Accounting

Accounting for Hedges

Covered by IAS 39 – Financial Instruments: Recognition and Measurement, and FAS 133 – Accounting for Derivative Instruments and Hedging Activities.

Three types of hedge:

  1. Fair value hedge – Hedge exposure to the changes in fair value of a recognized asset or liability, or unrecognized firm commitment (e.g. a swap to hedge against a fixed rate debt).
  2. Cash flow hedge – Hedge exposure to variability in the cash flow of a recognized asset or liability or a highly probably forecasted transaction (e.g. a swap to hedge against a floating rate debt).
  3. Net investment hedge – Hedge exposure to the net investment in a foreign operation (e.g. foreign currency exposure).

Accounting treatment:

  1. Fair value hedge – Derivative is marked to market. Changes in fair value of the derivative (e.g. swap) flow directly to the income statement, but are offset by changes in the fair value of the hedged item (e.g. fixed rate debt) which are recognized in the income statement at the same time.
  2. Cash flow hedge – Derivative is marked to market. Changes in fair value of the derivative (e.g. swap) are recognized first in statement of comprehensive income under Other Comprehensive Income (OCI). A portion of these gains or losses would be transferred out of comprehensive income to the income statement when a variable cash flow is realized (e.g. when interest is paid on a hedged debt).
  3. Net investment hedge – The gain/losses in the hedge are recorded in OCI, and the translation gains or losses on the investment is reported in the statement of comprehensive income instead of equity.

References:

  1. http://interestrateswaps.info/accounting.htm
  2. http://pages.stern.nyu.edu/~igiddy/fas133.htm
  3. http://www.iasplus.com/standard/ias39.htm

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