Page 93 - HRC_AR2020

HENGYUAN REFINING COMPANY BERHAD I 91

2 sUMMarY of siGnificant accoUntinG policies (continued)
2.8 DeriVatiVes anD HeDGinG actiVities (continued)
(c) Hedge effectiveness
Hedge effectiveness is determined at the inception of the hedge relationship, and through periodic prospective
effectiveness assessments to ensure that an economic relationship exists between the hedged item and
hedging instrument.

For refining margin swap hedges, the Company enters into hedge relationships where the critical terms of
the hedging instrument match exactly with the terms of the hedged item. The Company therefore performs a
qualitative assessment on the effectiveness. If changes in circumstances affect the terms of the hedged item such
that the critical terms no longer match exactly with the critical terms of the hedging instrument, the Company
uses the hypothetical derivative method to assess effectiveness.
In refining margin swap hedges, ineffectiveness may arise if there is a change in delivery date of crude oil, change
in volume of hedged items or if there is a change in credit risk of the Company or the derivative counterparty.
As all critical terms matched in the current and previous financial year, the economic relationship was 100%
effective. There was no ineffectiveness during the year in relation to refining margin swap hedges.

The Company enters into interest rate swaps that have similar critical terms as the hedged item, such as reference
rate, reset dates, payment dates, maturities and notional amount. The Company does not hedge 100% of its
loans, therefore the hedged item is identified as a proportion of the outstanding loans up to the notional amount
of the swaps. As all critical terms matched in the current and previous financial year, the economic relationship
was 100% effective.
Hedge ineffectiveness for interest rate swaps is assessed using the same principles as for refining margin swap
hedges. It may occur due to change in credit risk of the Company or the derivative counterparty, timing of
interest rate swaps interest payment or reduction in the notional amount of the interest rate swaps. There was no
ineffectiveness during the year in relation to interest rate swaps.
(d) Derivatives that do not qualify for hedge accounting

Certain derivative instruments do not qualify for hedge accounting. These derivatives are classified as held for
trading and accounted for at fair value through profit or loss in “other operating gains/losses”.
(e) embedded derivatives

Derivatives embedded in other financial instruments or other host contracts are treated as separate derivatives
when their risks and characteristics are not closely related to those of the host contracts and the host contracts
are not carried at fair value.
Crude purchases resulting in variability in the payable associated with the commodity price gives rise to an
embedded derivative which is not closely related to the host financial instrument. The Company has an accounting
policy choice for subsequent changes in the fair value of the embedded derivative. Cost of inventory could be
adjusted to reflect subsequent changes in the fair value of the embedded derivative on the basis that such
changes are part of the purchase and other costs incurred in bringing the inventory to its present location and
condition. Alternatively, these changes could be charged to profit or loss in accordance on the basis that the
cost of inventory is determined at the time of delivery and the bifurcated embedded derivative should be
accounted for separately as if it was a freestanding instrument.
The Company opted to reflect subsequent changes in the fair value of the embedded derivative as part of the
cost of inventory. The chosen policy will be consistently applied.