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HMRC internal manual

Corporate Finance Manual

Derivative contracts: hedging: regulation 9: appropriate accruals basis

This guidance applies to periods of account starting on or after 1 January 2015 where the company has elected for regulation 9 to apply. 

Appropriate accruals basis

Where regulation 9 has effect, fair value profits or losses on the interest rate contract are ignored, and credits and debits are computed as if the company had accounted for the contract on an ‘appropriate accruals basis’. Regulation 9(4) defines what this term means: it describes a basis of accounting that the company is, for tax purposes, deemed to have adopted, as follows:

  • The contract is shown in the company’s accounts at cost. Unless the company has paid a premium to enter into the contract, or has acquired the contract from a third party, that cost will be nil. If a cost is incurred, it should be accounted for on an accruals basis that accords with GAAP. Normally this will involve amortising the amount to profit and loss over the term of the contract.
  • If periodical payments arise on the contract (for example, on an interest rate swap), and the contract is hedging a loan relationship on which interest is paid or received, the periodical payments are aggregated with the interest payments or receipts, and brought into account as a loan relationships credit or debit. These credits or debits are computed in accordance with GAAP, on the assumption that an effective interest rate method is used. ‘Periodical payments’ also includes any case where only a single payment is to be made under a swap.
  • Where the contract is denominated in a foreign currency, it is retranslated at each balance sheet date, and exchange gains and losses are brought into account through profit and loss.
  • If the contract is terminated early, any termination payment made or received is spread over the unexpired term (if any) of the hedged item.
  • All fair value changes arising on the interest rate contract are disregarded, and replaced by use of the ‘appropriate accruals basis’, including amounts that go through profit and loss account because the hedge is not 100% effective.

The intention of regulation 9(4) is to describe an accruals basis of accounting for the contract that accords with UK GAAP as it stood before 1 January 2005. Given the wide variety of hedging arrangements that may come within the regulation, circumstances may arise in which the accepted accounting practice differs in point of detail from the description in regulation 9(4). In such cases, HMRC staff should be prepared to accept a method that accords with the statutory intention and gives a reasonable result.