7. Hedge accounting
Hedge accounting definition
Hedge arrangements are entered into to protect an entity from risk. Results in closer matching of the impact on profit and FS of the hedged risk. Protects the reported profit from volatility caused by FV changes over time
Basic principles of hedge accounting under IFRS (4)
1. Derivatives must be marked to market through the income statement.
Basic principles of hedge accounting under IFRS:
IFRS recognized that hedged risks should not affect the income statement.
Basic principles of hedge accounting under IFRS:
Therefore, under circumstances hedge accounting is permitted.
Basic principles of hedge accounting under IFRS:
Hedge accounting means that FV changes of derivatives are not recognized in the income statement but parked in equity (OCI) or adjusted to the hedged asset/liability.
To what items can hedge accounting be applied? (3)
1. Financial asset / liability recognized on the BS
2. A future but committed cash flow
3. An expected future cash flow
Doesn't need to be an entire asset, can also be a risk component
Conditions for hedge accounting (5)
Formal designation and documentation of the hedge at inception, in line with the hedge strategy.
Conditions for hedge accounting:
Hedging relationship consists only of hedged items and hedging instruments that are eligible for hedge accounting.
Conditions for hedge accounting:
Economic relationship between the hedged item and the hedging instrument.
Conditions for hedge accounting:
Credit risk does not dominate the value changes.
Conditions for hedge accounting:
Hedge ratio of the hedging relationship is the same as that resulting from the quantity of the hedged item and the quantity of the hedged instrument that the entity actually uses to hedge
that quantity of hedged items.
Definition of fair value hedge
a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment. The gain or loss from remeasuring the hedge is recognized in P&L.
Definition cash flow hedge
a hedge of the exposure to the variability in cash flows of a recognized asset or liability or firm commitment. It will affect future reported profit or loss.
Accounting treatment of gains and losses from cash flow hedge
The portion of the gain or loss of the hedging instrument determined to be an effective hedge is recognized in equity. Any ineffective portion is reported immediately in profit or loss if the hedging instrument is a derivative.