Hi,
Let's make the following assumptions.
ParentCo is CAD functional
Sub A is CAD functional
Sub B is GBP functional
All company wide IT costs are in GBP and incurred by Sub B and partially recharged in GBP to Sub A based on number of licenses at year end
IT costs are GBP100M, assume split GBP50M Sub A and GBP50M recharged to Sub B
All IT costs are external costs
GBPCAD at beginning of year is 1.75 CAD/GBP, 1.80 CAD/GBP average rate on the year and 1.85 CAD/GBP at year end
Let's assume everything is paid at the same time it is billed
Assuming that we take no hedging action.
P&L Sub A (CAD Functional)
Intercompany Cost = GBP 50M @ 1.85 = CAD92.5M (recharged at year end based on spot rate)
EBIT = GBP(50)M = CAD(92.5M)
P&L Sub B (GBP Functional)
Intercompany Revenue = GBP 50M
External Cost = GBP 100M
EBIT = GBP(50M)
And ParentCo (CAD Functional)
P&L Sub A + P&L Sub B (converted at average rate, intercompany transaction based on transaction rates) - Intercompany Transactions
External Revenue = 0
Intercompany Revenue = GBP50M * 1.85 GBP/CAD = CAD92.5M - CAD92.5 (to eliminate intercompany transactions) = CAD0
External Cost = GBP100M * 1.85 GBP/CAD = CAD185M
Intercompany Cost = GBP50M * 1.85 GBP/CAD = CAD92.5M - CAD92.5 (to eliminate intercompany transactions) = CAD0
EBIT = CAD(185)M
Now, my consolidated P&L in CAD functional is exposed to fluctuations CADGBP rates. If GBP strengthens, my consolidated CAD EBIT will be lower and vice-versa.
As such, I would like to hedge (via a cash flow hedge) my intercompany recharges such that my Sub A is no longer exposed to FX fluctuations at the standalone level and consolidated level.
Let's then implement the following hedge strategy at Sub A
Buy Forward GBP50M / Sell CAD @ 1.75 CAD / GBP
According to my understanding of IFRS9, I can implement a cash flow hedge on an intercompany transaction if there is an external component tied to this intercompany transaction. In this case, the intercompany transaction is a recharge of true external IT costs.
If I look at the individual subs' P&L.
P&L Sub A (CAD Functional)
Intercompany Cost = GBP 50M @ 1.85 = CAD92.5M (recharged at year end based on spot rate)
Hedge Benefit (against intercompany Costs) = CAD 5
EBIT = CAD(87.5M)
P&L Sub B (GBP Functional)
Intercompany Revenue = GBP 50M
External Cost = GBP 100M
EBIT = GBP(50M)
Now, I get a bit confused as to what the consolidated P&L look like? How do I eliminate the interco and where will the hedge benefit show up?
P&L Sub A + P&L Sub B (converted at average rate, intercompany transaction based on transaction rates) - Intercompany Transactions
External Revenue = 0
Intercompany Revenue = GBP50M * 1.85 GBP/CAD = CAD92.5M - CAD92.5 (to eliminate intercompany transactions) = CAD0
External Cost = GBP100M * 1.85 GBP/CAD = CAD185M
Intercompany Cost = GBP50M * 1.85 GBP/CAD = CAD92.5M - CAD92.5 (to eliminate intercompany transactions) = CAD0
Hedge Benefit (against intercompany Costs) = CAD 5
EBIT = CAD(180)M
Is that how I should think about this situation? Is my reasoning failing on the application of IFRS 9?
Thank you
Let's make the following assumptions.
ParentCo is CAD functional
Sub A is CAD functional
Sub B is GBP functional
All company wide IT costs are in GBP and incurred by Sub B and partially recharged in GBP to Sub A based on number of licenses at year end
IT costs are GBP100M, assume split GBP50M Sub A and GBP50M recharged to Sub B
All IT costs are external costs
GBPCAD at beginning of year is 1.75 CAD/GBP, 1.80 CAD/GBP average rate on the year and 1.85 CAD/GBP at year end
Let's assume everything is paid at the same time it is billed
Assuming that we take no hedging action.
P&L Sub A (CAD Functional)
Intercompany Cost = GBP 50M @ 1.85 = CAD92.5M (recharged at year end based on spot rate)
EBIT = GBP(50)M = CAD(92.5M)
P&L Sub B (GBP Functional)
Intercompany Revenue = GBP 50M
External Cost = GBP 100M
EBIT = GBP(50M)
And ParentCo (CAD Functional)
P&L Sub A + P&L Sub B (converted at average rate, intercompany transaction based on transaction rates) - Intercompany Transactions
External Revenue = 0
Intercompany Revenue = GBP50M * 1.85 GBP/CAD = CAD92.5M - CAD92.5 (to eliminate intercompany transactions) = CAD0
External Cost = GBP100M * 1.85 GBP/CAD = CAD185M
Intercompany Cost = GBP50M * 1.85 GBP/CAD = CAD92.5M - CAD92.5 (to eliminate intercompany transactions) = CAD0
EBIT = CAD(185)M
Now, my consolidated P&L in CAD functional is exposed to fluctuations CADGBP rates. If GBP strengthens, my consolidated CAD EBIT will be lower and vice-versa.
As such, I would like to hedge (via a cash flow hedge) my intercompany recharges such that my Sub A is no longer exposed to FX fluctuations at the standalone level and consolidated level.
Let's then implement the following hedge strategy at Sub A
Buy Forward GBP50M / Sell CAD @ 1.75 CAD / GBP
According to my understanding of IFRS9, I can implement a cash flow hedge on an intercompany transaction if there is an external component tied to this intercompany transaction. In this case, the intercompany transaction is a recharge of true external IT costs.
If I look at the individual subs' P&L.
P&L Sub A (CAD Functional)
Intercompany Cost = GBP 50M @ 1.85 = CAD92.5M (recharged at year end based on spot rate)
Hedge Benefit (against intercompany Costs) = CAD 5
EBIT = CAD(87.5M)
P&L Sub B (GBP Functional)
Intercompany Revenue = GBP 50M
External Cost = GBP 100M
EBIT = GBP(50M)
Now, I get a bit confused as to what the consolidated P&L look like? How do I eliminate the interco and where will the hedge benefit show up?
P&L Sub A + P&L Sub B (converted at average rate, intercompany transaction based on transaction rates) - Intercompany Transactions
External Revenue = 0
Intercompany Revenue = GBP50M * 1.85 GBP/CAD = CAD92.5M - CAD92.5 (to eliminate intercompany transactions) = CAD0
External Cost = GBP100M * 1.85 GBP/CAD = CAD185M
Intercompany Cost = GBP50M * 1.85 GBP/CAD = CAD92.5M - CAD92.5 (to eliminate intercompany transactions) = CAD0
Hedge Benefit (against intercompany Costs) = CAD 5
EBIT = CAD(180)M
Is that how I should think about this situation? Is my reasoning failing on the application of IFRS 9?
Thank you