16. EXPLANATORY NOTES TO THE FINANCIAL INSTRUMENTS AND FINANCIAL RISK
16.1. Financial instruments by category and class
16.2. Income, expenses, profit and loss and other comprehensive income
16.3. Fair value measurement
The Group recognises a financial asset or a financial liability in its statement of financial position when, and only when, the entity becomes a party to the contractual provisions of the instrument.
The Group derecognises a financial asset in statement of financial position when:
- the contractual rights to the cash flows from the financial asset expired; or
- the Group transferred the financial asset to another entity, and the transfer qualified for derecognition.
The Group removes a financial liability (or a part of a financial liability) from its statement of financial position when it is extinguished—i.e. when the obligation specified in the contract is discharged or cancelled or expires.
Measurement of financial assets and liabilities
Measurement of financial assets and liabilities
At initial recognition, the Group measures financial assets and liabilities not qualified as at fair value through profit or loss (i.e. held for trading) at their fair value plus transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial liability. The Group does not classify instruments as measured at fair value through profit or loss upon initial recognition, i.e. does not apply the fair value options.
At the end of the reporting period, the Group measures item of financial assets and liabilities at amortised cost using effective interest rate method, except for derivatives, which are measured at fair value.
With regard to equity instruments, in particular quoted/unquoted shares held for the purpose of obtaining contractual cash flows representing only principal and interest payments as well as in order to sell, the Group classifies the instruments as measured at fair value through other comprehensive income.
Gains and losses resulting from changes in fair value of derivatives, for which hedge accounting is not applicable, are recognised in the current year profit or loss.
Derivatives for the purchase of non-financial assets that are entered into and held with the intention of settling those transactions by physical delivery of the assets for use in the Group's own operations are not valued at the balance sheet date.
Impairment of financial assets
The Group recognizes a write-off due to expected credit losses on financial assets measured at amortized cost or measured at fair value through other comprehensive income (with the exception of investments in capital assets).
The Group uses the following models for determining impairment allowances:
- general model (basic),
- simplified model.
The general model is used by the Group for financial assets measured at amortized cost - other than trade receivables and for debt instruments measured at fair value through other comprehensive income.
In the general model, the Group monitors the changes in the level of credit risk associated with a given financial asset and classifies financial assets to one of the three stages of impairment allowances based on the observation of the change in the credit risk level in relation to the initial recognition of the instrument.
Depending on the classification to particular stages, the impairment allowance is estimated in the 12-month horizon (stage 1) or in the life horizon of the instrument (stage 2 and stage 3).
On each day ending the reporting period, the Group considers the indications resulting in the classification of financial assets to particular stages of determining impairment allowances. Indications may include changes in the debtor's rating, serious financial problems of the debtor, a significant unfavourable change in its economic, legal or market environment.
For the purposes of estimating the expected credit loss, the Group uses default probability levels based on market credit quotes of derivatives for entities with a given rating and from a given sector.
The Group includes information on the future in the parameters of the expected loss estimation model by calculating the probability parameters of insolvency based on current market quotes.
The simplified model is used by the Group for trade receivables.
In the simplified model, the Group does not monitor changes in the credit risk level during the life and estimates the expected credit loss in the horizon up to maturity of the instrument.
In the area of hedge accounting, the Group applies the requirements of IFRS 9. Derivatives designated as hedging instruments whose fair value or cash flows are expected to offset changes in fair value or in the cash flows of a hedged item are accounted for in accordance with fair value or the cash flow hedge accounting.
The Group has two types of hedging relation: cash flow and fair value hedge.
The Group assess effectiveness of cash flow hedge at the inception of the hedge and later, at minimum, at reporting date. In case of cash flow hedge accounting, the Group recognises in other comprehensive income part of profits and losses connected with the effective part of the hedge, whereas profits or losses connected with the ineffective part - under profit or loss.
In addition (in case of currency risk hedge - spot rate risk element), as part of equity in a separate item, the Group recognises a change in the fair value due to the hedge costs.
To assess the effectiveness of hedge the Group uses statistical methods, including in particular the direct compensation method. The verification of fulfilment of conditions in the scope of binding effectiveness is made on a prospective basis, based on a qualitative analysis. If it is necessary, the Group uses quantitative analysis (linear regression method) to confirm the existence of an economic link between the hedging instrument and the hedged item.
In case of applying fair value hedge accounting, the Group recognises profits or losses resulting from the revaluation of fair value of derivative financial instrument in financial result, and adjusts carrying amount of hedged item by profit or loss related to the hedged item, resulting from the risk being hedged and recognises it in the profit or loss (in the same item in which hedging derivatives are recognised). Cumulative adjustment of the measured hedged item due to the hedged risk is transferred to the profit and loss when the realization of the hedged item impacts the statement of profit and loss.
If a cash flow hedge is used the Group recognises a portion of the gain or loss on the hedging instrument that is determined to be an effective hedge due to the hedged risk in other comprehensive income. Additionally in case of currency risk hedging - a spot risk element, a change in the fair value due to the forward element (including the cross-currency margin) the Group recognise as part of equity as a separate item (hedging cost). The ineffective portion of the gain or loss on the hedging instrument the Group recognise in profit or loss.
If a hedge of a forecast transaction subsequently results in the recognition of a financial asset or a financial liability, the associated gains or losses that were recognised in other comprehensive income are reclassified to profit or loss of the reporting period in the same period or periods during which the asset acquired, or liability assumed, affects profit or loss.
However, if the Group expects that all or a portion of a loss recognised in other comprehensive income will not be recovered in one or more future periods, it reclassifies the amount that is not expected to be recovered to profit or loss.
If a hedge of a forecast transaction subsequently results in the recognition of a non-financial asset or a non-financial liability, or a forecast transaction for a non-financial asset or non-financial liability becomes a firm commitment for which fair value hedge accounting is applied, the Group removes the associated gains and losses that were recognised in the other comprehensive income and includes them in the initial cost or other carrying amount of the asset or liability when the item appears in the statement of financial position.
If a hedge of a forecast transaction results in the recognition of revenue from sales of products, merchandise, materials or services, the Group removes the associated gains or losses that were recognised in the other comprehensive income and adjusts above revenues.
In case of applying fair value hedge accounting, cumulated adjustment of hedged item valuation for hedged risk is transferred to the financial result at the moment when the realization of hedged item affects the result. Derivatives are recognised as assets when their valuation is positive and as liabilities in case of negative valuation.
Fair value measurement
The Group maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs to estimate the fair value, i.e. the price at which an orderly transaction to transfer the liability or equity instrument would take place between market participants as at the measurement date under current market conditions.
The Group measures derivatives at fair value using valuation models for financial instruments based on generally available exchange rates, interest rates, forward and volatility curves for currencies and commodities quoted on active markets.
The fair value of derivatives is based on discounted future flows related to contracted transactions as the difference between term price and transaction price.
Forward exchange rates are not modelled as a separate risk factor, but derive from the spot rate and the respective forward interest rate for foreign currency in relation to PLN.
The Management Board assesses the classification of financial instruments, nature and extent of risk related to financial instruments and application of hedge accounting. The financial instruments are classified into different categories depending on the purpose of the purchase and nature of acquired assets.