CFM27160 - Accounting for corporate finance: hedging: IAS 39: cash flow hedge: accounting

Accounting for a cash flow hedge

In order to apply hedge accounting, an entity must meet the criteria set out by IAS 39 (CFM27060). Assuming these criteria are met, cash-flow hedges should be accounted for as follows:

• The hedging instrument is measured at fair value.
• Gains or losses on the effective portion of the hedging instrument are recognised directly in a separate component of equity.
• The ineffective portion of the gain or loss on the hedging instrument is recognised in the income statement. Where a non-derivative financial instrument is designated as a hedge of foreign currency risk, only the foreign currency element of change in fair value should be included in the amount taken to equity.
• When cash flows relating to the hedged item are reported in profit and loss, amounts in equity are ‘recycled’ to the income statement. In particular, the separate component of equity is adjusted to the lesser of:

• The cumulative gain or loss on the hedging instrument from inception of the hedge;
• The cumulative change in fair value of the expected future cash flows of the hedged item from the inception of the hedge;

Any remaining gain or loss is recognised in the income statement.

If specific risks are excluded from the hedging relationship, gains or losses arising on the hedging instrument as a result of these risks are recognised in accordance with the instrument’s normal classification.

Where a hedge of a forecast transaction results in the recognition of a financial asset or liability, the gains or losses on the hedging instrument that have previously been recognised in equity are 'recycled' in the same period as the asset or liability affects profit or loss (for example, in the periods when interest expense or income is recognised). However, if an entity expects that any of a loss recognised in equity will not be recovered in future periods, it should reclassify to profit or loss the amount that is not expected to be recovered.

There is an example at CFM27170.

If a highly probable forecast transactions give rise to non-financial assets or liabilities, such as the cocoa beans (an addition to raw material stocks) acquired by the manufacturer in example 2 of CFM27150, the entity should adopt one of the following approaches as its accounting policy and apply that policy consistently.

• Reclassify gains and losses previously recognised in equity into the income statement ('recycled') in the same periods as the non-financial asset or liability affects profit or loss (for example, when stock is written off as part of cost of sales). Any losses that are deemed irrecoverable in current or future periods should be recognised in profit or loss immediately.
• Remove the gain or loss previously recognised in equity, and include it in the initial cost or other carrying amount of the asset or liability (sometimes referred to as a ‘basis adjustment’.

For cash flow hedges other than those covered by the provisions above, the amounts reported in equity are recycled to the income statement once the hedged transaction affects profit or loss (for example, when a forecast sale occurs).