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Chapter
25 /
Financial Instruments: Recognition and Measurement
(lAS
39)
271
(a) Changes in fair value of the
hedged item
are recognized in the current period to offset the
recognition of changes in the fair value of the hedging instrument. This is the accounting
treatment for fair value hedges.
(b) Changes in fair value of the
hedging ins trument
are
def erred
as a separate component of
equity
to
the extent the hedge is effective and released to profit or loss in the time periods
in which the hedged item impacts profit or loss. This is the accounting treatment for cash
flow hedges and hedges of net investments in foreign operations.
Practical Insight
Hedge accounting is not always necessary to reflect the effect of hedging activities in the fi–
nancial statements. When consistent accounting principles apply to offsetting positions (e.g.,
when both the hedging instrument and the hedged item are accounted for at fair value or at
amortized cost), there is no need for an entity to apply hedge accounting to achieve consistent
accounting for the offsetting positions.
8.3 Hedge Accounting Conditions
As discussed, hedge accounting is optional and allows entities to defer or acce lerate the recognition
of gains and losses under otherwise applicable accounting requirements. To prevent abuse, there–
fore, lAS 39 limits the use of hedge accounting to situations where special hedge accounting con–
ditions are met. To qualify for hedge accounting, the hedging relationship should meet three condi–
tions related to the designation, documentati on, measurement, and effectiveness of the hedging re–
lationships. These conditions are
(I )
There is formal designation and documentation of the hedging relationship and the entit y' s
risk management objec tive and strategy for undertaking the hedge. Hedge accounting is
permitted only from the date such designation and documentation is in place.
(2) The hedging relationship is effective
a] The hedge is expected to be highly effective in achieving offsetting changes in fair
value or cash flows attributable to the hedged risk ("prospective" effectiveness).
b] The effectiveness of the hedge can be measured reliably.
c] The hedge is assessed on an ongoing basis and determined actually to have been highly
effective throughout the financi al reporting periods for which the hedge was desig–
nated ("retrospective" effectiveness).
(3) For cash flow hedges of forecas t transactions, the hedged forecast transaction must be
highly probable and must present an exposure to variations in cash flows that could ulti–
mately affect profit or loss.
Example
The designation and documentation ofa hedging relationship should include identification of
• The hedging instrumentts)
• The hedged item(s) or transactionis}
• The nature of the risk(s) being hedged
• How the entity will assess the hedging instrument 's effectiveness in offsetting the exposure to
changes in the hedged item 's fair value or the hedged transaction 's cash fl ows attributable to
the hedged risk
Case Study
14
This case considers the reasons and conditions for hedge accounting.
Required
( 1) Describe the three types of hedging relationships specified by lAS 39.
(2) Discuss in what circumstances entities may want to apply hedge accounting.
(3) Discuss the conditions for hedge acco unting.