Hedge Accounting

Hedge accounting is optional: it is an elective decision of the management of an entity. Hedge accounting is a special accounting treatment available to ensure that the timing of P&L recognition on the hedging instrument matches that of the hedged item.

Overview

Hedge accounting:

1.  takes two forms:

a)  Fair value hedge: recognizing gains or losses in respect of both the hedging instrument and hedge item in the same accounting period,

b)  Cash flow or net investment hedge: deferring recognized gains and losses in respect of the hedging instrument on the balance sheet until the hedged item affects earnings.

2.   involves two elements which are linked by a hedging relationship:

a)  A hedged item: contains the risk exposure that could affect the income statement,

b)  A hedging instrument: in most cases, will be a derivative or group of derivatives used to mitigate the risk exposure encapsulated in the hedged item.

Documentation.

One of the fundamental requirements for a hedging relationship to qualify for hedge accounting is that formal hedge documentation be prepared at inception of the hedging relationship. The formal documentation must identify the following:

  • Entity’s risk management objective and strategy for undertaking the hedge,
  • Type of hedge: fair value, cash flow, or net investment,
  • Specific risk being hedged: foreign exchange, interest rate, commodity price,
  • Hedged item,
  • Hedging instrument,
  • How effectiveness will be assessed, both prospectively and retrospectively.

 Rules.

  • Hedge accounting is only applied from the date a hedging relationship is designated until the date it is discontinued: hedge accounting only applies prospectively, never retroactively,
  • You are not permitted to restate prior results and you are not permitted to designate or discontinue a hedging relationship in retrospect,
  • Changes in the fair values or cash flows of the components of a hedging relationship must be highly correlated throughout the term of the relationship to continue to be eligible for hedge accounting, any imperfection is recognized in net income immediately (hedge accounting always requires fair value measurement),
  • Hedge accounting stops when a hedging relationship becomes ineffective or is otherwise terminated.

CNS Treasury Hedge Accounting

CNS Treasury’s hedge accounting software provides:

  • The user with the tools necessary to resolve documentation and designation issues,
  • Fair value and effectiveness test calculations,
  • Suggested accounting journal entries based on the effectiveness testing outcomes.

IFRS9

Please refer to IFRS9 Financial Instruments.

 

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