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How to hedge disclosures?
IFRS 7 and Hedge Accounting - A first stocktaking
Master thesis within Business Administration

Financial Reporting and Analysis
Spring 2008
Authors: Manuel Hausin

Christoffer Hemmingsson
Jesper Johansson
Tutors: Pernilla Lundqvist

Jan Marton
Acknowledgements
After two exhausting, but also very informative, months of working on this thesis it is
time to thank those persons that supported us through the entire developing process of
our thesis. Special thanks go to the tutors of our thesis, Pernilla Lundqvist and Jan
Marton who were at all times willing to support us with their expertise and experience.
We want to thank them especially for their never ending patience regarding our regular
requests. For her vital feedback we also want to thank Jenny Andersson form KPMG
Stockholm. Her opinions and perception were of great help for the success of our
thesis. Even though they requested anonymity, we want to thank the two financial
analysts who were willing to conduct the interviews with us. Their statements and
opinions reflect an eminent part of our research.
Furthermore we want to thank all our seminar opponents who gave us valuable
feedback for the improvements of the various drafts. Special thanks go to our
opponents of the final seminar, Louice Petersson and Peter Hansson who had to
become acquainted with our entire thesis.
Also we want to thank Handelss IT-service. Without your effective, high-class
service and the first-class hardware available at this university we would not have
been able to hand in this thesis on time.
Finally, we want to give props to Thai Prayook, MEZE, Wasa All, 10-to-10 etc.
Without their almost daily supply of food and drinks, we definitely would have been
lost. Continue to exploit the students budgets!
Gteborg, 27th May, 2008
________________ ________________ ________________

Manuel Hausin Christoffer Hemmingsson Jesper Johansson
I
Abstract
Master thesis within Business Administration, School of Business, Ecnomics and Law,
University of Gothenburg, Financial Reporting and Analysis, Spring 2008.
Authors: Manuel Hausin, Christoffer Hemmingsson & Jesper Johansson.

Tutors: Pernilla Lundqvist & Jan Marton.
Title: How to hedge disclosures? IFRS 7 and Hedge Accounting A first stocktaking
Background and problem: Financial instruments are often highly complex. An

effective financial presentation of the certain risks is therefore vital for the users,
especially for the investors understanding of financial reports for their decision-making
processes. This is of special importance when it comes to hedge accounting and an
understanding of the companies risk management policies, and how hedging affects the
entities financial performances and risk situations. IASBs answer to this issue was the
introduction of the IFRS 7 Financial Instruments: Disclosure, an accounting standard
with the main goal to improve the quality of disclosed information, compulsory for all
annual reports from 1st January 2007 onwards.
Purpose: The purpose of this thesis is to explore how Swedish Large Cap entities have
disclosed information regarding hedge accounting in their annual reports 2007, after the
implementation of IFRS 7. Furthermore this thesis evaluates how the new hedge
accounting disclosure requirements are perceived by the financial analysts.
Delimitations: The thesis will only focus on that part which is presented in IFRS 7
regarding hegde accounting. The purpose is not to investigate how the companies use
hedges, nor the quality of the disclosed information. Moreover, the thesis will only
focus on the users perspective (investor).
Method: A mix between a quantitive and qualitative method have been chosen in order
to fulfill the purpose of the thesis. The quantitive method was used by conducting a
disclosure study. The secondary data was collected from annual reports 2007. With a
qualitative method, primary data was gathered from two telephone interviews with
financial analysts and one accounting specialist.
Conclusion: The findings and the analysis point out that for fair value hedges
approximately 88 percent of the entities disclosure information correlated with IFRS 7
hedge accounting requirements. For cash flow hedges and hedges of net investments in
foreign operations approximately 63 respective 81 percent of the entities provided
information correlating with the requirements Even though, different correlations
regarding the standards requirements and the information disclosed were identified, the
interviewed financial analysts did not perceive those inconsistencies as important issues
for their daily work, since hedge accounting disclosure were not considered as vital
information sources.
Suggestion on further research: It would have been interesting to conduct the same
study for financial institutions since hedge accounting is more vital for their business.
Furthermore, it would also be useful to evaluate the quality of the disclosed information,
besides the quantitative aspects we have tested.
II
Abberivations
B/S: Balance Sheet
CFH: Cash Flow Hedge
EU: European Union
FI: Financial Instruments
FVH: Fair Value Hedge
GAAP: General Accepted Accounting Principles
HIFO: Hedge of net Investments in Foreign Operations
IAS: International Accounting Standard
IASB: International Accounting Standards Board
IASC: International Accounting Standards Committee
IFRS: International Financial Reporting Standards
I/S: Income Statement
III
Table of contents
1 Introduction ................................................................................ 1
1.1 Background ............................................................................................. 1
1.2 Problem discussion ................................................................................. 2
1.3 Research questions ................................................................................ 2
1.4 Purpose ................................................................................................... 3
1.5 Delimitations ............................................................................................ 3
1.6 Disposition ............................................................................................... 3
2 Theoretical framework ............................................................... 4
2.1 IASBs conceptual framework and qualitative characteristics ............... 4
2.2 Information asymmetry ........................................................................... 5
2.2.1 Information problem ..................................................................... 5
2.2.2 Agency problem ........................................................................... 5
2.2.3 The lemon problem ...................................................................... 6
2.2.4 Usefulness of financial statements .............................................. 7
2.2.5 Usefulness of voluntary disclosures ............................................ 8
2.2.6 Disclosure, cost of capital for equity and market efficiency ........ 8
2.2.7 Overview of the information problem .......................................... 9
2.3 Hedge accounting ................................................................................... 9
2.3.1 Why use hedges? ...................................................................... 10
2.3.2 Why use hedge accounting? ..................................................... 11
2.4 How to account for hedging (IAS 39 and IFRS 7) ............................... 12
2.4.1 Hedged item ............................................................................... 13
2.4.2 Hedging instruments .................................................................. 13
2.4.3 Hedge relationships ................................................................... 13
2.4.4 Fair value hedge (FVH) ............................................................. 14
2.4.5 Cash flow hedges (CFH) ........................................................... 14
2.4.6 Hedge of a net investment in a foreign operations (HIFO) ....... 15
2.4.7 Hedge accounting disclosures in accordance with IFRS 7 ...... 15
3 Method ...................................................................................... 17
3.1 Research strategy ................................................................................. 17
3.2 Collection of data .................................................................................. 18
3.2.1 Secondary data of empirical findings ........................................ 19
3.2.2 Primary data of empirical findings ............................................. 20
3.2.3 Collection of theories ................................................................. 21
3.3 Evaluation of collected data.................................................................. 21
3.3.1 Secondary data of empirical findings ........................................ 22
3.3.2 Primary data of empirical findings ............................................. 24
3.4 Reliability and validity ........................................................................... 25
3.5 Criticism of chosen method .................................................................. 26
4 Empirical findings .................................................................... 27
4.1 Collected secondary data Annual reports 2007 ................................ 27
4.1.1 Disclosures about fair value hedges (Matrix 1)......................... 28
4.1.2 Disclosures about cash flow hedges (Matrix 2) ........................ 29
4.1.3 Disclosures about hedges of net investment in foreign
operations (Matrix 3) ............................................................................. 32
IV
4.2 Collected primary data Financial analysts interviews ....................... 34
4.2.1 General opinions about annual reports ..................................... 34
4.2.2 Hedge accounting and IFRS 7 .................................................. 35
4.2.3 Hedge accounting disclosures .................................................. 36
4.3 Collected primary data Accounting specialist .................................... 36
4.3.2 Hedge accounting disclosures and investors as main users
of financial statements .......................................................................... 37
4.3.3 IFRS 7 and its explicit hedge accounting paragraphs .............. 37
5 Analysis .................................................................................... 39
5.1 Secondary data Annual reports 2007 ................................................ 39
5.1.1 Disclosures about fair value hedges (Matrix 1)......................... 40
5.1.2 Disclosures about cash flow hedges (Matrix 2) ........................ 41
5.1.3 Disclosures about hedges of net investment in foreign
operations (Matrix 3) ............................................................................. 42
5.2 Primary data Interviews ...................................................................... 43
5.2.1 General opinions about annual reports ..................................... 43
5.2.3 Hedge accounting disclosures .................................................. 45
5.3 Summary of the analysis ...................................................................... 46
6 Conclusion ................................................................................ 48
7 Final discussion ....................................................................... 49
7.1 Suggestions on further research .......................................................... 49
References ..................................................................................... 50
Figures
Figure 1 :Overview of the theories regarding the information problem .................. 9
Figure 2: Example of an interest-rate swap........................................................... 10
Figure 3: Hedge accounting under IAS 39 ............................................................ 11
Figure 4: IAS 39 hedge accounting requirements. ................................................ 12
Figure 5: IFRS 7 Hedge accounting disclosure requirements .............................. 16
Figure 6: The performed research process ........................................................... 18
Figure 7: Disclosure scores ................................................................................... 23
Figure 8: Overview of the sample size's usage of different hedge types. ............ 27
Figure 9: Sample group's FVH score..................................................................... 28
Figure 10: FVH requirements met by the sample size .......................................... 29
Figure 11: Screenshots, Ericsson and Scania ...................................................... 29
Figure 12: Sample group's CFH score. ................................................................. 30
Figure 13: CFH requirements met by the sample size ......................................... 30
Figure 14: Screenshot, Sandvik. ............................................................................ 31
Figure 15: Screenshots, SKF and TeliaSonera..................................................... 31
Figure 16: Screenshots, Axfood and Boliden ........................................................ 32
Figure 17: Screenshot, SCA. ................................................................................. 32
Figure 18: Sample group's HIFO score ................................................................. 33
Figure 19: HIFO requirements met by the sample size. ....................................... 33
Figure 20: Screenshots, SAS and Stora Enso. ..................................................... 34
V
Figure 21: Overview of the used theories .............................................................. 47
Tables
Table 1: FVH disclosure-evaluation form .............................................................. 23
Appendix
Appendix 1 Interview guideline financial analysts .............................................. 54
Appendix 2 Interview guideline accounting specialist ........................................ 55
Appendix 3 Sample size ...................................................................................... 56
Appendix 4 Sample sizes use of different hedges ............................................. 57
Appendix 5 Fullfilment criteria IFRS 7 ................................................................. 58
Appendix 6 Matrix 1, Fair value hedges .............................................................. 59
Appendix 7 Matrix 2, Cash flow hedges .............................................................. 60
Appendix 8 Matrix 3, Hedges of net investment ................................................. 62
VI
- Introduction -
1 Introduction
This chapter starts with a background to the chosen subject leading to a further discussion of
the thesiss problem. Finally the purpose of this thesis will be presented and the area of
research will be limited.
1.1 Background
Over the last decades the business environment has become more and more global, which has
led to an increasing level of competition but also enabled entities to gain access to new
customers and additional resource markets. With a growing diversity of international business
operations an increase in risks naturally comes along, especially with risks related to financial
issues such as fluctuating currencies, commodity prices and interest rates. Consequently, the
need for entities to manage and limit those risks is vital for their medium- and long-term
survival. BBC News recently titled Weak dollar leads to EADS losses 1 meanwhile Dagens
Industri reported SSAB klarar sig frn dollarfallet2. Those two headlines indicate the
importance of an effective risk management in order to protect an organization from external
risk drivers, like in those examples a decreasing value of the U.S. dollar. When companies
face those kinds of risk-situations where needs arise to secure transactions from fluctuating
underlying factors, a common way to deal with such issue is the usage of hedge instruments.
Hedging can basically be described as an attempt to reduce the risk of an underlying
transaction by concluding an adverse transaction in order to offset the risks. 3 Theoretically,
perfect hedging therefore compensates all potential losses but also gains, however in practice
this is relatively difficult to achieve. 4
As the examples of EADS and SSAB indicate, the efficiency of hedging is ultimately
affecting the financial performance of a company. Since hedging is connected with many
business transactions, often central to the companies core business and involving large
amounts of funds, it is therefore essential for the users of the financial statements (e.g.
investors) to understand and evaluate the quality and impact of the entities hedging.
However, hedge instruments itself are often complex and complicated derivates and the
reporting of hedges and the correlating corporate risk management policies is the
quintessence of hedge accounting.5 For many entities it is a current practice to present
information to external parties isolated from the available internal corporate management
data, resulting in a lack of transparency and penalizing the financial statement users
(information asymmetry). The answer to this issue was the introduction of the IFRS 7
Financial Instruments: Disclosure, an accounting standard with the main goal to improve the
quality of disclosed information regarding financial instruments, compulsory for all annual
reports from 1st January 2007 onwards. 6 Considering the currently far-reaching consequences
of the subprime crisis on the U.S. mortgage market, one cannot help but think if such a crisis
would have been preventable, or at least would have been realized earlier, if disclosure
obligations like the ones of IFRS 7 would had been in place already. 7
1
BBC News (2008) http://news.bbc.co.uk/2/hi/business/7289013.stm. Accessed 01.04.2008
2
Dagens Indusrti (2008)
http://di.se/Nyheter/?page=/Avdelningar/Artikel.aspx%3FO%3DRSS%26ArticleId%3D2008%255c03%255c14%255c275071.
Accessed 01.04.2008
3
Franke, Hax (2005) p. 613
4
Alexander, Britton & Jorissen (2007) p. 402
5
Controller Akademie (2006) http://www.controller-akademie.ch/data/data_229.pdf. Accessed 02.04.2008
6
PricewaterhouseCoopers (2007) www.pwc.com/at/pdf/newsletter/financial_services/PwC_FS_34.pdf. Accessed 02.04.2008
7
Financial Times (2008) http://www.ft.com/indepth/subprime. Accessed 02.04.2008
1
- Introduction -
1.2 Problem discussion

From 1st of January 2005, onwards IAS/IFRS was introduced as new mandatory accounting
regulation for all public listed companies in EU. The standards therefore replaced the
previous Swedish GAAP for listed companies. The purpose of the substitution of the national
GAAPs and the adoption of IAS/IFRS by the EU is to improve the quality of financial
reporting, and increase the level of transparency and international comparability. 8 This
process of conversion was naturally connected with some difficulties. The most discussed
standard within this new regulation was the treatment of financial instruments, IAS 39. 9
Financial instrument has become more complex over the past 20 years since the development
of new innovations, such as interest rate swaps, treasury bonds and options, has increased. 10
Those instruments have been developed in order to meet new risk management concepts
(hedging). As a result of this, a need for more relevant and transparent information about the
entities risks arising from financial instrument and how the correlating risks are managed has
increased.11
Since the nature of those financial instruments is often highly complex and constantly
changing, an effective financial presentation of the certain risks is vital for the users, and
especially the investors, understanding of financial reports for their decision-making
processes. This is of special importance when it comes to hedge accounting and an
understanding of the companies risk management policies, and how hedging affects the
entities financial performances and risk situations (impact on profit and loss). 12
However, to perform hedge accounting is a voluntary decision of the companies. The benefit
from applying hedge accounting is that the reporting of the hedged items and the hedging
instruments (derivates) supports the qualitative characteristics of the IASBs conceptual
framework, resulting in the presentation of a fairer view of the companies economic and
financial positions by improving the level of transparency. It became obvious that the
disclosure requirements in the previous IAS 30 Disclosures in the financial statements of
banks and similar institutions and IAS 32 Financial instruments. Disclosures were not
keeping up with the rapid development within the area of risk management. Therefore a need
arose to revise and improve the disclosure regulation regarding risks resulting from FIs. IFRS
7 is the actual result of that approach, meaning it is also applicable for Swedish Large Cap
entities.13
1.3 Research questions

The presented background and problem discussion led us to the following research questions
whereas the first question serves as a main research field, whereas the second research
question can be considered as a supplement to complete the chosen area of research.
To which extent does the information provided in the annual reports 2007 of Swedish
Large Cap entities correlate with the hedge accounting disclosure requirements of
IFRS 7?
8
Grfer & Sorgenfrei (2007) p. 10
9
Alexander et al. (2007) p. 48
10
McDonnell (2007) p. 14
11
Pirchegger (2006) p. 115
12
Scott & Yeoh (2006) p. 38
13
Gornik-Tomaszewski (2006) p. 43
2
- Introduction -
How do financial analysts perceive the hedge accounting disclosures in accordance to

IFRS 7, provided in the entities annual reports for their decision making purposes?
1.4 Purpose
The purpose of this thesis is to explore how Swedish Large Cap entities have disclosed
information regarding hedge accounting in their annual reports 2007, after the
implementation of IFRS 7. Furthermore this thesis evaluates how the new hedge accounting
disclosure requirements are perceived by the financial analysts.
1.5 Delimitations
The research is limited to non-financial entities listed at the Large Cap list at OMX Nordic
Exchange in Stockholm and at those entities that used hedge accounting in their annual
reports of 2007. The purpose is not to investigate how the companies use hedges, nor the
quality of the disclosed information. Also, the thesis will only focus on that part which is
presented in IFRS 7 regarding hedge accounting. Thus, other parts concerning financial
information disclosures in IFRS 7 will not be discussed any further. Moreover, the thesis will
not focus on the producers perspective of financial statements when analyzing the usefulness
of the new hedge accounting disclosures. The thesis focuses only on the user perspective
since the investors (financial analysts) is referred as the primary user of financial reports
according to IASB.
1.6 Disposition
Chapter 1: Introduction Chapter 3: Method

This chapter starts with a background to the chosen subject
leading to the thesiss problem. Finally the research questions and In this chapter of the
purpose of this thesis are presented and the area of research is thesis the scientific
limited views and choices of
methods are
Chapter 2: Theoretical Chapter 4: Empirical presented. It is shown
framework findings how the data was
This chapter explains the In this chapter the thesiss collected and how the
theoretical framework which empirical findings are researchs underlying
is used as a primary tool to presented. First the collected sample size is defined
analyze the empirical secondary data from annual and analyzed. The
findings. The theoretical reports 2007 is presented. chapter is concluded
framework also helps the Furthermore, the most relevant by a discussion
reader to understand the information gathered from the regarding the
subject and contribute to interviews is provided in the reliability, validity and
answer the thesiss research second part of this chapter. weakness of the
questions and purpose. chosen methodology
Chapter 5: Analysis
In this chapter of the thesis the empirical findings are
analyzed and interpreted together with the theories and
models which are presented in the theory chapter.
Chapter 6 and 7: Conclusion and Final discussion

Those chapters present the thesiss conclusion and
the authors final discussion. Finally, suggestions
for further research are presented.
3
- Theoretical framework -
2 Theoretical framework
This chapter explains the theoretical framework which is used as a primary tool to analyze
the empirical findings. The theoretical framework also helps the reader to understand the
subject and contribute to answer the thesiss research questions and purpose.
2.1 IASBs conceptual framework and qualitative characteristics

To make it easier for the producers when preparing financial statements and to facilitate users
when interpreting financial statements, IASB has created a Framework for the Preparation
and Presentation of Financial Statements. The document describes the basics by which
financial statements are prepared and serve as a guideline in those accountings issues that are
not directly covered in the international accountings standards, IAS/IFRSs. However, in case
of a conflict between the standard and the conceptual framework, the specific standard is
prioritized.14 The EU has also adopted the Framework in their regulation which means that
Swedish entities that are following IFRS have to use the Framework as a guideline. 15 Even if
the Framework addresses all users of accounting information (paragraph 6), paragraph 10
explicitly states that investors serve as the primary and most important user-group. Since
investors provide risk capital to the companies, the Framework argues that ...the provisions
of financial statements that meet their needs will also meet most of the needs of other users
that financial statements can satisfy16. The developed IAS/IFRSs are in line with the
Frameworks perspective and primarily serve the needs of investors. Financial statements
prepared under IAS/IFRS therefore preferential serve an information/accountability function
and can be perceived as generating general purpose financial statements.17
The IASBs Framework is extensive and the most relevant parts for the purpose of this thesis
are those paragraphs concerning the qualitative characteristics of financial statements.
Qualitative characteristics are the aspects which make the information provided in financial
statements useful to the users. The Framework presents four main characteristics. First, it is
essentially that information provided in the financial statements is understandable by users
with an adequate knowledge of business and economics. Information about complex matters
should be provided because of its relevance, even if it could be too difficult for certain users
to understand. Second, information included in financial statements should also be relevant
for the decisions-making purposes of the users. Information is relevant when it gives aid to
the users to evaluate the economic impact of past, present and future events. 18
Third, information should also be reliable. Information is considered as fulfilling this
criterion when it is free from material error and bias, and when the users could reasonably
expect that the information reflects what it is expected to represent. 19 There is a conflict
between relevance and reliability, therefore this has to be balanced in accounting and
financial reporting. For investors, financial reports are considered as being relevant when
they reflect all material transactions in a way that is close to reality, e.g. by using fair value
on assets and liabilities. However, the calculation of fair value is in certain cases difficult and
subjective, which can lower the reliability of the presented information. IASBs general view
is that fair value should be the underlying notion on those assets and liabilities that can be
14
IAS Plus (2008) http://www.iasplus.com/standard/framewk.htm Accessed 21.04.2008
15
Marton, Falkmann, Lumsden, Pettersson & Rimmel (2008)
16
IASB Framework for the Preparation and Presentation of Financial Statements (2003) paragraph 10
17
18
IASB Framework for the Preparation and Presentation of Financial Statements (2003) paragraph 24-30
19
4
measured on in a reliable way, e.g. financial instruments, commodities or investment

property.20
The forth and last qualitative characteristic is that it should be possible to compare financial
statements of an entity over time and with other entities financial statements, in order to
identify the developments of financial figures and performance. 21 A standardization of
accounting regulations is necessary for the possibility of making such comparisons since a
standardized regulation reduces numbers of options for entities by using different methods or
policies. Hence, a well developed and harmonized regulation will make the comparison
between companies out of different jurisdictions easier, and lowers investors transaction
costs, which creates a more efficient market. 22
It is not clear, which qualitative characteristics are the most important ones for investors in
their decision-making purposes. An investigation done by Ernst & Young23 has shown that a
majority of investors has identified transparency as the most important aspect in the initial
stage when considering an investment. The investigation defines transparency as the
investors need for relevant information in the communication with external shareholders, in
order to indentify economic risks. 24 Furthermore, the EU argues that a high degree of
transparency and comparability of financial statements are the most important aspects for a
well-functioning capital market in Europe. 25
2.2 Information asymmetry

The following section of the theory deals with the traditional and fundamental information
problem which copes with the dilemma of unequally distributed information within the
corporation and the market. The chosen theories dealing with this issue are the information
problem (asymmetry), agency problem, the lemon problem, the cost of capital, voluntary
disclosures and the usefulness of financial statements. The theories suit the purpose of the
thesis, because they discuss the issue in a broad and flexible context, which is of special
importance since we realized that specific research regarding hedge accounting disclosures is
currently almost non-existent.
2.2.1 Information problem

If one party in a contractual relationship has more information than the counter-party,
naturally an information issue arises, due to the unequally distributed information. Such
unequally distributed information between the two parties is called information asymmetry.
This phenomenon is often discussed by using the model of the agency-problem, which is
explained in the following paragraph. Also the presented theory regarding the lemon problem
(presented below), demonstrates this problem in an additional context. 26
2.2.2 Agency problem

According to Rimmel the agency theory examines the efficient organization of cooperative
relationships between two or more individuals27. Furthermore, Jensen and Meckling defines
20
Marton et al. (2008)
21
22
23
For this survey, 137 institutional investors in 16 different countries were interviewed in 2005.
24
Ernst & Young (2006a) http://www.ey.com/global/assets.nsf/International/Global_Risk_-_Investor_Survey_Report/$file/EY-Risk-
Investor-Survey-Report.pdf Accessed 22.04.2008
25
European Union (2001) http://www.europarl.europa.eu/meetdocs/committees/juri/20020225/449285EN.pdf. Accessed 22.04.2008
26
Rimmel (2003)
27
Rimmel (2003)
5
the agency relationship as a contractual relationship where one or more individual (the
principal) hires another (the agent) to execute a service on the behalf of the principal. The
agent therefore acts sovereign but on account of a third party. 28 But this delegation of
decision-making authority is an issue, because the agent often does not have the same
incentives as the principal. If this principal-agent dilemma is transferred to corporations, the
agent (management) possesses unique information about the corporations business decisions,
which is not available to the principal (e.g. shareholders) which creates information
asymmetry.29
The agent model assumes that all individuals act in their own self-interest. The principals are
presumed to be risk neutral and reducing their risk through spreading their wealth in many
different companies. At the same time, the agents cannot diversify away this risk and are
assumed to be risk adverse. Hence, the agent has more at stake than the principal because he
or she has financial wealth tied up in the company; therefore his or her wealth is depending
upon the performance of the corporation solely. In addition, the agency theory assumes that
management attempts to maximize its own welfare rather than the welfare of the whole
corporation.30 Differences in objectives between the agent and the principal will result in a
conflict of interests. The principal wants the managers to act in the best interest of the owners.
The principals personal objectives may interfere with the agents if the agent chooses to
maximize the personal earnings, which might have a negative impact on the principal. 31
Legal requirements like company acts, accounting regulation or corporate governance
guidelines can help to minimize the information asymmetry between agents and principals.
Such a framework of supportive financial reporting requirements is able to increase the level
of transparency (an important accountability criteria, according to the mentioned survey of
Ernst & Young) because they lead to additional disclosures which would not always been
provided by the agents voluntarily. 32 However, in their article, Healy and Palepu showed that
the solely fulfillment of the financial requirements for annual reports are not enough to
provide sufficient reports to the principals.33 The provision of additional, voluntary
disclosures which improve the agents credibility regarding their financial reporting can be a
solution to this issue. Such (voluntary) disclosures (will be discussed in chapter 2.2.5) are a
way to reduce the impact of the agency problem since agents might be requested to articulate
the corporations long term strategy, or use nonfinancial information that can be used to
evaluate the effectiveness of such a strategy. 34
2.2.3 The lemon problem

Another prevalent discussed example for the information problem (asymmetry) is the so-
called lemon problem. According to Rimmel, the lemons problem arises from information
differences and conflicting incentives between managers and investors 35. The lemon
problem refers to the used-car market in order to clarify the underlying issues of unequally
distributed information. In a used car market, the buyers often cannot differentiate the good
cars from the lemons (i.e. the ones with technical problems). Therefore the same model will
sell for the same price, regardless whether they are lemons or not. This is due to the fact
28
Jensen & Meckling (1976) p. 308
29
Rimmel (2003)
30
Rimmel (2003)
31
Rimmel (2003)
32
Schttler, Spulak & Baur (2003) p. 20
33
Healy & Palepu (1993)
34
Rimmel (2003)
35
Rimmel (2003)
6
that the seller has much more information about the quality of the cars than the buyer
(information asymmetry). If the buyer cannot distinguish between good cars and lemons, they
will settle that issue by just offering a compromise price. The risk of buying a lemon will
lower the price the buyers are willing to pay for any car. For the seller of a faultless car that
price will be too low, so those sellers will stay out of the market. Thus, the information
asymmetry drives the overall quality of used cars on offer down, since mainly just those
sellers will remain in the market, which sell faulty cars. Consequently, if the lemon problem
is not fully solved, and if the problem is related to the capital market, it will undervalue good
ideas and overvalue bad ideas relative to the information available. This means that such an
information asymmetry ultimately increases the cost of capital since the providers of capital
compensate their lack of information by requesting a premium for their resources (discussed
in detail in chapter 2.2.6). 36
A solution to the lemon problem is the design of optimal contracts between agents and
principals, which provide incentives for full disclosure of private information, allowing a
higher level of transparency. Since the lemon problem is another example of the information
problem resulting in an information asymmetry, (legal) regulation 37, like the by the EU
adopted IAS/IFRS that require managers to fully disclose private (internal) information in
financial statements is perceived as a solution to this issue. 38
2.2.4 Usefulness of financial statements

When financial statements are prepared, they rely to a great extent on accounting
information, which reflects and measures the economic consequences of the entitys activities
within a certain time period. 39 Based on a pure statutory perspective, financial statements
serve determination, documentation and information/accountability functions. 40 According to
Alexander et al accounting is about the provision of figures to people about their
resources. But this provision of information cannot be limited to a simple delivery-process
of text and figures. It is essential that accounting information is communicated, not just
delivered.41
According to the IASBs and FASBs Conceptual Frameworks, relevance in connection with
reliability and the other qualitative characteristics (mentioned above) determine the
usefulness of accounting information and the resulting financial statements. 42 Mensah,
Nguyen and Prattipati argue that those financial statements which are prepared in accordance
with the Conceptual Framework and the suitable accounting standards 43 usually result in high
quality financial statements. 44 This is of special importance, since such financial statements
(and especially their disclosure) can be perceived as suitable tools to reduce information
asymmetries (i.e. the agent- and the lemon problem) and to lower the costs of capital (chapter
2.2.6) for the companies providing them. 45
36
Rimmel (2003)
37
38
Rimmel (2003)
39
Soffer & Soffer (2003) p. 4
40
41
Alexander et al (2007) p. 3-10
42
Maines & Wahlen (2006) p. 401
43
Pankoff & Virgil (1970)
44
Mensah, Nguyen & Prattipati (2006) p. 48
45
7
2.2.5 Usefulness of voluntary disclosures

A study by Lang and Lundholm documented that better disclosure practice improve analysts
forecasts of next years earnings. In addition, Banghog and Plenborg examined that a higher
level of voluntary disclosure reduces the information gap (asymmetry) between companies
and investors. The result of their study shows that voluntary disclosure seems to reduce the
level of information asymmetry. Voluntary disclosure can be defined as information which is
provided over and above existing regulation. 46 It is often argued that companies that provide
voluntary disclosures to investors and analysts will find it advantageous. 47 If a firm does not
provide such information, the investors could become suspicious about the quality of their
investment and discount its quality to the point where managers always are better off with a
full disclosure practice. 48 On the other hand, the provision of too much information may
result in a loss of competitive advantage and disproportional disclosure costs. 49
Eccles and Mavrinac conducted a national survey between corporate managers, financial
analysts, and portfolio managers to examine disclosure regulations and how they
communicate with the capital market. 50 The analysis indicated that all three groups think that
the market functioning is imperfect. They do not see a need for increased financial
reporting regulation. On the other hand, the analysis suggests that companies can improve
the quality of disclosure and communication by developing a strategy for corporate
information disclosure, upgrading the role of the investor relations staff and voluntary
reporting of nonfinancial information. These improvements would lead to an increasing
level of managements credibility and a better understanding of the entitys business by the
financial analysts, which would ultimately result in an increasing or less biased share price.51
Lang and Lundholm examined the relations between the disclosure practices of firms, the
number of analysts following a firm and the effects this has on the analysts earnings
forecasts. They provided evidence that firms whit more informative disclosure policies have
a larger analyst following, more accurate analyst earnings forecasts, less dispersion among
individual analyst forecasts and less volatility in forecast revisions. Lang and Lundholm
observed that potential benefits of disclosure are increased investor following, reduced
estimation risk and reduced information asymmetry, every of which have been shown to
reduce a corporations cost of capital in theoretical research. 52
2.2.6 Disclosure, cost of capital for equity and market efficiency

It has been discussed above that the disclosed information in financial reports lowers the
information asymmetry and therefore decreases the companys cost of capital for equity. 53
Cost of capital can be defined as the opportunity cost of an investment; that is how much a
company has to pay to obtain capital from investors or creditors. The cost of capital for
equity is basically the return that the investors demand for investing in the company. It
corresponds to what the market or investor demands for bearing the risk of the ownership or
owning the asset. 54 In general, different tracks have been developed in accounting research
regarding the correlation between disclosures and cost of capital. One track argues that
46
Adrem (1999)
47
Lang & Lundholm (1996)
48
Verrecchia (1983)
49
50
Eccles & Mavrinac (1995)
51
52
53
Daske (2006)
54
Soffer & Soffer (2003) p. 31-33
8
higher information quality reduces an entitys cost of capital by lowering non-diversifiable

estimation risk.55 This is due to the fact that investors, when they construct their optimal
portfolio56, are not just only exposed to a systematic risk. In addition, they also face an
estimation risk since investors have to estimate different factors from the available
information that might affect the stocks return. By providing additional qualitative
information, the estimation risk will be lowered which tends to attract risk-averse investors. 57
However, another research track argues that improved disclosures lead to a greater liquidity
of the stock and raises demand from large investors which decreases an entitys cost of
capital.58 This is explained by the existing information asymmetry among the various
investors and research has shown that an increased and higher quality of disclosures reduces
the information asymmetry among investors and thereby stimulates the liquidity of the share,
which ultimately lowers the cost of capital for the entity. 59
However, how financial information disclosures affect the market efficiency has for long
time been discussed in financial theory. The classic underlying notion is that the more well-
informed the whole market is; the stronger is the market efficiency.60
2.2.7 Overview of the information problem

The following figure describes how the authors perceive the connections between the
discussed theories regarding the information problem. After reading this theory chapter, the
reader should grasp that the agency problem and the lemon problem are basically two ways to
describe an information asymmetry. Two ways to minimize this asymmetry is to use high
quality financial statements and voluntary disclosures, which consequently can lower the cost
of capital due to a more efficient market.
Figure 1 : Overview of the theories regarding the information problem (self provided model).
2.3 Hedge accounting

In the second part of this chapter, theoretical concepts regarding hedging and hedge
accounting will be discussed. First, a brief introduction of hedging is presented. Second, an
overview of the subject of hedge accounting is provided. This is done in order to provide the
55
Daske (2006), p. 333
56
An optimal portfolio consists of investments that fit the investors personal risk awareness. According to this individual risk an investor
must decide how to diversify his investments in order to meet the perfect risk structure (Franke & Hax, 2003).
57
Clarkson, Guedes & Thompson (1996)
58
Daske (2006) p 333 and Espinosa & Trombetta (2007) p. 1374-1375
59
Diamond and Verrecchia (1991)
60
Grossman & Stiglitz (1980)
9
reader with a solid theoretical basis regarding hedging, which is helpful for a deeper
understanding of the standards accounting requirements (IAS 39 & IFRS 7) and the
conducted research.
2.3.1 Why use hedges?

Today, firms face several financial risks in their daily business activities due to international
trading and transactions. One way to cope with those kinds of risks is to use hedging which is
a cost-effective solution to lower the total risk in the entitys business system. 61 However, the
cost of implementing such hedges affects the companys decision for the use of hedging and
is a reason why not all risks and transactions are hedged. Traditional arguments to motivate
hedging are managerial risk aversion, reduction of expected costs for financial activities, tax
reasons and benefit from capital market imperfections. 62
Basically, there are three different kinds of risks that companies are exposed to: currency-,
interest-, and price-risks63. Those risks can be hedged by the usage of derivates. Derivates are
kinds of financial instruments whose changes in market value are depending on changes in
underlying variables (asset and/or liabilities). Common examples of underlying variables are
interest rates, exchange rates, stock prices, stock-market indices, or prices of commodities. A
derivative instrument is basically a contract, consisting of minimum two parties. For instance,
one of the participants buys the right to buy or sell the underlying asset in the future while the
other party is usually obliged to fulfill the contract in the future. Derivatives can in general be
divided into three major groups; forward contracts, swaps, and options. The common
denominator is that they all are regulated at a future date. 64
Simplified, hedging is applied to minimize the risks borne in certain business transactions
and/or balance sheet items. The desired effect of a hedging relationship is that the changes in
value of the hedging instrument (derivate) and the hedged item (e.g. fixed-interest bearing
loan) compensate each other. This can be exemplified by a company with a fixed-interest
bearing loan, as the figure below indicates. Since the value of a fixed-interest bearing loan
changes with fluctuations on the interest rate market, the company is exposed to fluctuations
in the interest level. An increase of the interest rate creates a profit (due to the value of the
loan decreases) and vice versa. In order to protect them against this interest rate risk, the
entity could acquire an interest-rate swap since it generates a loss when the interest rate
increases and a profit when the interest rate decreases. Due to the character of an interest-rate
swap, the exchange of interest payments compensates the risk exposures. 65
Figure 2: Example of an interest-rate swap (self-provided model).
61
Wramsby & stlund (2004)
62
De Ceuster, Mark, Durinck, Laveren, & Lodewyckx, (2000)
63
Currency risk (also known as foreign exchange risk) arises from fluctuations in exchange rates between currencies; Interest rate risk arises
due to the variability of interest rates which lead to a change in an assets or liabilitys value; Price risk refers to uncertainties of current
and future market prices of certain resources, e.g. commodities (Wramsby & stlund, 2004).
64
65
10
2.3.2 Why use hedge accounting?

IFRS as well as US-GAAP contain certain regulations regarding how to account for hedging
activities. 66 Simplified, hedge accounting deals with the accounting treatment of two or more
contracts (financial instruments), described in the paragraph above, that are assigned to be
associated with each other in order to mitigate a certain economic risk. The intention of hedge
accounting is to report the opposite developments of the hedged item and the hedging
instrument in a way that the gains of one item compensate the losses of the other item. 67 This
basically means that hedge accounting regulation ensures that an offsetting gain or loss (e.g.
changes in fair value or cash flow) from a hedging instrument affects the firms profit and
loss account in the same period as the gain or loss from the hedged item. 68
The need for specific hedge accounting regulation arises from the mixed model which IAS
39 is based on. Accounts an entity according to the normal rules of IAS 39, the following
constellation would be possible: while the hedged item of a hedging relationship is carried at
amortized cost, is the associated hedge instrument (derivate) strictly recognized at fair
value.69 From a pure economic perspective, the entity would not face a gain or loss at all,
since the opposite performances of the hedged item and the hedging instrument would
compensate each other. However, the accounting, according to the normal rules of IAS 39,
would lead to an asymmetric reporting: just the changes in fair value of the hedging
instrument would be recognized in profit and loss; but not the changes in value of the hedged
item (carried at amortised cost). In such a constellation, the economic risk of loss would have
been compensated successfully; however the financial risk of a possible decline of the
entitys profit situation would exist further on and could affect the financial reports.
Inferentially, the use of hedging according to the mixed model would result in a mismatch of
timing in the entitys gain and loss recognition. 70
Figure 3: Hedge accounting under IAS 39 (translation from PwC, 2004).

Therefore the particular hedge accounting regulation of IAS 39 can be perceived as a special
case, correcting the described mismatch by changing the timing of recognition of changes in
66
Pirchegger (2006) p. 115
67
68
Pichegger (2006) p. 115
69
70
PricewaterhouseCoopers (2008) http://www.pwc.de/fileserver/RepositoryItem/fs_Hedge%20Accounting_Download.pdf?itemId=58817.
Accessed 28.04.2008
11
value of the hedged item and the hedging instrument to the same period. The possibility of
carrying the hedged item at fair value, instead of amortized cost, and compensate its changes
by the corresponding fair value changes of the hedging instrument is called the fair value
option. This leads to a significantly lower volatility in the entitys income statement (see
figure 3).71
However, due to the way hedge accounting rules are designed by the standard setter, their use
can be perceived as an option rather than an obligation. 72 Therefore one can assume that
companies are expected to have a strong incentive to apply hedge accounting, wherefore it is
not mandatory regulated by the standard. Trombley, for example, states that companies that
engage in hedge activities would like very much to be allowed to use hedge accounting73.
This perspective is based on the assumption that hedge accounting generates superior
information to the financial statement users (besides the reduction of volatile effects on the
entitys income statement) and thus benefits the company by reducing an information
asymmetry and resulting in lower costs of capital. 74 However, Melumad et al and Barnes
exposed in their studies that eminent costs can be associated with hedge accounting and
therefore lead to significant distortions from optimal hedges, which can affect the entitys
incentive to use hedge accounting and therefore the usage not categorical decreases the
entitys cost of capital. 75
2.4 How to account for hedging (IAS 39 and IFRS 7)

In accordance with IAS 39 hedge accounting recognizes the offsetting effects on profit or loss
of changes in the fair values of the hedging instrument and the hedged item. 76 Since hedge
accounting can be perceived as an expectation to the usual rules for financial instruments, the
usage is connected with the fulfillment of strict criteria. The entitys management has the
obligation to identify, document and test the effectiveness of the particular transactions for
which hedge accounting is applied. The standard states specific requirements that have to be
met in IAS 39.88, presented in the figure below. 77
Figure 4: IAS 39 hedge accounting requirements (self-provided figure).
71
PricewaterhouseCoopers (2008) http://www.pwc.com/Extweb/service.nsf/docid/1378D3155AA439D18025714D002F7838.
Accessed 28.04.2008
72
Pichegger (2006) p. 115
73
Trombley (2003) p. 33
74
75
Melumad et al (1999) p. 266; Barnes (2001)
76
IAS 39 paragraph 85
77
Accessed 28.04.2008
12
2.4.1 Hedged item

Hedge accounting can just be applied to hedged items that qualify for this special accounting
treatment. By definition, a hedged item must generate a risk-exposure, which could affect the
entitys income statement at present or in future periods. According to the theory, common
types of risks that are hedged include interest-rate risk, commodity-price risk, credit risk and
foreign currency risk. Basically every asset or liability, which generates an exposure to risk,
can be hedged. 78 However, the standard states two exceptions: first, financial instruments
classified as held-to-maturity cannot be hedged against interest-rate risk and second,
investments in associates (consolidated or measured by using the equity method) are
permitted to be a hedged item in a fair value hedge. 79 According to PwC, common hedged
items are:80
a) Monetary items in a foreign currency (risk of changes in a foreign exchange rate);
b) Fixed-interest dept financial instruments classified as available for sale (risk of
changes in interest rates or credit risk);
c) Highly supposable forecast sale/purchase in a foreign currency; and
d) Originated loans (interest-rate risk)
2.4.2 Hedging instruments

In most cases, only external derivates qualify for a use as a hedging instrument. But even if
the standard usually requires a one-to-one designation of hedge item and hedge instrument, a
single external derivate with multiple elements (e.g. a cross-currency interest rate swap) can
be used to hedge more than one type of risk (in such a case the interest rate and foreign
currency risk). However, the different risk types have to be clearly identifiable and it must be
possible to calculate the effectiveness of each hedge relationship reliably. 81 The range of
tradable, external derivates has increased tremendously over the last decades, since business
has become more globally and naturally comes along with different types of risks, compared
to previous periods. Nowadays, common external derivates used as hedge instruments are
stock options, future contracts for interest, currency or noble metal, interest-/ currency swaps,
and credit default swaps to mention a few. 82
2.4.3 Hedge relationships

In general, IAS 39 distinguishes between three types of hedging relationships: fair value
hedge, cash flow hedge and hedge of a net investment in a foreign operation.83 All of the
following explanations about how to account for various hedge types apply just for those
hedge relationships that are perceived as being effective (range of 80 to 125% over the
hedges lifetime). All ineffective hedge relationships are recognized in an entitys income
statement directly as income or expenses. 84
78
KPMG (2004) http://www.rwp.bwl.uni-muenchen.de/files/workshop/loew.pdf. Accessed 29.04.2008
79
Accessed 29.04.2008
80
Accessed 29.04.2008
81
Accessed 29.04.2008
82
Dawson (2007) p. 59-60
83
IAS 39 paragraph 86
84
13
2.4.4 Fair value hedge (FVH)

The essence of a fair value hedge is that it hedges changes in fair value of assets, liabilities or
unrecognized firm commitments (attributed to certain risks), which will affect the entitys
income statement. Such changes in fair value might arise as a result from changes in interest
rates (e.g. for loans with a fixed rate), foreign exchange rates or fluctuations in commodity
prices, for example. The effect on the entitys income statement can be immediate or happen
in the future. For instance, a loan borrowed in a foreign currency that is translated at the
closing date and would affect the entitys income statement immediately. 85
When a fair value hedge is applied, the hedged item (e.g. an asset or a liability measured at
cost) is adjusted for changes in fair value, according to the assignable risk, and these changes
are recognized in the income statement. The oppositional arranged hedge instrument
(derivate) is measured at fair value and its changes in fair value are recognized in the income
statement in the same period as well. By doing so, the already mentioned reduction of
volatility in the firms income statement is achieved. 86
2.4.5 Cash flow hedges (CFH)

A cash flow hedges object is to hedge the potential volatility of future cash flows (related to
certain risks which can be assigned to assets, liabilities or highly possible future transactions),
which will affect the firms income statement. 87 For example, future interest payments or the
reception of future debt-payments, based on a floating interest rate, can be perceived as
typical future cash flows. 88 Furthermore, future cash flows can also be assigned with future
transactions like forecast purchases or sales in a foreign currency, or the foreign currency risk
related to an unrecognized firm commitment. 89 Determinates that have an impact on the
volatility of future cash flows are changes in exchange and/or interest rates and changes in
commodity prices. It is noticeable that the mentioned determinates have an essential impact
on many hedged items, affecting their fair values and/or future cash flows. Therefore many
fair value hedges can as well be designated as cash flow hedges. However, in order to qualify
as cash flow hedges they must contain a variability exposure in future cash flows, as a result
of the hedged items. 90
In comparison to fair value hedges, changes in the hedging instruments fair value are
recognized in the hedging reserve, a balance sheet line item of the entitys equity, to the
extent the hedge is effective. This equity portion will be recycled to profit & loss when the
actual hedged transaction affects the firms income statement. By doing so, the hedge
relationship achieves its compensative effect. 91 The function of an interest-rate swap, mention
above in section 2.3.1, which converts a loan with a variable interest rate to a fixed-rate
interest loan, can be perceived as a rudimentary example of a cash flow hedge. 92
85
Accessed 29.04.2008
86
87
IAS 39 paragraph 88c
88
Accessed 29.04.2008
89
90
Accessed 29.04.2008
91
Accessed 29.04.2008
92
14
2.4.6 Hedge of a net investment in a foreign operations (HIFO)

Out of an accounting perspective, this hedge type is very similar to a cash flow hedge 93, and
is accounted for in a similar way. 94 Especially for internationally operating corporations,
which have subsidiaries in different jurisdictions using different currencies, this hedge type
might be attractive. When the consolidated accounts are prepared, the exchange differences
are deferred into equity until the subsidiaries are liquidated. When a subsidiary finally is
disposed, this portion of the equity has to be recognized in the entitys income statement as a
part of the gain or loss of the liquidation of the subsidiary. The fair value changes of the
hedging instrument (derivate), assumed it is effective, are also recognized in entitys equity
until the disposal of the subsidiary. This matching generates the compensatory effect of the
hedge relationship. In order to be effective, the net investment hedge will almost always be
denominated in the subsidiaries local currency.95
2.4.7 Hedge accounting disclosures in accordance with IFRS 7

As mentioned in the introduction chapter, from 2007 onwards IFRS 7 replaces the old
standards IAS 30 and 32 regarding disclosure requirements for financial instruments. The
general outcome of the full application of IFRS 7 is to present information to the users about
an entitys financial risk exposures and how those risks are managed by the entity. This will
aid the investors by the provision of information regarding the impact FIs have on profit or
loss and how the entity manages the risk involved in financial activities.96
The criteria regarding hedge accounting disclosures in IFRS 7 are provided in paragraph 22 -
24. Each hedge type (described above) has different requirements which are presented in
figure 5. As the figure shows, a description of each and its hedging instrument, measured in
fair value, has to be disclosed. Furthermore, the disclosure requirements for cash flow hedges
are the most extensive ones and differ most from previous standards. IFRS 7 has expanded
the requirements concerning the gain or loss on the hedging instrument which is transferred
from equity to the income statement. In addition, it has to be disclosed which line-item in
income statement is affected.97 Also the requirements of providing disclosed information
regarding the ineffectiveness of CFHs and HIFOs in the income statement are new in IFRS 7.
A further new requirement is that entities, which use fair value hedges, need to report the
gains or losses on the hedging instrument and hedging item attributable to the certain hedge.98
The ultimate outcome with the disclosures requirements for hedge accounting is to clarify for
the users what kinds of risks are involved in an entitys hedging activities. The objective is
also to provide a better description regarding what kind of FIs has been used as hedging
instruments and the fair value of them. 99
Real life examples supporting the discussed IFRS 7 requirements are provided in the
empirical findings of this research. We believe these examples can help the reader to get a
better understanding of the standards requirements by offering insights into disclosure
practices of the analyzed Swedish Large Cap entities.
93
Alexander et al (2007) p. 405
94
IAS 39 paragraph 102
95
Accessed 29.04.2008
96
Balans (2008) p. 41-42
97
Ernst & Young (2006b) http://www.ey.com/Global/Assets.nsf/Russia_E/IFRS_-_7_Financial_Instruments/$file/IFRS_7_publication.pdf
Accessed 07.05.2008
98
Ernst & Young (2006b) http://www.ey.com/Global/Assets.nsf/Russia_E/IFRS_-_7_Financial_Instruments/$file/IFRS_7_publication.pdf.
Accessed 07.05.2008
99
Balans (2008) p. 41-42
15
Since neither the standards basis of conclusion or further theories regarding the certain
paragraphs dealing with hedge accounting were available, the conducted interview with
Jenny Andersson from KPMG Stockholm (presented in the following method and empirical
findings chapter) served as an analysis-foundation in the analysis part of the thesis.
Figure 5: IFRS 7 Hedge accounting disclosure requirements (self-provided figure).
16
- Method -
3 Method
In this chapter of the thesis the scientific views and choices of methods are presented. The
chapter starts with an introduction to the applied method and a presentation of the research
strategies that are used in the thesis. Subsequently it is shown how the data was collected and
how the researchs underlying sample size is defined and analyzed. The chapter is concluded
by a discussion regarding the reliability, validity and weaknesses of the chosen methodology.
In order to answer the purpose and research questions we have chosen to follow Saunders,
Lewis & Thornills ideas of how to conduct a research process. The process consists of
different steps where the researcher chooses between various approaches in order to perform
a qualitative/quantitative investigation. By applying a model like this, it will be easier to
structure and analyze the collected data more methodical. 100 A structured process will help us
to avoid pitfalls that can arise during our research and will systematically raise the probability
of making a qualitative thesis.
3.1 Research strategy

When performing research the collection of information can be proceed in two different
ways. The collection can be done with a qualitative or quantitative method, or a combination
of these. The chosen method shall be based on the research projects problem discussion and
purpose, and the kind of theories that are used. 101 A quantitative study tries to answer the
question of how many times something has happened meanwhile a qualitative study focuses
on why something has happened. 102 Our chosen research method can be perceived as a
quantitative approach combined with a qualitative approach. This is chosen because we
wanted to investigate to which extent Swedish Large Cap entities follow the new hedge
accounting requirements of IFRS 7 and how the financial analysts perceive this information.
The combination of these two methods will provide us with a deeper understanding of the
subject and, according to Holme & Solvang, this combination could be beneficial in order to
recognize essential coherences. 103 Furthermore the application of a qualitative approach will
also allow us a better understanding of the subject which is important due to the complexity
of hedge accounting. By knowing why information regarding hedge accounting is disclosed
and what the users opinions are, a combined method will provide the thesis with a more
complete and understandable portrait concerning the subject.
Our research strategy is based on a combination of exploratory and descriptive studies. An
exploratory study is trying to find out what is happening and to gain new insights. According
to Robson it can be described as an approach to asses phenomena in a new light. 104
Descriptive research can be described as an attempt to portray actual events, situations and
coherences. The purpose of that strategy is to investigate how things are and how things have
been, without making any own judgments. 105 The descriptive approach focused on the
analyzed annual reports and helps us to understand how the disclosures regarding hedge
accounting are presented currently. An advantage of applying this descriptive approach is that
our preliminary understanding was regularly complemented by additional insights and led us
finally to a deeper understanding of the issue with hedge accounting disclosures. For
100
Saunders, Lewis & Thornill (2003)
101
Trost (2005)
102
Saunders et al. (2003)
103
Holme & Solvang (1997)
104
Robson (2002) p. 59
105
Saunders et al. (2003) p. 97
17
- Method -
example, when we tested how to analyze the annual reports we realized that is was not
always that clear where the information regarding hedge accounting was disclosed. This was
useful to bear in mind when we analyzed the annual reports and lead to a more efficient
collection of secondary data.
The reason why the exploratory approach was chosen as well, was because we wanted to
clarify our understanding of the problem since we were aware of the complexity of hedge
accounting and its accounting treatment. Especially for our collection of primary data, the
exploratory approach was beneficial since it is considered as a very flexible research method,
which is adaptable to changing circumstances. The conducted interviews provided us with
additional insights into the disclosure issues of hedge accounting and helped us to gain
different viewpoints of the topic. For example, after the conducted interview with the
accounting specialist we interpreted the actually wording of some standard requirements out
of a different perspective (for instance, how to interpret the nature of risk being hedged in
paragraph 7.22 c), IFRS 7).
3.2 Collection of data

Collected data can both be in form of primary- and secondary data. In general, data that has
been collected for another purpose than the explicit research and still provides reanalyzing
abilities is known as secondary data, for example, written materials such as journal articles,
books or essays. Primary data is information that has been collected specifically (first-hand)
in order to serve a research purpose, for example the conduction of interviews or
questionnaires. 106 However, even if secondary data can provide useful information to answer
a research question, it is advantageous to combine it with primary information sources to
support the informational value of the founded secondary data. 107
Figure 6: The performed research process (self-provided model).

As the figure above indicates, the research conducted in this thesis was based on primary- and
secondary data, mainly because we already early in the prearrangement-process realized the
importance of analyzing the problem regarding hedge accounting in a broader context. A
focus only on secondary data would probably not direct the thesis into a desirable direction.
Last year, 2007, was the first fiscal-year that IFRS 7 was used in financial reporting and
consequently would existing sources regarding on how the standard effect the users be non-
existent. Therefore, primary data gained in interviews with financial analysts and an
accounting specialist, will also be presented in the empirical findings in order to successfully
106
107
Lundahl & Skrvad (1999)
18
- Method -
answer the second research question. However, the vast majority of the empirical findings are
based on secondary data, which is logically since the main purpose of this thesis is to identify
how information regarding hedge accounting is disclosed. The secondary data is based on
information collected in annual reports and answers the first research question. Collecting
primary data for this purpose is almost impossible and is therefore not an option in our case.
In general, the collection of the primary- and secondary data was performed simultaneously,
except the interview with the accounting specialist, which was performed after the disclosure
study. Because of that, the practical insights we gained complemented each other
beneficially. The following headlines provide the reader with an overview how the collection
of primary- and secondary data was preceded.
3.2.1 Secondary data of empirical findings

In order to fulfill the purpose of the thesis and to answer the first research question it is
necessary to do a sample selection of the population, since very often it is impracticable and
useless to survey an entire population. We have chosen to use a non-probability, also called
judgmental 108, sampling of our population which basically consists of all companies that are
publically listed in Sweden, OMX Nordic Exchange in Stockholm. All publically listed
companies, on group level, within Sweden (EU) have to follow the standards of the IASB
which have been implemented into EU legislation by the EU Commission. Even if it would
be interesting to investigate the annual reports of all companies listed on the OMX Nordic
Exchange in Stockholm, such an extensive analysis has not been performed mainly due to a
lack of resources (e.g. time constrains). Consequently, we were constrained to some kind of
non-probability selection of our population. We do not believe that this will affect our study
essentially, since many researchers argue that the use of sampling increases the possibility of
higher overall accuracy than the use of full population. It still may be possible to generalize
from non-probability about the population, but not on statistical basis. 109
Our first selection-criterion was those entities that are listed on the Large Cap list on OMX
Nordic Exchange in Stockholm. The Large Cap consists of those Swedish companies that
have the highest market capitalization (over 1 billion Euro). 110 We have chosen that list
because we believed that it was more likely that those companies reported their hedging
activities in their financial statements, compared to companies with a lower market
capitalization due to their higher level of accounting expertise and international business
operations. Our sample group consisted of the 67 entities111 of the Swedish Large Cap list on
08.04.2008 (see appendix 3). Moreover, since the research focuses on listed non-financial
institutions, which reported hedge accounting in their annual reports 2007, the sample size
was limited to 48 entities, excluding the lists financial institutions. However, non-financial
institutions still represent the majority of the Swedish Large Cap list. Financial institutions
were excluded from the sample size for several reasons. First, financial institutions have to
fulfill additional and sometimes complex regulation (e.g. Basel II and special local
requirements by Finansinspektionen). Second, the extent and complexity of financial
institutions transactions differ essentially from business transactions of regular/non-financial
organizations. Finally, the application of IFRS 7 was new to those companies whereas
financial institutions already applied the requirements of this standard. OMX Nordic
Exchanges industry-classification was used in order to differentiate between financial and
non-financial entities.
108
109
110
Market capitalisation is calculated through multiply the entities number of share with its price.
111
OMX Nordic Exchange (2008) http://omxnordicexchange.com/priceinformation/shares/. Accessed 08.04.2008
19
- Method -
Furthermore, since hedge accounting according to IAS 39 is voluntary, not all entities
included in the sample size reported their hedging activities. Therefore the research is limited
to those companies which applied hedge accounting in the fiscal year 2007. Due to that,
seven companies had to be excluded from the initial sample size of 48 entities. In order to
perform this assessment we set a deadline (25 th April 2008) for the acceptance of annual
reports for the year 2007. In addition, three companies had to be excluded since they were
following US GAAP or Canadian GAAP instead of IAS/IFRS. Additionally one company
was disqualified since they had a broken fiscal year and consequently had not implemented
IFRS 7. All this resulted in a final sample size of 37 companies. A company became part of
the sample size when their state within its annual report, of the fiscal year 2007, explicitly
that hedge accounting is applied. The evaluation process whether an entity used hedge
accounting or not was not difficult since it was in general clearly stated if hedge accounting
in accordance to IAS 39 was applied. The evaluated annual reports were collected
electronically from the companies websites.
3.2.2 Primary data of empirical findings

To meet the purpose of this paper, we conducted in total three interviews with professionals
out of the accounting and investment profession. The accounting-specific interview was
performed with Jenny Andersson from KPMG Stockholm, whereas two financial sell-side
analysts at different broker firms were interviewed in order to cover the investor-specific
perspective and to answer research question number two. Since the analysts requested
anonymity, their names and places of work are not presented in the thesis.
This sample was chosen because we found it reasonable to interview professional users of
financial statements in order to gain a better understanding of the issues connected with the
disclosure of hedge accounting. Moreover, a purpose of this paper is to evaluate how the new
hedge accounting disclosure requirements are perceived by financial analysts. Due to that, the
chosen interview partners seemed to be suitable to answer this question because of their
professional expertise and experience. The companies covered by the two financial analysts
are Alfa Laval, ABB, Atlas Copco, Husqvarna, Linab, Nobia, Sandvik, SKF and Trelleborg.
The interview with the accounting specialist from KPMG helped us to identify the underlying
issues of the standard and gave us useful practical insights about how the standard is applied
by entities and which particular paragraphs are critical, both for investors and the entities
itself. This interview was of great importance for the thesis since it was hard to find any
extensive information regarding IFRS 7 and hedge accounting disclosure. Because of that, the
interview with Jenny Andersson also served as a source for analysis purposes (research
question one). In addition, the interview was helpful to gain knowledge about her opinion
how disclosures are perceived by investors for decision making purposes (research question
two).
KPMG Stockholm was contacted via e-mail together with the residual Big Four in the
auditing industry. The KPMG office in Stockholm was the first that responded to our request
and provided us a contact with an appropriate accounting specialist in financial instruments.
The fact that only KPMG responded, and we decided to just have one interview with an
interviewee out of the accounting industry, is not affecting our research since the interview
only served as a basis for a better understanding of the subject and as a source for analysis
purposes.
In order to get in contact with financial analysts of the chosen sample size, we accessed their
e-mail addresses from the companies investors relations websites. Not all companies of the
20
- Method -
sample size provided information regarding which financial analysts are following them
permanently. Therefore we were not able to get access to the complete list of analysts
evaluating the companies of our sample size. Due to that 86 analysts were contacted via e-
mail. Six of those e-mails were non-deliverable, whereas 16 responded to our request. This
resulted in two interviews and 14 rejections. The two main reasons for the rejections were
either that hedge accounting was not important for the analysts evaluations at all, or
individual time constraints due to the unfavorable timing of our interview request, since the
companies Q1 2008 reports have been released simultaneously. We believe that the fact that
we limit our primary research to two interviews with financial analysts is not affecting our
research, since the main focus of this thesis lays on the analysis of the companies disclosed
information. Naturally, a more extensive number of interviews would have provided us with
more information and additional perspectives. But since the two interviews mainly
complemented our research and gave us an insight into the usefulness of the disclosed
information regarding hedge accounting, we believe that our decision to conduct two
interviews is appropriate.
3.2.3 Collection of theories

Secondary data was used in the collection of the theoretical framework in order to provide a
better understanding of the subject and to clarify what issues to investigate in. Literature
sources will help the researchers to develop a good understanding and to gain insight into
previous research. 112 Thus, initially we studied the IFRS 7 and its Basis for conclusion (even
though the particular Basis for conclusion is not available for the hedge accounting section of
the standard) in detail plus the course literature from previous courses in accounting, to grasp
the concept of hedge accounting and disclosures. IASBs Conceptual Framework was also
studied to understand the underlying notion of international accounting. Information was
moreover collected from the big auditing firms homepages to receive a current view of the
subject. However, as mentioned earlier, we realized early in the process that the existence of
previous research was minimal and due to this the literature search was focused on general
theories that could serve as useful tools when analyzing our empirical findings. A brief
clarification regarding the importance of the chosen theories can be found in the theory
chapter of this thesis.
Like mentioned before, several secondary data sources have been used in order to increase
the credibility of the thesis such as books, scientific articles and other printed reports. Those
search engines that we have used are GUNDA, the library catalogue, Blackwell Synergy,
Science Direct and Business Source Premier. A selection of keywords used when searching
were hedge accounting, IFRS 7 disclosure, hedges and information asymmetry among others.
Finally, all information regarding accounting regulation and standards were collected from
EUs homepage for internal market/accounting 113.
3.3 Evaluation of collected data

Virtually all research will result in some numerical or qualitative data that has to be
structured in a proper way in order to analyze it systematically. 114 Since this thesis consists of
both secondary, quantitative, data collected from annual reports and primary, qualitative, data
collected from interviews, the following paragraphs will therefore describe how the analysis
of the data was conducted.
112
113
European Union (2008) http://ec.europa.eu/internal_market/accounting/index_en.htm. Accessed 09.04.2008
114
21
- Method -
3.3.1 Secondary data of empirical findings

For the purpose of the analysis of the annual reports, three different matrixes were designed
to evaluate to which extent Swedish Large Cap annual reports 2007 correlate with the hedge
accounting requirements of IFRS 7. This evaluation process was used to answer the first
research question. In order to prevent an unsystematic evaluation process and to assure that
annual reports are evaluated in the same way, we used Deloittes IFRS Presentation and
Disclosure Checklist 2007 as a starting point to develop our case specific matrixes. The
checklist was downloaded from Deloittes IFRS website 115. This checklist was chosen due to
the fact that it represents a systematical and practically tested auditing tool, which provided
us with sureness that all hedge accounting disclosure requirements have been checked in our
analysis of the annual reports. The checklist was furthermore compared with the hedge
accounting part of IFRS 7 (paragraphs 22 24). We realized that the standards requirements
were identical with the checklists criterion.
Since IFRS 7 instructs different requirements for the three different hedge types 116, we
decided to develop one matrix for each hedge type. After analyzing the standard and the
disclosure checklist we realized that there are no constant universal requirements for hedge
accounting in general but specific requirements for each hedge type. For instance, an entity
shall disclose the following separately for each type of hedge described in IAS 39 117, can
be perceived exemplarily. In addition the usage of hedge type specific matrixes helped us to
analyze the disclosed companies information out of a specific perspective for each hedge
type. This was helpful to make sure that disclosed information regarding hedge accounting
was tested against all individual requirements of the three different hedge types. An
evaluation matrix identical with the standards requirements (paragraph by paragraph) was
not useful since some paragraphs apply for more than one hedge type. Therefore a
classification into three type specific matrixes (considering the relevant paragraphs, e.g. fair
value hedges tested against paragraphs 22 a), 24 a), etc.) was more applicable and fits more
coherent presentation purposes.
The secondary data is presented in the empirical findings chapter according to the three
different matrixes we used in the evaluation purposes. The matrixes tested the requirements
in a binominal way, meaning that the outcome of each evaluation resulted in the criterion
fulfilled (1) or not fulfilled (0). The different matrix-criteria for the three different hedge
types are presented below. Since the first research question of this thesis is to assess if the
sample sizes companies fulfill the IFRS 7 requirements regarding hedge accounting, such a
binominal evaluation seemed to be an appropriate way to answer this questions, since the
results of such a study are simply to measure. The research results show to which extent, in
percentage, the companies disclosures are correlating with the hedge-type specific
requirements in the three different matrixes. Furthermore, the research will provide the reader
of the thesis with an individual and detailed listing about the extent to which the certain
Swedish Large Cap companies disclosures correlate with the hedge accounting requirements
of IFRS 7. The calculation is done by using the following formula, where d i is disclosed itemi
which is 1 if the item is disclosed, and otherwise 0; mj is the maximum number of items and
nj is total number of companies that are supposed to fulfill the standards requirements.
115
Deloitte (2008) http://www.iasplus.com/fs/2007checklist.pdf. Accessed 23.04.2008
116
See the theory chapter 2.4.7
117
IFRS 7 paragraph 22
22
- Method -
Figure 7: Disclosure scores (Adrem, 1999 p. 70)
How to interpret the matrixes

For instance, with Matrix 1 we analyzed if a sample size company fulfilled the disclosure
requirements regarding fair value hedges (FVH). If a certain company followed the fair value
hedge criterion of IFRS 7, it resulted in a company-specific score. Met criteria resulted in a 1,
otherwise a 0. This scoring model was applied to all matrixes. As Figure 3 indicates, Matrix 1
dealt with the disclosure requirements regarding fair value hedges; whereas Matrix 2 and 3
were used to evaluate the disclosure of cash flow hedges (CFH) respectively hedges of net
investment in foreign operations (HIFO).
Matrix 1: Fair value hedges (FVH)

Company Industry Use of FVH 7.22 a) 7.22 b) 7.22 c) 7.24 a) i 7.24 a) ii
Alfa Laval Industrials 0 0 0 0 0 0
ASSA ABLOY Industrials 1 1 1 1 1 1
Atlas Copco Industrials 1 1 1 1 1 1
Total:
Maximum:
Percentage:
7.22 a): a description of hedge type.
7.22 b): hedging instrument and their fair value at the reporting date.
7.22 c): the nature of risks being hedge.
7.24 a) i: gains or losses on the hedging instrument.
7.24 a) ii: gains or losses on the hedge item attributable to the hedged risk.
Table 1: FVH disclosure-evaluation form (self-provided model).

To exemplify how the evaluation process was conducted the presented matrix above shows
the first three entities of our sample size (in alphabetical order). A complete list of the sample
size as well as a complete presentation of all evaluation sheets (Matrix 1-3) can be found in
the appendix.
The usefulness of the matrixes
Before we started to analyze the annual reports we were aware of the fact that annual reports
often are very extensive and consist of numerous of pages. This naturally influenced the wa y
how the annual reports were analyzed. Due to that, we were forced to carefully consider all
chapters, paragraphs and notes in the annual reports. Information regarding hedge accounting
was for instance presented in the administration report, in the comments on the income
statement and balance sheet, or in the financial risks and policies chapter. However, in
general disclosures regarding hedge accounting were provided within the extensive note-
system and as a separate headline under accounting principles. Only few of the entities in the
sample-size presented information regarding hedge accounting explicitly as a separate note.
Since the disclosure requirements for hedge accounting in IFRS 7 are detailed and specific,
we have been relatively strict in our judgment if certain criteria is fulfilled or not. The
complete list of our evaluation criteria can be found in appendix 5. In general, the three first
23
- Method -
evaluation criteria in the Matrixes, common for all types of hedges (paragraph 22 in IFRS 7),
did not created any issues in our evaluation of the annual reports. However, during the data -
collection-process some minor factors arose which had to be considered in the evaluation. For
evaluation criteria 7.24 a) i and 7.24 a) ii in Matrix 1 (Fair value hedge), some entities only
provided information regarding the net gain or losses of fair value hedges. Those cases led to
a not fulfilled criteria, since the standard explicitly require companies to present
information regarding gains or losses both on the hedging instrument and the hedged item.
For evaluation criteria 7.23 d) in Matrix 2 (Cash flow hedges), we rejected those entities that
only presented information concerning the amount that was removed from equity and/or
included in profit or loss for the period. This is due to the fact that IFRS 7 additionally
requires information about the amount included in each line item in the income statement.
The criteria regarding ineffectiveness recognized in profit or loss for cash flow hedges and
for hedges in net investments in foreign operations (7.24 b) for CFH and 7.24 c) for HIFO),
were also fulfilled in those cases where information was disclosed that no hedges were
ineffective under the period. However, some entities only provided data on ineffectiveness on
an aggregate level, i.e. CFH and HIFO included in the same line item. Those cases were not
accepted and led to a not fulfilled criterion (0), since, according to the standard,
ineffectiveness needs to be presented individually for each kind of hedge (CFH and HIFO).
3.3.2 Primary data of empirical findings

In order to answer the second research question of this thesis it was first necessary to gain the
attitudes of professional users of financial statements, and second to evaluate their statements.
The recovery of the financial analysts and the accounting specialists opinions was
conducted with the help of qualitative interviews. In comparison to quantitative research
methods, qualitative interviews focus not on representativeness but on the collection of
typical and exemplary outcomes, so that issues, developments and practical experiences can
be recognized. 118 Due to that, the chosen data collection method matched with the purpose of
our research question, since this study aims for exemplary user opinions rather than a
representative pattern or general opinion.
In qualitative oriented interviews (characterized by its openness) the interviewee becomes a
dialog partner or expert from whom one tries to experience as much as possible in an
interactive communication. 119 Because of its openness, qualitative interviews tend to lead to a
data load which is often difficult to review. 120 Therefore we chose a sort of a qualitative
interview that is characterized by a higher structuring: the semi-structured interview.121 When
applying this type of interview, the interviewer bases the conversation on a guideline,
allowing the interviewee to talk free but at the same time assuring that the interviewer can
keep track of the purpose of the conversation. 122 For this thesis, the interview guidelines acted
like a data-collecting framework, ensuring that the second research question was answered
and the previously analyzed theories were tested against the practical opinions of the
financial analysts. The used interview guidelines can be found in appendix no.1 and 2.
The primary data was collected in three telephone interviews with the interview partners
mentioned above. All interviews were conducted in Swedish, since the interviewees have
Swedish as their native language. For later analysis purposes the interviews were recorded
118
Glser & Laudel (2004) p. 36
119
Khn & Fankhauser (1996) p. 57
120
Helfferich (2004) p. 24
121
Hopp (2000) p. 177
122
24
- Method -
plus notes were taken simultaneously. The records and notes were subsequently written down
into complete text to get a sound overview about the interviewees opinion. The most
relevant parts of the transcripts are presented in the empirical findings.
3.4 Reliability and validity

When conducting research, it is vital to reduce the possibility of getting the answer wrong.
This means that two major aspects have to be taken into consideration when research is
designed: reliability and validity. The first aspect reliability can be defined as the probability
that data collection methods or analysis methods will lead to consistent findings, similar
observations and conclusions, if the research would be conducted by other researchers. 123
Since the collected data for this thesis consisted of both, primary and secondary data we had
do make sure that the gathered information had a sound quality in order to result in a high
level of reliability. The primary data consisted of information gained from interviews with
financial statement users (analysts & accounting specialist). In order to support the criteria of
reliability the interviewer has to be aware of the fact that his or her verbal communication
could have an impact on how the respondent answers. 124 To guarantee the usage of reliable
primary data we were aware of our verbal communication and made sure that we were not
leading the conversation into a certain direction. Also the interviews were recorded on tape
and later noted down on paper in order to avoid posterior misinterpretations.
By basing our study partly on secondary data, we increased our level of reliability by nature.
According to Saunders et al. data from large and well-known organizations (e.g. companies
annual reports which are also audited before they are released) are likely to be reliable and
trustworthy, in general. 125 Since the disclosure-information we analyzed is regulated by
accounting standards (IFRS 7), the researched data is reliable by law. However, annual
reports usually are extensive and individually designed documents and therefore there is a
possibility that the researcher misses some information. Hence, our research group consisted
of three students we were able to at least double-check how the data was collected from the
individual annual reports. This fact helped us to overcome the problem that important data
was left out. Due to the fact that this thesis is mainly based on secondary data, we believe that
other researchers would come up with the same or similar results/conclusions.
The second aspect validity can be defined as a level to which the collected data accuracy
measures what it was intended to measure. It can also be perceived as the extent to which
research findings are really about what they profess to be about. 126 Validity for the used
primary data in this paper depends on the extent to which the interviewer has access to the
respondents knowledge and experience. Furthermore, it is also depending on the researchers
ability to interpret the respondents answers and the used language and terminology. To
guarantee a high level of validity it is important that the obtained information is flexible and
responsive interactions are possible during the interview. This allows meanings to be probed
and also that topics can be covered from different perspectives. Besides that, it will allow to
address questions clearly and understandable to the respondents. 127 To address this issue in
the conducted research we sent out the background, problem discussion and a interview
guideline to the interview partners in advance, to obtain data that matched our research
question.
123
Saunders et al. (2003) p. 100-101
124
Healey & Rawlinson (1994) p. 138
125
126
Ryan, Scapens & Theobald (2003) p. 155
127
25
- Method -
The validity for secondary data, annual reports, used in this thesis may be one of the most
sensitive aspects. Often when secondary data is used it can lead to answers that do not match
with the original questions. Unfortunately, there are no clear solutions to this dilemma.
According to Saunders et al., a sound approach to overcome this problem is trying to
evaluate the extent of the datas validity and let the researchers make their own decisions. 128
Since the thesis is about the impact of the recently introduced IFRS 7 we had to get a sound
understanding of the IFRS 7 hedge accounting requirements and how hedge accounting is
regulated in IAS 39. Finally, it is important for the reader to be aware of the fact that none of
the authors of this thesis has English as a native language which could result in some minor
comprehension issues. In addition to that, we are aware of the fact that interpretation issues
could arise for the conducted telephone interviews since the conversations were translated
from Swedish to English in order to present the findings to the reader.
3.5 Criticism of chosen method

Our chosen method consists of both primary data (collected qualitatively) and secondary data
(collected quantitatively). Since for both collection approaches the chosen sample size was
rather small and not representative, the research conclusions cannot be generalized. For
instance, the research was limited to the largest non-financial institutions on the OMX Nordic
Exchange in Stockholm as well as to financial analysts. Therefore the sample size does not
represent a general market or all various stakeholders relying on financial statements.
Furthermore, when data is collected primary through interviews there is a risk that
misinterpretations occur. It cannot be fully guaranteed that the respondents are interpreted in
the desired way. 129 Due to the fact that the interviews have been conducted by telephone there
is a risk that the judgments and evaluations done by the researchers are not complying with
the actual opinions of the interviewees. According to Trost is it not appropriate to conduct a
telephone interview if the purpose of the interview is to develop a deeper understanding
regarding the respondents attitudes. In addition, it can be difficult to create an environment
of personal trust which might sometimes be helpful to retrieve as much information as
possible.130 Since the interviews are based on an interview guideline (semi-structured
interviews), it is essential that the researchers design the guideline in a way that is coherent
with the purpose of the research. In order to guarantee that, it is vital that the researchs
underlying theories are interpreted in an appropriate way and critical issues are reflected in
the interview guideline. An adequate design of the questions (matching with the theories and
research questions) is therefore pivotal for the usefulness of the guideline. 131
Since the secondary data was collected through self-developed matrixes (based on IFRS 7,
section hedge accounting) the evaluation tool can be considered as subjective. This could
partly affect the researchs objectivity. Also that the disclosure requirements are tested in a
binominal way can affect our study because that chosen method could miss to explain
naturally reasons behind why some disclosures are left out. Furthermore, there is a risk that
we have missed or interpreted some information regarding the companies hedge accounting
in the wrong way, since the financial reports are extensive documents and we are not
extremely experienced evaluators of financial reports. Finally, it is important to point out that
the disclosure study does not evaluate the quality of the provided hedge accounting
disclosures.
128
129
McDaniels & Gates (2005)
130
Trost (2005)
131
26
- Empirical findings -
4 Empirical findings
In this chapter the thesiss empirical findings are presented. First the collected secondary
data from annual reports 2007 is presented. Furthermore, the most relevant information
gathered from the interviews is provided in the second part of this chapter. The interview-
guidelines used can be found in appendix, as well as the complete set of matrixes used for the
collection of the presented findings.
4.1 Collected secondary data Annual reports 2007

This part of the empirical findings presents the results of research question one, which is: To
which extent does the information provided in the annual reports 2007 of Swedish Large Cap
entities correlate with the hedge accounting disclosure requirements of IFRS 7?. Since the
collection of the secondary data was conducted by the help of the matrixes described in the
method chapter, the findings are presented according to the three different (hedge type
specific) matrixes. This means that first the findings regarding the fair value hedges are
provided, followed by the presentations of cash flow hedges and hedges of net investment in
foreign operations. As described in the method, the collection of the secondary data was
conducted by an analysis of the sample sizes annual reports 2007.
The following figure illustrates the usage of hedge accounting for the different hedge types of
the chosen Swedish Large Cap entities. As an introduction to this part of the empirical
findings, it is helpful to get an overview about the fact for what kind of hedge types hedge
accounting is applied for. This might aid the reader in a better understanding of the following
presentation of the findings concerning the various hedge types, since not all hedge types are
used by all entities. As the figure below demonstrates, out of 37 companies, almost 52
percent (19) of the sample size used hedge accounting for fair value hedges, whereas
approximately 60 percent (22) used hedge accounting for hedges of net investment in foreign
operations (called net investment hedge in the figure). The high score of 97 percent (36)
indicates that cash flow hedges were by far the most popular hedge type. The only company
that did not state information in their annual report 2007 regarding the usage of cash flow
hedges was SSAB.
100%
90% 97,30%
80%
70%
60%
50% 59,46%
51,35%
40%
30%
20%
10%
0%
Fair value hedge Cash flow hedge Net investment
(FVH) (CFH) hedge (HIFO)
Figure 8: Overview of the sample size's usage of different hedge types.
27
4.1.1 Disclosures about fair value hedges (Matrix 1)

As stated above, 19 entities of the sample size used hedge accounting for fair value hedges in
accordance to IAS 39 in their annual report 2007 and was thereby supposed to follow the
disclosure requirements of hedge accounting in IFRS 7. Matrix 1 was used in order to collect
the data from the annual reports for fair value hedges. This Matrix had five different criteria,
each corresponding to the requirements in IFRS 7 for fair value hedges. The requirements can
be found in the theory chapter 2.4.7.
The evaluation of the annual reports (figure 9) showed that the total sample size fulfilled the
fair value hedge accounting requirements of IFRS 7 with approximately 87 percent. The
groups total score provided by the Matrix was an amount of 83 (the sum of all 1), whereas
95 was the maximum score the sample group could have achieved if every individual entity
within the sample group would have fulfilled the disclosure requirements. Thus, the results in
Matrix 1 indicated 12 deviations (95 minus 83) from the best possible score (which was 95),
meaning that those requirements of the standard were not met even though fair value hedges
were used by the companies.
Figure 9: Sample group's FVH score
Furthermore, the research regarding the disclosure of fair value hedges indicated that certain
criteria of the standard were fulfilled differently. As the figure below (figure 10)
demonstrates, paragraph 7.22 a) was met by even more than the 19 entities which were using
fair value hedges. This is due to the fact that six companies 132 presented a description of this
hedge type even though they were not applying fair value hedging. Therefore this column
naturally exceeds 100 percent and resulted in a score of 131.58 percent. Many entities used
standard formulations close to IAS 39s definition of this hedge type. Paragraphs 7.22 b) was
met by all companies. The information regarding the fair value of the hedge instruments were
regularly available in the notes of the balance sheet under financial instruments, for example.
The nature of hedged risks, 7.22 c), was also often fulfilled by using common descriptions of
currency, interest rate and/or raw material price risks. Many times those descriptions were
unspecific and more of a general nature, meaning that the certain transactions which were
supposed to be hedged were not described explicitly.
132
Axis, Eniro, Hexagon, Husqvarna, Oriflame SDB & Volvo.
28
7.22 a): a description of hedge type

7.22 b): hedging instrument and their
fair value
7.22 c): the nature of risks being hedge
7.24 a) i: gains or losses on the hedging
instrument
7.24 a) ii: gains or losses on the hedged
item
Figure 10: FVH requirements met by the sample size
When it comes to paragraph 7.24 a) i and ii, gains and losses on the hedging instrument and
the correlating hedge item are naturally highly related to each other. As figure 10 indicates,
those criteria were not met by all analyzed entities. Whereas the gain/loss of the hedging
instrument was disclosed by almost 74 percent (14 entities), the corresponding gain/loss on
the hedged item was just published by approx. 63 percent (12 entities). The assessment of the
fulfillment of those two paragraphs was critical since some entities either did not disclose any
information about the gains/losses of their hedging relationships at all, or just the gains/losses
for one side of the hedge relationship. Furthermore, some companies also presented the
information regarding gains/losses just as a net result. Since IFRS 7 requires an explicit
disclosure of gains/losses on both, hedge instrument as well as hedged item, an
aggregated/net result of a hedge relationship therefore resulted in a score of 0. This can be
exemplified by the two following screenshots from the annual reports of Ericsson and Scania,
which should help the reader of this thesis to understand the basis of our judgment:
Figure 11: To the left, Ericssons annual report 2007 (p. 65); to the right, Scanias annual report 2007 (p. 114)
Ericssons disclosure serves as an example for companies which provided net results (no
score point), whereas Scanias note is an example of disclosed information which fulfilled the
evaluation criteria and therefore received a score point. To conclude, the hedge accounting
requirements of IFRS 7 regarding fair value hedges was mostly met, only the last two
paragraphs resulted in a lower percentage of fulfillment.
4.1.2 Disclosures about cash flow hedges (Matrix 2)

All companies of the sample size, except one as stated above, disclosed information in their
annual report 2007 that hedge accounting for cash flow hedges in accordance to IAS 39 was
applied. Hence, 36 entities were supposed to follow the disclosure requirements for that
specific hedge-type in IFRS 7. Matrix 2 was used in order to collect the information
regarding cash flow hedges from the annual reports and this Matrix consisted of nine
29
different criteria, referring to the IFRS 7 requirements for cash flow hedges. The specific
disclosure requirements for cash flow hedges can be found in the theory chapter 2.4.7.
As the figure below indicates, the evaluation of the annual reports points out that
approximately 62 percent of the analyzed entities fulfilled the disclosure requirements in
IFRS 7 for cash flow hedges. The outcome of Matrix 2 resulted in a total score of 202 (the
sum of all 1). The maximum score the sample group could achieve was 324, if every
individual company within the group would fulfill the disclosure requirements. Consequently,
the deviations from the best possible score (which was 324) for this hedge type was 122 (324
minus 202), meaning that those criteria of Matrix 2 were not fulfilled, even though cash flow
hedges were used by the entities.
Figure 12: Sample group's CFH score.

Moreover, if the deviations are analyzed in detail, the result of Matrix 2 shows that certain
criteria of IFRS 7 were fulfilled differently. Just as for fair value hedges, the common
specific requirements for all hedge types criteria 7.22 a-c), were fulfilled by almost all
companies within the sample group, which figure 13 demonstrates. For the a) criterion, all
entities except Hakon Invest provided a description of the hedge type (i.e. cash flow hedge)
which naturally would result in a lower percentage than the maximum.
100% 7.22 a): a description of hedge type

100% 97,22% 100% 7.22 b): hedging instrument and their
90% fair value
91,67% 7.22 c): the nature of risks being hedge
80% 7.23 a): The period when the cash flow are
70% expected to occur/affect profit or loss
7.23 b): A description of any forecast
60% 63,89%
transaction for which hedge accounting had
previously been used, but which is no longer
50% expected to occur.
7.23 c): The amount that was recognized in
40% 47,22% equity during the period.
41,67% 7.23 d): The amount removed from equity
30% and included in profit and loss for the period
(specific for each line item in the income
20% statement).
10% 16,67% 7.23 e): The amount removed from equity and
5,56% included in the initial cost or other carrying
0% amount of non-financial liability whose
acquisition or incurrence was hedged.
7.22 7.22 7.22 7.23 7.23 7.23 7.23 7.23 7.24 7.24 b): The ineffectiveness recognized in
a) b) c) a) b) c) d) e) b) profit or loss that arises from CFH.
Figure 13: CFH requirements met by the sample size
However, this is not the case since the only company (SSAB) that did not apply cash flow
hedging presented a description of that hedge type. Thus, this column resulted in a score of
30
100 percent. Standard formulations close to IFRS 7s definition for this hedge type were
often used by the entities in the sample group. Furthermore, paragraph 7.22 b) was met by all
companies except three133, which did not disclose any information regarding which hedging
instrument designated to hedge accounting and the fair value of those instruments. This
resulted in a score of almost 92 percent and the information regarding the valuation of the
cash flow hedge instrument were often available in the notes of the balance sheet under
financial instruments. As the figure below shows, criterion 7.22 c), which explains the nature
of the hedged risk, was fulfilled by almost all entities within the sample group. Hakon Invest
was the only annual report that did not fulfilled this criterion. Just as for the fair value hedge
evaluation, this paragraph was often fulfilled by using common descriptions of currency,
interest rate and/or raw material price risks.
The following paragraphs (7.23 a-e) are unique disclosures requirements for cash flow
hedges. The first paragraph, 7.23 a), resulted in a score of approximately 64 percent, meaning
that 23 entities out of 36 disclosed information regarding the periods when the cash flow are
expected to occur and when they are expected to affect profit or loss. The findings concerning
this paragraph are contrasting. Either the disclosed information was explicit and detailed like
the example out of Sandviks annual report demonstrates, or it was basically non-existent.
Figure 14: Sandvik's annual report 2007 (p 25), periods when the cash flows are expected to occur and when
they are expected to affect profit or loss.
The next tested evaluation criterion resulted in an even lower result, as figure 13
demonstrates. Approximately 16 percent (6 entities) provided information in their annual
report 2007 about any forecast transaction for which hedge accounting had previously been
used, but which is no longer expected to occur. Of those annual reports that had a score for
this criterion, different disclosed information could be found, which the following
screenshots from the annual reports 2007 of SKF and TeliaSonera can exemplify:
Figure 15: To the left, SKFs annual report 2007 (p 78); to the right TeliaSoneras annual report (p 76)
As figure 15 indicates, SKF disclosed information that they had a transaction in 2006 for
which hedge accounting was applied, but is which no longer expected to occur. At the same
time TeliaSonera disclosed information that no cash flow hedges were discontinued.
Furthermore, criterion 7.23 c) was met by all 36 entities using cash flow hedges and the
information regarding the amount recognized in equity was in all annual reports available in
the consolidated statements of changes in equity. However, the following criterion for
paragraph, 7.23 d) was only fulfilled by 17 of the analyzed annual reports which resulted in a
133
Hakon Invest, Hexagon & Holmen
31
score of almost 48 percent. As mention in the method chapter, the judgment of the fulfillment
of this paragraph was critical since almost every entity provided information about the
amount removed from equity and included in profit or loss for the period; but without
including which line item in the income statement was affected. Since this is explicitly
required by IFRS 7, this consequently resulted in a score of 0 for those entities which did not
provide such information. For clarification purposes, the two following screenshots from the
annual reports of Axfood and Boliden can serve as an example:
Figure 16: To the left, Axfoods annual report 2007 (p 82); to the right, Bolidens annual report 2007 (p 68)
Axfoods disclosure serves as an example for companies providing information of which

income line item was affected (received a score point), meanwhile Bolidens screenshot is an
example of disclosed information which did not fulfill the evaluation criterion.
For criterion, 7.23 e), only two companies 134 out of 36 provided information in their annual
reports regarding the amount that was removed from equity and included in the initial cost or
other carrying amount of non-financial asset or non-financial liability whose acquisitions or
incurrence was hedged. As the figure 13 indicates, this resulted in a score of approximately
six percent for this paragraph. The following screenshot from SCAs annual report of 2007
can exemplify how this requirement can be disclosed:
Figure 17: SCAs Annual Report 2007 (p. 59).

Finally, the last criterion in Matrix 2 measures how the entities within the sample size
disclosed information regarding the ineffectiveness recognized in the income statement for
cash flow hedges. As the figure 13 shows, almost 42 percent of the annual reports (15
entities) disclosed information regarding this requirement, which consequently shows that 58
percent of the annual reports (21 entities) failed to fulfill this requirement. Since cash flow
hedges and hedges of net investments in foreign operations are accounted for in a same way,
two examples about findings concerning this paragraph can be found in figure 20 below. To
sum up the findings regarding CFHs, it becomes obvious that the various criteria of the
standard dealing with this hedge type were met very differently. Whereas the more general
criteria of the paragraphs 7.22 a-c were fulfilled by most of the analyzed companies, the
paragraphs requiring more detailed and explicit information (e.g. 7.23 b) and e)) were only
met by the minority of the entities.
4.1.3 Disclosures about hedges of net investment in foreign operations

(Matrix 3)
The analysis of the sample sizes annual reports 2007 identified that out of 37 entities only 22
used hedges of net investments in foreign operations (HIFO). In order to collect the research-
134
Ericsson & SCA
32
data, Matrix 3 was used. This matrix tests the four hedge type specific requirements of IFRS
7 against the information disclosed by the analyzed entities. Like for the two matrixes
presented above, a complete description of these four criteria can be found in chapter 2.4.7 of
this thesis. The analysis of the annual reports exhibited that the tested companies fulfill IFRS
7s requirements with almost 81 percent. The sample sizes total score, provided by the
Matrix, was 71 (the sum of all 1), whereas 88 is the maximum score the analyzed entities
could achieve, if every individual entity within the sample group fulfills the disclosure
requirements. Hence, the results in Matrix 3 indicate 17 deviations (88 minus 71) from the
total score (which was 88), meaning that those requirements of the standard were not met
even though hedges of net investment in foreign operations were used by the entities.
Figure 18: Sample group's HIFO score (self-provided)

Moreover, the evaluation pointed out that some disclosure requirements of the standard
regarding HIFOs were met variably. Similar to the fair value hedges discussed above,
paragraph 7.22 a) was fulfilled by even more than the 22 companies, which applied HIFOs.
This is due to the fact that three entities 135 presented a description of this hedge type even
though those companies were not using any hedges of net investments in foreign operations.
Because of that, the particular column of figure 19 exceeded 100 percent, resulting in a score
of 133,64 percent. It was noticeable that many analyzed entities used standard formulations,
close to the definition of this hedge type in the standard. The requirements of paragraph 7.22
b) regarding the disclosure of the hedging instruments fair values was fulfilled by almost 91
percent. Precisely as for the other hedge types presented above, the fair value of the hedging
instruments were usually findable in the notes referring to the balance sheet line item
financial instruments. The nature of the risks being hedged by HIFOs,
120%
100% 113,64%
100,00% 7.22 a): a description of hedge type
80% 90,91% 7.22 b): hedging instrument and their
fair value
7.22 c): the nature of risks being hedge
60% 7.24 c): the ineffectiveness recognized
in profit or loss that arises from
40% HIFO
20% 31,82%
0%
7.22 a) 7.22 b) 7.22 c) 7.24 c)
Figure 19: HIFO requirements met by the sample size.
135
Getinge, Lundin Petroleum & Scania
33
paragraph 7.22 c), were usually described in general terms, similar to the other two hedge
types presented previously. Description in general terms means that usually just the
functionality of HIFOs was explained, but no subsidiaries hedged with the help of HIFO-
relationships were stated explicitly. This paragraph was met by all companies (100 percent)
using hedges of net investments in foreign operations.
As figure 19 demonstrates, paragraph 7.24 c), dealing with the recognition of the
ineffectiveness arising from HIFOs in the income statement, was only met by 31,82 percent
(seven entities) of the analyzed companies. The fulfillment of this criterion was either
achieved by stating an explicit number in the notes to the income statement in form of a table
or by providing the information as written text within diverse sections of the annual reports,
for example the financial risk management or the presentation of the entities financial
instruments.
Figure 20: To the left SASs annual report 2007 (p 68); to the right Stora Enso's annual report 2007 (p 184).
Figure 20 illustrates exemplarily two examples about how the information regarding the
ineffectiveness of HIFOs was presented in the analyzed annual reports. Whereas SAS
provides the information plainly in a table as a part of the notes to the income statement,
Stora Enso disclosed the same content as written text within their notes referring to equity
hedging (sub-headline: hedging of net investment in foreign operations). After reviewing the
findings regarding HIFOs it became evident that most of the standards requirements were
met, with an exception of paragraph 7.24 c), meaning that information referring to the
ineffectiveness arising from hedges of net investments in foreign operations was not
disclosed by the majority of the analyzed entities.
4.2 Collected primary data Financial analysts interviews 136

This part of the empirical serves as a source of data to answer the second research question of
this thesis: How do financial analysts perceive the hedge accounting disclosures in
accordance to IFRS 7, provided in the entities annual reports for their decision making
purposes?. As stated in the method chapter, the primary data was collected by two
telephone interviews with sell-side financial analysts working at two different Swedish
broker firms. Both interview partners had worked four years in their profession. The two
interview partners are named Analyst A and Analyst B in this section of the empirical
findings.
4.2.1 General opinions about annual reports

In general, both interviewees perceived annual reports as useful analysis-tools for the
evaluation of their companies. In addition, they both stated that the annual reports are of
special use if a new company is included in the set of entities they are following. This is due
136
Telephone interviews (29th April 2008)
34
to the fact that more basic information is needed in order to understand the company and its
strategy/industry in a better way. For their analysis purposes the analysts mainly used the
annual reports to get information of the companies cash flows and their income statements.
Regarding the usage of the annual reports for analysis purposes, the perceptions of the two
interviewed analysts differed. Analyst A evaluated the balance sheet in the annual reports
more than the ones presented in the interim reports. For A the significance of the annual
reports and especially its disclosures depended on the ability to understand how the different
parts of the financial reports are connected and related to each other. Analyst A furthermore
stated that a sound understanding of factors and transactions which led to the actual figures in
the reports is necessary in order to assess the impact of the disclosed number and to
understand the financial situation of the entity as a whole.
Analyst B believed that annual reports are of special usage when a deeper and more extensive
analysis of an entity is conducted. However, B stated that the disclosures of annual reports are
not that important for the analysis of entities on a daily basis. Anyhow, B mentioned that
disclosure notes are particularly useful to clarify arisen ambiguities or if figures have changed
fundamentally.
4.2.2 Hedge accounting and IFRS 7

Both analysts were aware of the fact that IAS/IFRS are applied for all listed Swedish
companies. However, only analyst B knew that IFRS 7 was recently implemented, but
admitted that he had no deeper knowledge of the standard. Analyst A could not really identify
and separate individual standards and instead he perceived all IAS/IFRS standards in one
broader context. Compared to previous years, both analysts had so far not observed any
changes concerning the disclosed information, even though 2007 was the first year IFRS 7
was applied. Besides the new disclosure requirements, both analysts were aware of hedge
accounting, stating that this phenomenon was nothing new to them, since the entities they
were following already apply hedge accounting for a while.
In addition to that, both analysts stated that they neither focus very detailed on hedging
activities nor the available hedge accounting information. This is due to the fact, that A and B
believed that hedging and hedge accounting were not of special significance, since their
entities just bind minor financial resources in those activities. Basically, the transactions were
just not material enough for deeper analysis efforts. However, they both agreed that the
purpose of hedge accounting is in general positive since it leads to a smoother result by
evening out fluctuations in the entities income statement. Also they stated that the whole
concept of hedging and hedge accounting is more vital for financial institutions since it
affects the competitive advantages of those organizations.
For B it was more of interest what kind of hedges the entities he analyzes use, rather than
they apply hedge accounting or not. However, he stated that if he had a company where the
hedging activities and hedge accounting are of significance, he would read the standards
requirements first and continue with an analysis of the disclosed information in the financial
statements and the corresponding notes. Analyst A mentioned that hedge accounting is useful
when it increases the transparency of important business transactions. For A it was vital that
he could gather information which indicates what proportion of a figure is influenced by
external factors like currency effects and which proportions refer to the business performance
solely.
35
The question regarding the importance of the different hedge types (FVH, CFH and HIFO)
was answered complete differently. Whereas B stated that the CFH are the most interesting
hedges to evaluate (with the most evaluation significance), he was not able to specify the
essence of this hedge type in detail. Analyst A admitted that he was not able to characterize
any of the three hedge types regulated in the standards.
4.2.3 Hedge accounting disclosures

Since none of the interviewees had a deeper understanding of hedge accounting and the
corresponding disclosure requirements of IFRS 7, the following discussion gathered from the
interviews refers mainly to the usage of disclosures in general.
Both analysts stated that standardized information and formulations are usually provided in
many disclosures. They argued that this kind of information is basically of no use. The
analysts furthermore said that they are more interested in receiving quantitative information,
for instance what kind of currency flows are expected to occur and which maturity dates
hedging the contracts have, even though such information would not be of significance for
their companies. Analyst A believed that the entities do not report all their numbers regarding
their financial instruments in the financial reports and therefore a direct and personal contact
with the entities CFOs is important for his analysis purposes. Analyst B agreed with As
statements, confirming that an informal contact with the CFOs is often more important than
the information which is publicly available (e.g. annual and interim reports). Analyst B
generally believed that substance over form is important when disclosure requirements are
implemented in order to enable the companies to account for their business transactions in a
flexible and unique way (and to provide their particular disclosures). However, in the same
context B mentioned that the comparison of financial information between different entities is
of special importance. Besides that, A believed that sometimes the disclosed information in
total is too extensive and unclear. He preferred plain, well structured tables instead of detailed
descriptions in text.
To sum up, the two interview partners were basically satisfied with the information provided
by the entities regarding their hedge accounting activities and believed that their efforts
support a true and fair view of their financial and economic situation. However, the area of
hedges and hedge accounting was not a significant and material issue for the entities the
interviewees follow. Analyst B suggested to disclose information about how the figures in the
I/S and B/S would look like if no hedge accounting would have been applied. The direct and
often informal contact with the financial departments of the companies was perceived as
extremely vital whereas the information available in the financial statements was assessed as
an additional, useful analysis tool.
4.3 Collected primary data Accounting specialist 137

A telephone interview with Jenny Andersson from KPMG Stockholm was conducted in order
to get a deeper understanding of the subject of hedge accounting and its disclosure
requirements regulated in IFRS 7. The interviewee has several years of working experience in
the accounting/auditing profession and is specialized on financial instruments and risk
management.
137
Telephone interview (9th May 2008)
36

According to Jenny Andersson the reason why IFRS 7 was implemented is that IASBs
objective was to have a disclosure standard, which is applicable for both kinds of entities,
financial and non-financial institutions. She also stated that an additional reason for the
introduction of IFRS 7 was to improve the previous regulation (IAS 30 and 32) since
especially IAS 32 was difficult to interpret. In particular, she believed that there was a need to
clarify the regulation and requirements regarding the disclosure of hedge accounting
activities. However, she had the opinion that it is still difficult to grasp the effect hedge
accounting has on the entities results and how the various accounting departments apply the
hedge accounting rules. On the other hand she believed that the new standard could improve
the quality of disclosed information regarding hedge accounting since more detailed
requirements could have a pedagogical effect on the companies disclosure practices because
they are nowadays required to explain their activities and transactions more in detail.
4.3.2 Hedge accounting disclosures and investors as main users of

financial statements
From an investors point of view, she mentioned that one of the most critical aspects is to
receive information regarding what unrealized value changes are reflected in the I/S and how
the effect of hedge accounting is affecting the companys equity, meaning that it is vital to
understand what amount is transferred to equity and when it will be removed from it in future
periods. Jenny Andersson did not believe that these new disclosure requirements were
required from investors or financial analysts in particular. She rather believed that for this
user group it is more important that they understand the already disclosed information and
grasp the substance and the meaning of the figures. Furthermore, she stated that she did not
believe that the voluntary choice of hedge accounting is necessarily leading to a better and
deeper understanding of the entities. It would rather depend on the individual nature of the
companys business. From her experience, the impact of hedge accounting for many non-
financial institutions is rather minimal. In fact, she stated that the economic hedges 138 are
often more important for analysis purposes since they could represent a bigger proportion of
an entitys hedging activities in total, compared to the ones hedge accounting is applied for.
Since financial analysts do often not have an extensive accounting knowledge, she believed
that those two concepts (economic hedges and hedge accounting) are often mixed up.
4.3.3 IFRS 7 and its explicit hedge accounting paragraphs

In general, she believed that the implementation of IFRS 7 can be considered as a learning
process. It will take some time until the companies understand how to present and formulate
the standards requirements in a way that it fits the needs of the statement users. Jenny
Andersson stated that the auditing firms provided entities with support when it comes to the
formulation of the disclosures but she personally believed that the disclosures have to be
useful for the readers and has to provide them with aiding information. Just to include
disclosures which do not tell the user anything is useless.
Regarding paragraph 7.22 she argued that it is crucial that the companies explain the
function of the various hedge types in detail and that they provide extensive information
concerning the hedged risks. For the hedged risks, she stated that it is important that not only
the risks are mentioned but also that the certain components of the hedged risk are described
138
An economic hedge is designated as a hedging activity for which no hedge accounting is applied for, e.g. the requirements of IAS 39,
section hedge accounting, are not met.
PwC (2008) http://www.pwc.com/Extweb/service.nsf/docid/1378D3155AA439D18025714D002F7838. Accessed 16.05.2008
37
explicitly. For instance, a hedged interest rate risk should be explained by providing
information regarding what portion of the interest rate is actually hedged, the risk free portion
or the risk portion.
Furthermore Jenny Anderson stated that in the discussions with her clients she realized that
paragraph 7.23 is the most critical one within IFRS 7 regarding hedge accounting. Especially
7.23 a) is difficult to fulfill in practice since it is hard to interpret whether the future cash
flows from the hedged item or the hedging instrument should be disclosed in detail. The
standard is not very clear in that point. In addition, she said that 7.23 b) is also very seldom
disclosed in financial reports since the presentation of forecast transactions for which hedge
accounting has been previously used but which is no longer expected to occur basically
means that the entities would admit that they have difficulties to predict their future cash
flows. Naturally, the finance and accounting departments therefore tend to avoid such
presentations. According to Jenny Andersson, particular 7.23 e) is a paragraph which is not
often applied in practice, since only very few companies have very expensive
machines/inventory purchases which are hedged.
For paragraph 7.24, she stated that especially a separate disclosure of the gains/losses of the
hedged item and the hedging instrument is an important issue for analysis purposes. In
practice, the provision of such figures should not be difficult for the entities. In her opinion,
an ineffectiveness of the CFHs and HIFOs is not so common in practice and if companies fail
to provide this kind of information it is most likely just due to slackness. The same
circumstance applies for 7.23 d), dealing with the disclosure of the amount removed from
equity (CFHs) and included in each line item of the I/S.
38
- Analysis -
5 Analysis
In this chapter of the thesis the empirical findings are analyzed and interpreted together with
the theories and models presented in the theory chapter. In order to facilitate the reader
following the discussion, this part of the thesis is structured analog to the empirical findings
presented above.
5.1 Secondary data Annual reports 2007

In this part of the analysis chapter the results of the empirical findings gathered from the
secondary research is analyzed. Every matrix-result is discussed separately and compared
with IFRS 7 requirements regarding hedge accounting disclosures and the feedback gained
from the interview with the accounting specialist. The analysis of each hedge type starts with
an analysis on an aggregate level analyzing the sample groups score, followed by a
discussion focusing on the more detailed findings of each of the three different hedge types
and their partly specific requirements (FVH, CFH & HIFO).
Before the analysis concerning the various hedge types is presented, an analysis covering the
general findings of the research is conducted. As chapter figure 8 indicates, 51,35 percent of
the sample sizes entities used FVHs, whereas the majority of the analyzed companies
applied CFHs (97,30 percent). The usage of HIFOs was identified for 59,46 percent of the
tested Swedish Large Cap entities.
The conducted research demonstrated that the CFHs were by far the most popular hedge type,
since besides one company all analyzed entities used such hedge relationships to minimize
their business risks. This implies that the common usage of CFHs should actually increase the
comparability between the tested Swedish Large Cap entities since all of them, which were
using this hedge type were supposed to fulfill the standards requirements and could therefore
be evaluated under same circumstances. However, the previous presented findings showed
that some disclosure criteria were met differently (different matrix scores). Some of them
were just presented by a minority, even though those firms in general applied this hedge type,
which consequently reduces the level of comparability between the various companies. Since
January 2007, IFRS 7 is a mandatory part of the EU adopted IAS/IFRS. Because of that, this
first-time practical implementation can be considered as an initial step in an ongoing learning
process, according to the interviewed accounting specialist Jenny Andersson from KPMG
Stockholm. This early level of the implementation process should be kept in mind when the
following correlations between the findings and the standard requirements are analyzed.
According to the theory, the purpose of using the concept of hedge accounting is to lower the
volatility in the entities income statements.139 Since this is affecting an entities annual profit
and paid dividends, information regarding such an effect can be considered as relevant.140 On
the other hand, the mentioned issue that certain criteria were met very differently by the
analyzed companies demonstrated that the disclosed information regarding hedging activities
is currently lacking a high level of reliability 141 and is not always supporting the IASB
Conceptual Frameworks qualitative characteristic of understandability 142 (e.g. the
presentation of net results of hedging relationships instead of a clear split up between
139
Accessed 28.04.2008
140
141
142
39
- Analysis -
profit/loss of hedged item and hedging instrument). As introduced earlier, a more detailed
analysis of the three hedge types is presented in the following chapters of this part of the
thesis.
5.1.1 Disclosures about fair value hedges (Matrix 1)

On an aggregate level, the result of Matrix 1 (figure 9) demonstrated that the sample groups
score regarding fair value hedges is close to 88 percent. This means that a majority of the
empirical findings of Matrix 1 correlated with the IFRS 7 requirements regarding FVHs. An
interesting finding was that some companies disclosed a description of this hedge type
(resulting in a score of 131,58 percent) even though they were not applying fair value
hedging. This fact is not harmonizing with Jenny Anderssons perception of useful disclosure
and common Swedish accounting policies, since just that information should be provided in
annual reports which supports the users. Therefore, on the basis of her perception and
personal experience as an accounting specialist, information regarding business transactions,
policies or strategies which are not performed by the particular entity is of no use. One
possible explanation for this could be that this standard requirement seems to be an easy
obligation to fulfill if just the plain wording of the standard is considered. Therefore those
companies could have decided to provide a complete description of all three hedge types even
though they did not apply all of them in practice. This perspective is supported by the fact
that most of the analyzed entities used standard formulations to describe their used hedge
types (paragraph 7.22 a)).
Also the description of the hedging instruments and their fair value at the reporting date was
disclosed by all entities (paragraph 7.22 b)). This might be due to the fact that such
information for FVH hedging instruments was just simply available for all entities and
therefore presented by all of them. Even though that the accounting specialist of KPMG
mentioned that it was crucial that the companies explained their hedged risks in detail, the
results of Matrix 1 regarding the particular paragraph 7.22 c) showed that all companies met
this criterion. However, it was a common practice to explain the risks exposures in a broader
context, not incurring into certain transactions or business situations. This obvious gap
between our findings and the perception of Jenny Andersson could be explained by the fact
that we conducted this research in an initial stage of the implementation process of IFRS 7.
Currently, a proven implementation practice (e.g. implementation guidance or comparison
possibilities with competitors) is non-existent and therefore the pure wording of the standard
is interpreted subjectively and might therefore not necessarily correlated with the standard
setters original objective.
The disclosure concerning the gains/losses of hedged item and hedging instrument, paragraph
7.24 a) i and ii, was the most critical ones for this hedge type (figure 10). As figure 10
indicates, almost 74 percent of the companies provided this kind of information for their
hedging instruments, whereas just 63 percent disclosed this information for their hedged
items. The low score regarding this paragraph is striking, since according to Jenny Andersson
such information is important for investors analysis purposes. In addition, she mentioned
that the provision of figures serving these criteria usually is not a problem in practice.
Because of that it is surprising that some companies provided just net results or incomplete
information (no gains/losses or just for one side of the hedge relationship). The incomplete
disclosures regarding those criteria could be due to the fact that the accounting departments
consider this kind of information as non-relevant for the statement users. Furthermore, these
40
- Analysis -
two criteria of IFRS 7 are new compared to the previous standards143, which could explain
the current deviations from the best possible score.
5.1.2 Disclosures about cash flow hedges (Matrix 2)

After analyzing the results of Matrix 2 it is possible to state that on an aggregate level the
sample groups CFH score was just approx. 62,35 percent (figure 12). This clarifies that
information of this hedge type was more difficult to disclose for the analyzed entities,
compared to the other two hedge types. As the following discussion demonstrates, IFRS 7
requires the most extensive disclosures for this hedge type and consequently some results
showed that the correlation between the empirical findings and the standards requirements is
not always that high. 144 As discussed in the theory chapter (chapter 2.4.7), the disclosure
requirements for CFHs were the ones that differed most from previous regulation, which
could serve as an explanation why certain scores were not that high, considering that the
implementation process of new accounting standards can be perceived as ongoing learning
process.
Like for FVHs (discussed above), the fact that all analyzed annual reports fulfilled the
requirement to provide a description of the hedge type, paragraph 7.22 a), can be explained
by the usage of standardized formulations. For CFH, the following two requirements,
paragraph 7.22 b) and c), resulted in a lower correlation compared to the FVHs. However,
those results differed just therefore from the FVH-findings because a few companies failed to
provide this kind of information. Since the sample size for this hedge type was bigger, the
results were still close to 100 percent, so it is possible to conclude that the correlation
between the findings and the requirements of paragraph 7.22 in general is very high. The
previous discussion regarding the three criteria of paragraph 7.22 (chapter 5.1.1, FVHs) is
also applicable for CFHs.
The following discussion focuses on the paragraphs which are unique for cash flow hedges.
As shown in figure 13, almost 36 percent failed to provide information regarding periods
when cash flows are expected or occur and when they are expected to affect profit or loss
(paragraph 7.23 a)). According to Jenny Andersson, this relatively high percentage of
companies that did not meet this criterion could be due to the fact that the standard is not
clear in this point whether the future cash flow from the hedged item or the hedged
instrument (or even both) should be disclosed. This could be an explanation why some
companies failed to disclose such information. For criterion 7.23 b) the percentage of firms
providing the required information was only 16,37 percent. Basically, there could be two
reasonable explanations for this relatively low score. First, the majority of the sample size did
not have any forecast transactions for which hedge accounting previously had been used, but
which are no longer expected to occur. If this would have been the case, the companies did
not had to disclose any kind of information regarding such transactions because, according to
Jenny Andersson, it is a common accounting practice to just disclose information which has
actually affected the companies transactions and is therefore useful and relevant for the
reader. However, as figure 15 demonstrates some firms like for example TeliaSonera
disclosed information even though they had no discontinued cash flow hedges. Second
explanation could be that paragraph 7.23 b) is problematic in practice since, according to the
accounting specialist, a provision of such facts would basically mean that the entity would
143
Balans (2008) p. 41-42
144
Balans (2008) p. 41-42
41
- Analysis -
have to admit that they have difficulties to predict their future cash flows. Therefore the
accounting and finance departments usually tend to avoid such presentations.
The fact that the empirical findings concerning paragraph 7.23 c) correlated completely with
the standards requirement could be due to the fact that this information is easily available in
the consolidated financial statements (changes of equity). Since the recognition of value
changes of the hedging instrument in the equity is basically the essence of a cash flow
hedge145 (mention in the theory chapter), a report of this amount seemed quite logical. As
figure 13 points out the following evaluation criterion, 7.23 d), resulted only in a score of
47,22 percent. The low correlation could be explained by the fact that this criterion had most
changed146, compared to previous regulation. In addition, Jenny Andersson stated that
especially the requirement concerning the disclosure of the amount removed from equity and
included in each line item of the income statement, was not always met in practice. She
believed that this could be due to slackness. Another possibility could be that the analyzed
companies just did not remove any amount from equity or that the removed amounts were in
fact provided in the changes of equity but not explicitly stated in a particular note to the
income.
The empirical findings regarding 7.23 e) 147 also support Jenny Anderssons view that this
criterion is very seldom applied in practice and could therefore explain why the percentage of
companies providing such particular information was only 5,56 percent. Paragraph 7.24 b),
which requires a disclosure of the ineffectiveness from CFHs in the income statement was
only fulfilled by approx. 46 percent of the analyzed annual reports. The most reasonable
explanation for this might be that ineffectiveness of cash flow hedges is not so common in
practice, according to Jenny Andersson. In addition to that, 7.24 b) is, compared to the
previous regulation, a new requirement 148 which could explain the low score if the
implementation of IFRS 7 is considered as a learning process in an initial stage. On the other
hand, Jenny Andersson argued that the ineffectiveness of a hedge relationship is not difficult
to measure in practice, wherefore missing disclosures could also be due to slackness.
5.1.3 Disclosures about hedges of net investment in foreign operations

(Matrix 3)
As Figure 18 highlights, the analyzed annual reports resulted in a total HIFO-score of almost
81 percent. Due to that, it becomes obvious that the correlation between the research findings
and the standards requirement was quite high. Like for the already analyzed FVHs,
paragraph 7.22 a) was fulfilled by almost 114 percent. This means that more entities
disclosed a description of this hedge type even though they were not applying such hedging
relationships. As mentioned above, the interviewed accounting expert from KPMG stated that
such a disclosure practice is normally considered as non-relevant/non-useful and should
therefore be avoided. A reason why companies nevertheless provided that kind of
information might be due to the fact that this criterion does not require a complicated
verbalization and is therefore often fulfilled by providing definitions of this hedge type close
to the one presented in IAS 39. Like for the previous discussed CFHs, also for HIFOs a
description of used hedging instruments and their fair value at the reporting date was not
disclosed by all entities. This exception cannot be explained by the available theories or any
145
Accessed 28.04.2008
146
Balans (2008) p. 41-42
147
An example for a hedged transaction where the amount removed from equity is included in the initial cost/carrying amount of a non-
financial asset or liability can be the purchase of very expensive inventories or machines. (Empirical findings 4.3.3)
148
Balans (2008) p. 41-42
42
- Analysis -
interview feedback, although such information should not be difficult to provide since the
necessary financial instruments must be recognized in the consolidated accounts. According
to the theory, hedging instruments of HIFO relationships are almost always denominated in
the subsidiaries local currency 149. Therefore the (fair) value of those instruments (e.g. loans
and bonds) must already be existent in the corporations accounting system. Since paragraph
7.22 c) is of general nature (applies for all three hedge types) 150, the analysis concerning this
criterion is identical with the discussion mentioned above, in the analysis of fair value
hedges.
The recognition of the ineffectiveness from HIFOs (paragraph 7.24 b)) was only disclosed by
31,82 percent of the sample size. The explanations for lacking information regarding the
ineffectiveness of HIFOs could be identical with the ones provided in the analysis of the
CFHs. This seems just reasonable since the accounting treatment for both hedge types is very
similar, according to the presented theory. 151
5.2 Primary data Interviews

In this part of the analysis chapter the result of the empirical findings collected by the primary
research is analyzed. This part starts with a general analysis regarding the respondents
opinions about annual reports and disclosures, followed by a particular analysis regarding
how the respondents perceive the information provided concerning hedge accounting and its
disclosures. As mention earlier in the thesis, the primary data was mainly collected by two
telephone interviews with financial analysts, which represents the investors perspective.
Also, the interview with the accounting specialist, Jenny Andersson, is used in the analysis
due to her sound insight about how investors use financial reporting. To make it easier for the
reader to follow the analysis of the empirical findings, same sub-headlines are used in this
part of the thesis as in the empirical finding chapter.
5.2.1 General opinions about annual reports

As stated in the empirical findings, both financial analyst A and B agreed upon that annual
reports serve as a useful analysis-tool in the evaluations of their companies. This supports
Pankoff & Virgil152 who believe that annual reports which represent a high quality are an
important resource for investors decisions. However, even if IASBs conceptual framework
primary tries to serve the needs of the investors 153, the interview partners general argued that
not all information provided in the annual reports is used in their work as analysts. For
instance, they are more interested in information regarding the most fundamentals figures in
the annual report, i.e. cash flow and income statement instead of detailed and extensive
disclosures. For A was it vital that he understands the annual reports and its disclosures in
order raise the significance of the provided information. This fact could be related to the
importance of the Conceptual Frameworks qualitative characteristic of understandability 154
for financial reporting. On the other hand, for A and B, disclosures are not that important for
their work on a daily basis. However, they both mentioned that they use the disclosures if
critical issues arise. Therefore is it possible to conclude that disclosed information is not that
149
Accessed 28.04.2008
150
A differentiation of IFRS 7 hedge accounting disclosure requirements between general (apply for all three hedge type) and hed ge type
specific criteria can be found in the theory chapter 2.4.7.
151
Alexander et al. (2007) p. 405
152
Pankoff & Virgil (1970) p. 269
153
IASB Framework for the Preparation and Presentation of Financial Statements (2003) paragraph 10
154
43
- Analysis -
relevant155 for their analysis processes. This finding conflicts with Alexander et al156, who
argue that in todays complex and globalized business world the provided figures must be
explained in detail in order to raise the significance and understandability of the presented
information. If this would apply in practice, the interviewed financial analysts should rely
more on the entities information provided in their disclosures.

According to the empirical findings presented above, it is possible to state that both
interviewed analysts had not an extensive understanding of current accounting policies and
the content of the various IAS/IFRSs. Only analyst B had a basic understanding of some
accounting standards. He was also aware of the fact that IFRS 7 was introduced recently.
This finding is corresponding with Jenny Anderssons opinion that the hedge accounting
disclosure requirements were not requested from investors and financial analysts in
particular. On the other hand, the fact that both financial analysts do not really have a sound
understanding of accounting regulation is conflicting with the presented theory about the
usefulness of financial statements. According to the theory, financial statements rely to a
great extent on accounting information 157. Due to the nature of financial statements, one
could say that those statements are a reflection of accounting data. Therefore it is striking that
those analysts who are working with financial statements, which basically serve an
information/accountability function 158, lack a fundamental insight into the underlying
accounting regulation. Another interesting fact was that none of the two interviewees had
observed any changes concerning the hedge accounting disclosures of the companies they
follow. This observation could harmonize with the empirical findings of our disclosure study
showing that the rather new requirements of the standard (e.g. the specific criteria for CFHs)
resulted in lower scores, compared to criteria which were already existent in previous
regulation.
Both the financial analysts and Jenny Anderssons opinion regarding the significance of
hedging matched. They all believed that it is more vital to understand what kind of hedging
activities (e.g. economic hedges) that are used instead of reviewing whether hedge accounting
is applied or how it is implemented. Even though the companies decided to provide voluntary
information regarding their hedging activities it is not appreciated by the two interviewed
analysts, since they do not consider this data for their analysis purposes. Compared to the
presented theory about voluntary disclosure 159, this would mean that such additional
information is not used to reduce an existing information asymmetry, although this is
supposed to be the objective of voluntary disclosure. According to Eccles & Mavrinac160,
there is a need for increased financial reporting regulation and a requirement for disclosures
meeting a high level of quality. Due to the fact that the entities analyzed by A and B are non-
financial institutions and do not bind large financial resources in their hedge accounting
activities, they consider the provided information simply as non-relevant for their purposes.
This was also the conception of Jenny Andersson, since she thinks that the concept of hedge
accounting is more crucial for financial institution because it directly affects the disclosure of
data concerning the core-business of those organizations and partly their competitive
advantages. However, both financial analysts understood the concept of hedge accounting
155
156
Alexander et al. (2007) p. 3-10
157
Soffer & Soffer (2003) p. 4
158
159
160
44
- Analysis -
and perceived it in general as a positive concept since it smoothes the companies results in
their income statement. This perception harmonizes with the essence of the hedge accounting
concept presented in the theory chapter of this thesis 161. Besides the fact that hedge activities
and hedge accounting is not important for the companies they follow, analyst A in general
perceived hedge accounting as a helpful concept if it is relevant for the analyzed companies
and increases the transparency of the entities business transactions. This opinion correlates
with Ernst & Youngs survey result 162 and the EUs perception of useful financial
statements163 that transparency is the most vital criterion for the usefulness of provided
financial information.
After reviewing the analysts statements it became obvious that the interviewees had
difficulties to differentiate between the different characteristics of the three hedge types
(FVHs, CFHs & HIFOs). This fact corresponds with Jenny Anderssons perception that
financial analysts often not have an extensive accounting knowledge. She believed that the
concepts of economic hedges and hedge accounting are often mixed up. This could indicate
that the disclosures regarding hedge accounting are not that important for analysis purposes
for the most non-financial institutions.
5.2.3 Hedge accounting disclosures

In general, all three interview partners agreed that many disclosures in annual reports are
designed in a standardized way, using formulations which are well-established and often
unspecific. Besides that, the financial analysts highlighted their demand for quantitative
rather than qualitative information. They argued that the provided disclosures often contain
too much unspecific text or unclear information. Out of their perspective, plain and well
structured sets of figures and tables are more desirable than descriptive information. An
interesting finding is also that the analysts perceived the informal contacts to the CFOs of the
companies they are analyzing as more important than the information gathered from the
entities annual reports, especially in cases when ambiguities arise.
The result that A and B considered some of the voluntarily provided hedge accounting
information as not helpful, due to the fact that they are just of an unspecific nature, is
conflicting with the theory of voluntary disclosure. Since hedge accounting is a voluntary
accounting policy (IAS 39) the resulting disclosure can be considered as voluntary as well.
For instance, Adrem defines voluntary disclosures as information disclosed over and above
existing regulations. 164 In accordance with this theory, voluntary disclosure should minimize
an existing information asymmetry by the provision of additional data 165. The need for such
additional information can be explained by the traditional principal-agent conflict 166, dealing
with the dilemma of unequally distributed information between a party in operating charge
and another one providing the necessary resources. Like Banghog and Plenborg argue167, a
higher level of voluntary disclosure tends to reduce the information asymmetry between
companies and investors. However, the findings of the conducted research showed that this is
not the case for the interviewed financial analysts. Since they both do not used the
additionally provided data, the voluntary disclosure is not changing the status of a potential
161
Chapter 2.3.2
162
Ernst & Young (2006a) http://www.ey.com/global/assets.nsf/International/Global_Risk_-_Investor_Survey_Report/$file/EY-Risk-
Investor-Survey-Report.pdf Accessed 22.04.2008
163
European Union (2001) http://www.europarl.europa.eu/meetdocs/committees/juri/20020225/449285EN.pdf. Accessed 22.04.2008
164
Adrem (1999)
165
166
Rimmel (2003) p. 21
167
45
- Analysis -
information asymmetry situation between them and the companies they follow. For the two
interviewed analysts, the finding diverges with Trompleys perception that (besides the
reduction of the volatile effects on the entitys income statement) hedge accounting should
generate superior information for the statement users, which should help the entities to reduce
an information asymmetry. 168
In addition, the fact that they consider informal, personal contacts with the firms CFOs as
more important than information gathered from annual reports is undermining the theories
regarding the usefulness of financial statements169. If this fact is combined with the issue of
voluntary disclosure mentioned above, it is possible to conclude that in this particular case
hedge accounting is not leading to a reduction of cost of capital. 170 According to the design of
the presented theoretical framework, approaches like the provision of voluntary disclosure
and useful financial statements should ultimately lower the cost of capital since an efficient
capital market would appreciate such additional approaches aiming to minimize information
gaps by more equally distributed information and transparent communication policies. 171
5.3 Summary of the analysis

After reviewing the empirical findings regarding the hedge accounting disclosures of the
analyzed Swedish Large Cap entities, the matrixes scores identified that the different IFRS 7
criteria were fulfilled diverse. For those cases were disclosed information was rated with a
score of 1, it is possible to say that at least the minimum standards of IFRS 7 were met.
According to the IASB, IFRS 7 was introduced to increase the transparency about the risks
firms bear from the usage of financial instruments. The disclosed information should so aid
the decision-making process of financial statement users by providing them with helpful data
to make informed judgments. 172 Due to that, tested disclosure rated with a 1 could therefore
be perceived as an element contributing to the usefulness of financial statements, assumed
that financial statements provided in accordance with established IAS/IFRS are considered as
useful. In addition, the previously presented findings exposed that some entities provided
even more (and often clearer) information than the pure wording that the standard regulates
(e.g. Sandvik, figure 14). Hence, such additionally disclosed information can be assessed as
voluntary disclosure. According to Daske, such provided high quality information should
therefore lead to a reduction of an entitys cost of capital. 173
Otherwise, the study of the Swedish Large Cap entities showed that not all criteria regarding
hedge accounting was always met (those cases where criteria were rated with a score of 0). If
the discussion from above is continued consequently, one could argue that financial
statements which are lacking this information can be considered as at least less useful,
compared to the ones providing the required disclosure (meeting IFRS 7). The conducted
binary classification and the result of the quantitative research can therefore be related to the
lemon problem 174 presented in the theory chapter. Similar to the used-car market which the
lemon problem refers to, the fact that certain tested IFRS 7 criteria is met differently indicates
that information is allocated asymmetric when it come to hedge accounting disclosures. For
the conducted study, the provided disclosures can be considered as mixtures of complete and
168
169
170
171
Daske (2006), Esoinos & Trombetta (2007)
172
Balans (2008) p. 41-42
173
Daske (2006) p. 333
174
See chapter 2.2.3
46
- Analysis -
incomplete sets of information (even within companies which in general had a high score,
some criteria were met very seldom). Thus, even though IFRS 7 is a mandatory accounting
standard, the study-result indicates that the provided information still can be characterized as
a lemon market. This perspective is supported by the already presented analysis about how
the two interviewed financial analysts perceive the provided hedge accounting information. It
is the lacking relevance and reliability of such disclosures which lead to the fact that they
both do not resort to this kind of information, wherefore the researched hedge accounting
disclosure even not corresponds with Daskes opinion concerning a reduction of the entities
cost of capital (described above). To sum up, the analysis of the available findings rather
points out that the cost of capital cannot be lowered by the simple usage of hedge accounting
and its necessary disclosure. Information problem
Figure 21: Overview of the used theories (self-provided)
To support the readers understanding, figure 21, shows which theories have been used to
analyze the gained empirical findings. Furthermore, this figure points out which theories have
been provided in a broader, more general context, serving a basic understanding of the
subject and which of the theories and models presented in the theory chapter have been
actually used to analyze the research findings. This should aid the reader to understand how
the authors get to their final conclusion, presented below.
47
- Conclusion -
6 Conclusion
This chapter presents the conclusions the authors draw and answers the thesiss research
questions and purpose.
To which extent does the information provided in the annual reports 2007 of Swedish Large
Cap entities correlate with the hedge accounting disclosure requirements of IFRS 7?
For each hedge type in IFRS 7, a specific matrix was designed in accordance to the
standards requirements. The findings and the analysis of the matrixes scores point out that
for FVHs approx. 88 percent of the entities disclosure information correlated with IFRS 7
hedge accounting requirements. For CFHs and HIFOs approx 63 respective 81 percent of the
entities provided information correlating with the requirements.
The general hedge accounting requirements (paragraph 7.22), which apply for all hedge
types, basically resulted in very high scores (total correlation close to 100 percent), with just
a few minor deviations. Therefore we believe that it is possible to conclude, that the
correlation between the findings and the standards requirements is in general very high. The
various hedge type specific matrixes-scores showed regularly a lower correlation between the
disclosure information and the IFRS 7 requirements (paragraphs 7.23 and 7.24). Furthermore,
we believe that it is possible to identify a trend, showing that those criteria which require
more detailed, sensitive and complex information correlate less often with the disclosures
provided by the entities.
How do financial analysts perceive the hedge accounting disclosures in accordance to IFRS
7, provided in the entities annual reports for their decision making purposes?
Even though the matrixes-scores identified different correlations regarding the standards
requirements and the information disclosed by the entities, the interviewed financial analysts
did not perceive those inconsistencies as important issues for their daily work. The fact that
IFRS 7 was recently introduced was only recognized by one of the interviewees. We believe
that the conducted research shows that disclosures regarding hedge accounting of non-
financial entities were not that important for the analysis purposes of the two financial
analysts. In addition, disclosures in general were not of special importance for their analysis
processes.
They both perceived the provided common disclosures often as standardized and overloaded
with text. Instead they prefer quantitative and specific data, for instance in form of plain
tables. The analysts both perceived the existing accounting regulation as extensive and
complex and preferred instead alternative accounting policies which would cover more the
substance over form perspective.
To conclude, we believe that the new hedge accounting disclosures, regulated in IFRS 7, are
not very important for analysts decision making process when it comes to the analysis of
non-financial entities.
48
- Final discussion -
7 Final discussion
In this chapter the authors conclude the thesis with a final discussion regarding the research
topic. Furthermore, suggestions for further research are presented.
Even though the general hedge accounting requirements, which apply for all hedge types,
were fulfilled by almost all analyzed entities it is striking that the disclosed information is
often of standardized and unspecific nature. The more hedge type specific criteria were met
less often. We think that this could be due to the fact that those criteria are new, compared to
previous regulation, and deal with more detailed, complex and often sensitive information.
Therefore the entities might tend to avoid such presentations. However, since 2007 was the
first fiscal year the standard was applied, we believe that the disclosure practice regarding
hedge accounting will develop over the years resulting in disclosures closer to the standard
setters objective.
The research regarding the financial analysts perception of IFRS 7 was challenging, since it
became obvious that the interview partners were lacking a solid accounting knowledge. The
concepts of hedging and hedge accounting were regularly mixed up and an understanding of
the explicit standard was missing. We were surprised about that finding, since the IASBs
Conceptual Framework addresses investors as the main users of financial statements, and
financial analysts can be perceived as representatives of investors. Our perception that hedge
accounting disclosure is not of special importance for financial analysts is supported by the
fact that the response rate of the contacted sell-side analysts was relatively low. Most of the
responses that rejected a participation in this research were due to the fact that the analysts
considered hedge accounting as not important for their daily work. We believe that this could
be explained by the fact that the hedge accounting section of IFRS 7 is just a minor part of
the whole standard and the hedge accounting activities also just cover a very small area of an
analysts area of activity.
In our view, one interesting finding was that the interviewed financial analysts perceived
informal contacts with the entities CFOs as extremely vital for their daily work, stating that
such direct accesses to information was even more important than provided financial reports.
7.1 Suggestions on further research

After performing this research, we believe that it would be interesting to analyze how the
results of a similar study would look like in a few years. Since an implementation of an
accounting standard can be perceived as a learning process, the outcome most likely would
differ. In addition to that, it would have been interesting to conduct the same study for
financial institutions since hedge accounting is more vital for their business. Furthermore, we
think it would be useful to evaluate the quality of the disclosed information, besides the
quantitative aspects we have tested. Due to the fact that hedge accounting is perceived as a
challenging accounting concept, a study focusing on the producers perspective, would be of
great use.
Finally, a research with a larger sample size of financial analysts would help to analyze
whether the presented perceptions can be generalized or not. In addition, it would be
interesting if analysts following different kind of entities (size, turnover, and financial/non-
financial) perceive hedge accounting in various ways.
49
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http://www.europarl.europa.eu/meetdocs/committees/juri/20020225/449285EN.pdf.
Accessed 22.04.2008
European Union (2004) International Accounting Standard 39: Financial Instruments.
http://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2004:363:0001:0065:EN:PDF
Accessed 01.04.2008
European Union (2006) International Financial Reporting Standard 7: Financial Instruments
Disclosures.
http://eurlex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ:L:2006:024:0001:0036:EN:PDF.
Accessed 01.04.2008
European Union (2008) The EU single market. Accounting.
http://ec.europa.eu/internal_market/accounting/index_en.htm. Accessed 09.04.2008
Financial Times (2008) In depth: surprime fallout. http://www.ft.com/indepth/subprime.
Accessed 02.04.2008
IAS Plus (2008). Framework for the Preparation of Financial Statments.
http://www.iasplus.com/standard/framewk.htm Accessed 21.04.2008
PricewaterhouseCoopers (2004) Die Vorschriften zum Hedge Accounting nach IAS 39.
http://www.pwc.de/fileserver/RepositoryItem/fs_Hedge%20Accounting_Download.pdf?item
Id=58817. Accessed 24.08.2008
PricewaterhouseCoopers (2007) Abfalter, Sabine. IFRS 7 Ein Meilenstein in Sachen
Finanzmarkttransparenz.
www.pwc.com/at/pdf/newsletter/financial_services/PwC_FS_34.pdf. Accessed 02.04.2008
PricewaterhouseCoopers (2008) Hedge accounting.
http://www.pwc.com/Extweb/service.nsf/docid/1378D3155AA439D18025714D002F7838.
Accessed 28.04.2008
OMX Nordic Exchange (2008) Shares.
http://www.omxnordicexchange.com/priceinformation/shares/ Accessed 08.04.2008
Publications
Barnes, R. (2001) Accounting for derivatives and corporate risk management policies.
Working Paper, London Business School.
IASB Framework for the Preparation and Presentation of Financial Statements (2003).
KPMG (2004) Lw, Edgar. Aktuelles zur Rechnungslegung ber Finanzinstrumente.
Working paper. Ludwig-Maximilian University Munich. http://www.rwp.bwl.uni-
muenchen.de/files/workshop/loew.pdf. Accessed 29.04.2008
Annual reports 2007
All annual reports of the companies included in the sample size (see appendix 3). The
documents were downloaded from the entities investors relations websites.
53
Appendix 1 Interview guideline financial analysts
Name: Years of work as analyst:
Company: Title:
Introduction
1. Which companies do you analyze at the Large Cap list?

2. How do you analyze annual reports and other financial reports in your work as an analyst?
a) In general, how important is disclosed information for your work as an analyst?
3. Are you aware of the new disclosure requirement (IFRS 7) regarding financial instruments?
a) Have you noticed a difference from previous years disclosure requirements regarding
financial instruments in financial reports?
Hedge accounting
4. What is your opinion about companies that decide to use hedge accounting?
a) Are there hedges that you think are of special importance when you analyze a
company?
b) Are there any differences between industries regarding the relevance of hedges and
hedge accounting?
5. How important is the disclosed hedging information for your work as an analyst?
a) Does the voluntary choice regarding hedge accounting help you to understand the
companies risk situation in a better way?
b) What is the most critical information in IFRS 7 regarding hedge accounting for
analysis purposes?
6. How do you appraise the provided information? Do you have to deal with standardized
information? Or is it mostly company-specific?
a) IFRS 7 requires the companies to disclose qualitative and quantitative information.
Which one do you assess as most important?
7. From your personal perspective, has the introduction of IFRS 7 led to an improvement
regarding the disclosed information of the entities hedge activities?
a) How do you perceive the differences from the previous years?
b) Was the introduction of IFRS 7 necessary for your work as an analyst?
Additional questions
8. What is your opinion of IFRS 7 and hedge accounting in general?

a) Is the standard necessary in order to provide a true and fair view of the companies
risk situations?
9. Would you like to have other/more information regarding hedge accounting?
54
Appendix 2 Interview guideline accounting specialist
Name: Years of work within accounting:
Company: Title:
1. According to your opinion, what is the primary reason for the introduction of IFRS 7?
2. Has IFRS 7 the same importance for non-financial institutions? If not, why?
3. Do you believe that the new parts of the hedge accounting disclosures in IFRS 7 were
demanded by the investors/financial analyst? Why?
4. Do you believe that IFRS 7 provides a more fair value regarding hedge accounting activities
compared to previous regulation?
5. Which part regarding hedge accounting is most critical in IFRS 7, from an investors point of
view?
6. What is your opinion about the voluntary choice of hedge accounting? Is that aiding the users
to understand the risks nature in a better way?
7. The most prominent change regarding the disclosure requirements for hedge accounting,
compared to earlier regulations, is those about cash flow hedges. What is the idea behind that?
8. From your perspective, which areas within hedge accounting and its disclosure requirements
are discussed most in practice?
55
Appendix 3 Sample size
56
Appendix 4 Sample sizes use of different hedges
57
Appendix 5 Fullfilment criteria IFRS 7
58
Appendix 6 Matrix 1, Fair value hedges
59
Appendix 7 Matrix 2, Cash flow hedges
60
61
Appendix 8 Matrix 3, Hedges of net investment
62

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How to hedge disclosures?

IFRS 7 and Hedge Accounting - A first stocktaking

Master thesis within Business Administration

Authors: Manuel Hausin

Tutors: Pernilla Lundqvist

Gteborg, 27th May, 2008

________________ ________________ ________________

Authors: Manuel Hausin, Christoffer Hemmingsson & Jesper Johansson.

Background and problem: Financial instruments are often highly complex. An

1.2 Problem discussion

1.3 Research questions

How do financial analysts perceive the hedge accounting disclosures in accordance to

Chapter 1: Introduction Chapter 3: Method

Chapter 6 and 7: Conclusion and Final discussion

2.1 IASBs conceptual framework and qualitative characteristics

measured on in a reliable way, e.g. financial instruments, commodities or investment

2.2 Information asymmetry

2.2.1 Information problem

2.2.2 Agency problem

2.2.3 The lemon problem

2.2.4 Usefulness of financial statements

2.2.5 Usefulness of voluntary disclosures

2.2.6 Disclosure, cost of capital for equity and market efficiency

higher information quality reduces an entitys cost of capital by lowering non-diversifiable

2.2.7 Overview of the information problem

2.3 Hedge accounting

2.3.1 Why use hedges?

Figure 2: Example of an interest-rate swap (self-provided model).

2.3.2 Why use hedge accounting?

Figure 3: Hedge accounting under IAS 39 (translation from PwC, 2004).

2.4 How to account for hedging (IAS 39 and IFRS 7)

Figure 4: IAS 39 hedge accounting requirements (self-provided figure).

2.4.1 Hedged item

2.4.2 Hedging instruments

2.4.3 Hedge relationships

2.4.4 Fair value hedge (FVH)

2.4.5 Cash flow hedges (CFH)

2.4.6 Hedge of a net investment in a foreign operations (HIFO)

2.4.7 Hedge accounting disclosures in accordance with IFRS 7

Figure 5: IFRS 7 Hedge accounting disclosure requirements (self-provided figure).

3.1 Research strategy

3.2 Collection of data

Figure 6: The performed research process (self-provided model).

3.2.1 Secondary data of empirical findings

3.2.2 Primary data of empirical findings

3.2.3 Collection of theories

3.3 Evaluation of collected data

3.3.1 Secondary data of empirical findings

Figure 7: Disclosure scores (Adrem, 1999 p. 70)

How to interpret the matrixes

Matrix 1: Fair value hedges (FVH)

Table 1: FVH disclosure-evaluation form (self-provided model).

3.3.2 Primary data of empirical findings

3.4 Reliability and validity

3.5 Criticism of chosen method

4.1 Collected secondary data Annual reports 2007

Figure 8: Overview of the sample size's usage of different hedge types.

4.1.1 Disclosures about fair value hedges (Matrix 1)

Figure 9: Sample group's FVH score