CFM16300 - Accounting for financial instruments: IAS 32 and IAS 39: cash flow hedges

Hedging exposure to cash flow fluctuations

A cash flow hedge is a hedge of the exposure to variability in cash flows that is attributable to a particular risk associated with a recognised asset or liability, or a highly probable forecast transaction, and could affect profit and loss.

Example 1

A company borrows £10 million at LIBOR plus 2%. Changes in LIBOR will clearly affect the company's future cash flows. It might hedge this risk by entering into an interest rate swap.

Example 2

A chocolate manufacturer assesses it as highly probable that it will buy 5,000 tonnes of cocoa in six months' time, paying the spot rate at the time it places the order. Changes in cocoa prices will affect its future cash flows; it may use cocoa bean futures to hedge the exposure.