative amount in OCI is reclassified to profit or loss. Here, if the loan is in USD and the subsidiary's net assets are in EUR, a USD strengthening increases the USD value of the loan (liability) causing a loss, but the net investment in EUR also decreases, so the OCI offset is effective. Equity (translation reserve) remains unchanged net of hedge.

WHAT INTERVIEWERS LISTEN FOR

  • ✓Effective portion in OCI
  • ✓Offset translation gain/loss on net investment
  • ✓Ineffective portion in P&L
  • ✓No net impact on equity if fully effective
  • ✓Reclassification upon disposal

COMMON MISTAKES

  • ✗Saying impact goes to P&L
  • ✗Confusing with cash flow hedge
  • ✗Ignoring ineffectiveness

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