CFM27060 - Accounting for corporate finance: hedging: IAS 39: conditions for hedging

Conditions for hedging

IAS 39 sets out various criteria, all of which must be met, for a hedging relationship to qualify for hedge accounting.

Formal documentation of hedging relationship

At the start of the hedge, there must be formal designation and documentation of the hedging relationship and the entity's risk management objective and strategy for undertaking the hedge. The documentation should include identification of the hedging instrument, the hedged item or transaction, the nature of the risk being hedged, and how the entity will assess the hedging instrument's effectiveness in offsetting the exposure to changes in the hedged item's fair value or cash flows attributable to the hedged risk.

Expectation of high effectiveness

The hedge must be expected to be highly effective in achieving offsetting changes in fair value or cash flows, consistent with the originally documented risk management strategy. Hedge ineffectiveness is immediately recognised in the income statement, along with all other fair value changes in derivatives that do not function as hedges.

High probability of occurrence

For cash flow hedges, a forecast transaction that is the subject of the hedge must be highly probable, and must present an exposure to variations in cash flows that could ultimately affect profit and loss.

Reliably measurable

It must be possible to measure reliably the effectiveness of the hedge, which in turn means that it must be possible to reliably measure both the fair value or cash flows of the hedged item attributable to the hedged risk and the fair value of the hedging instrument.

Ongoing assessment and actual effect

The hedge must be assessed on an ongoing basis and determined actually to have been highly effective throughout the reporting periods for which the hedge was designated.