CFM16295 - Accounting for financial instruments: IAS 32 and IAS 39: fair value hedge accounting

Accounting for a fair value hedge

The hedging instrument is measured at fair value if it is a derivative. (Non-derivatives may only be designated as hedging instruments for a hedge of a foreign currency risk and in that case it is only the foreign currency element of the non-derivative that is remeasured).

The carrying value of the hedged item is adjusted for the hedged risk only. This may mean adjusting an item normally carried at cost to its full fair value, if substantially the whole of the fair value changes are attributable to the risk being hedged. But this will not necessarily be the case.

Suppose, for example, a company makes a loan at a fixed rate of interest, which is classified as a loans and receivables asset and would normally be carried at amortised cost. Both changes in market rates of interest, and changes in the borrower's credit status, will affect the fair value of the loan. If the company hedges the interest rate risk, the carrying value of the loan will be adjusted for changes in fair value attributable to interest rate changes, but not for those attributable to changes in credit quality.

All gains and losses are taken to the income statement so the result is that there is no net profit and loss effect, other than any hedge ineffectiveness. Where the hedged item is an available-for- sale (AFS) financial asset, the gain or loss attributable to the hedged risk is recognised in the income statement, rather than equity, although the remainder of any fair value gain or loss still goes to equity.