Tesco 2006 Annual Report Download - page 108

106 Tesco plc
Notes to the Parent company financial statements continued
Derivative financial instruments are recognised initially at
cost. Subsequent to initial recognition, derivative financial
instruments are stated at fair value. The fair value of derivative
financial instruments is determined by reference to market
values for similar financial instruments, or by discounted
cash flows or by the use of option valuation models. Where
derivatives do not qualify for hedge accounting, any gains or
losses on remeasurement are immediately recognised in the
Profit and loss account. Where derivatives qualify for hedge
accounting, recognition of any resultant gain or loss depends
on the nature of the hedge relationship and the item being
hedged. To qualify for hedge accounting, the hedge relationship
must be documented and tested for effectiveness.
In order to qualify for hedge accounting, the Company is
required to document from inception the relationship between
the item being hedged and the hedging instrument. The
Company is also required to document and demonstrate an
assessment of the relationship between the hedged item and
the hedging instrument, which shows that the hedge will be
highly effective on an ongoing basis. This effectiveness testing
is performed at each period-end to ensure that the hedge
remains highly effective.
Fair value hedging
Derivative financial instruments are classified as fair value
hedges when they hedge the Company’s exposure to changes
in the fair value of a recognised asset or liability. Any gain or
lossfrom remeasuring the hedging instrument is recognised
immediately in the Profit and loss account. Any change in the
fair value of the hedged item, attributable to the hedged risk,
is adjusted against the carrying value of the hedged item and
recognised immediately in the Profit and loss account.
Derivativefinancial instruments qualifying for fair value hedge
accounting areprincipally interest rate swaps.
Cash flow hedging
Derivative financial instruments are classified as cash flow
hedges when they hedge the Company’s exposure to variability
in cash flows that are either attributable to a particular risk
associated with a recognised asset or liability or a highly
probable forecasted transaction.
The effectiveelement of any gain or loss from remeasuring the
derivative instrument is recognised directly in equity.
The associated cumulative gain or loss is removed from equity
and recognised in the Profit and loss account in the same
period or periods during which the hedged transaction affects
the Profit and lossaccount. Any element of the remeasurement
of the derivative instrument which does not meet the criteria for
an effective hedge is recognised immediately in the Profit and
lossaccount.
Derivative instruments qualifying for cash flow hedging
are principally forward foreign exchange transactions and
currency options.
Hedge accounting is discontinued when the hedging instrument
expires or is sold, terminated or exercised, or no longer qualifies
for hedge accounting. At that point in time, any cumulative
gain or loss on the hedging instrument recognised in equity
is retained in equity until the forecasted transaction occurs. If
ahedged transaction is no longer expected to occur, the net
cumulative gain or loss recognised in equity is transferred to
the Profit and loss account.
Net investment hedging
Derivative financial instruments are classified as net investment
hedges when they hedge the Company’s net investment in an
overseas operation. The effective element of any gain or loss
from remeasuring the derivative instrument is recognised
directly in equity. Any ineffective element is recognised
immediately in the Profit and loss account. Gains and losses
accumulated in equity are included in the Profit and loss
account when the foreign operation is disposed of.
Derivative instruments qualifying for net investment hedging
are principally forward foreign exchange transactions.
Derivative financial instruments – Accounting policy for year
ended 26 February 2005
Derivative instruments utilised by the Company are interest
rate swaps, floors and caps, forward start interest rate swaps,
cross currency swaps, forward rate agreements and forward
exchange contracts and options. Termination payments made
or received in respect of derivatives are spread over the life
of the underlying exposure in cases where the underlying
exposure continues to exist. Where the underlying exposure
ceases toexist, any termination payments are taken to the
Profit and loss account.
Interestdifferentials on derivative instruments are recognised
by adjusting net interest payable. Premia or discount on
derivativeinstruments are amortised over the shorter of the
lifeof the instrument or the underlying exposure.
Currency swap agreements are valued at closing rates of
exchange. Forwardexchange contracts are valued at
discounted closing forward rates of exchange. Resulting gains
or losses are offset against foreign exchange gains or losses
on the related borrowings or,where the instrument is used to
hedge a committed future transaction, are deferred until the
transaction occurs or is extinguished.
Note 1 Accounting policies continued