Ind AS 109 Hedge Accounting: Fair Value vs Cash Flow Hedges

A few weeks ago I was giving a lecture about hedge accounting to the group of auditors. Most of them were audit managers and seniors – so not really freshmen, but experienced and highly qualified people. Opening Entry The first thing you need to do before you even start to play with hedge accounting is to determine the TYPE of hedge relationship that you’re dealing with.

Defining Cash Flow Hedges

The hedge accounting standard is now easier to apply, and companies may want to explore whether to implement it. The CPA Journal is a publication of the New York State Society of CPAs, and is internationally recognized as an outstanding, technical-refereed publication for accounting practitioners, educators, and other financial professionals all over the globe. Edited by CPAs for CPAs, it aims to provide accounting and other financial professionals with the information and analysis they need to succeed in today’s business environment.

• This involves a debit or credit to the account, depending on whether the hedging instrument gains or loses value.
• In summary, hedging directly supports strategic financial planning for companies by locking in rates, reducing uncertainty, stabilizing cash flows, and improving forecast reliability.
• For example, an airline expects to purchase 5 million gallons of jet fuel over the next year, and jet fuel prices are volatile, so the airline enters into futures contracts to purchase 5 million gallons at $2.50 per gallon.
• On July 31, 2019, the forward contract is adjusted to fair value, resulting in a $4,055 gain recognized in other comprehensive income.
• Hedge accounting is a practice that helps mitigate the effects of market volatility on financial statements by synchronizing the recognition of gains and losses from hedging instruments with their corresponding hedged items.

Fair Value Measurements and Hedge Effectiveness

Understanding these key differences allows companies to utilize the appropriate hedging strategy to mitigate their predominant financial risk. The change in fair value of a foreign currency forward contract designated as a cash flow hedge with hedge effectiveness based on changes in forward rates is currently recognized in other comprehensive income. The net effect on earnings is the period’s amortization of the cash flow hedge vs fair value hedge initial premium or discount on the foreign currency forward contract. Fair value hedges and cash flow hedges are integral tools for aligning the accounting treatment of a company’s derivative instruments with their underlying economic or operational exposures.

Cash Flow Hedge Vs. Fair Value Hedge: Key Differences Explained

• Here, a forward contract is a hedging instrument, and the hedging is effective only if changes in the cash flow of hedged instruments and hedging offset each other.
• Some common financial instruments used for hedging include futures contracts and options.
• As per IFRS 9, businesses need to provide formal documentation and designation of hedged item, hedging instrument, nature of the risk being hedged, and their risk management strategy.
• Oil companies use them to hedge against or counteract the prospect of future price changes.
• Unlike IFRS 9, a firm commitment to enter into a business combination or an anticipated business combination does not qualify as a hedged item under US GAAP.
• “Per the FASB’s thinking, hedge accounting is a privilege for which the requisite criteria have to be met and, even if met, then hedge accounting is not mandatory but is an election,” Goswami said.

“I try to break it down into bite-sized pieces for clients, because it is too much to digest the entirety of the standard at once,” Moore said. It became effective for public business entities for fiscal years and interim periods beginning after Dec. 15, 2018. For all other entities, a delayed effective date was announced in November 2019, and it is now effective for them for fiscal years beginning after Dec. 15, 2020, and interim periods within fiscal years beginning after Dec. 15, 2021.

Conversely, if the fair value of the inventory remains at $100,000 or increases, the value of the futures contract will decrease accordingly, but Company A will still benefit from the stable value of its inventory. Hedge accounting is not mandatory under FRS 102, but it’s a complex area that requires specialist valuers to determine fair values or calculate the effectiveness of hedging relationships. Through strict control of costs and revenues, hedging can help to maintain the profitability of your business. Tools like Ramp automate expense categorization and syncing, helping finance teams maintain trial balance accurate cash flow data critical for effective hedge tracking. At Payro Finance, we understand the pressure of maintaining consistent cash flow, especially when payroll deadlines loom.