CA Final · Financial Reporting

Hedge Accounting: formula sheet

Full chapter guide

Key formulas

Why hedge accounting exists: Accounting mismatch = hedging instrument measured at FVTPL, but hedged item not measured or recognised in the same way or period; Hedge accounting removes the timing mismatch. It does not remove the economic risk.
Nature of hedge accounting: Hedge accounting = optional treatment, available only if the Ind AS 109 qualifying criteria are met; It is not automatic and is not allowed merely because a derivative is held.
Types of hedge: Fair value hedge | Cash flow hedge | Hedge of a net investment in a foreign operation; The scope and objective apply to all three. Accounting differs by type.
Ind AS 107 para 21A objective: Users understand: (a) how the entity manages risk (risk management strategy) + (b) how hedging affects the amount, timing and uncertainty of future cash flows + (c) the effect of hedge accounting on the balance sheet, profit and loss and equity statement; Applies to risk exposures the entity hedges and for which it applies hedge accounting. The detailed requirements are in paras 22A to 24G.
Eligible hedging instrument: Derivative at FVTPL (except some written options) OR non-derivative financial asset/liability at FVTPL; Must be with an external party. A financial liability designated at FVTPL whose own-credit-risk change is presented in OCI is excluded. For foreign currency risk only, the foreign currency component of other non-derivative financial items can be used, but not an equity instrument designated at FVOCI.
Written option: Written option qualifies only if it offsets a purchased option (including one embedded in another instrument); A net written option or a standalone written option is not an eligible hedging instrument.
Proportion of instrument: Designate the whole instrument, or a proportion (such as 60% of nominal); You cannot designate for only part of its life. Splitting by time period is not allowed.
Eligible hedged item: Recognised asset or liability | firm commitment | highly probable forecast transaction | net investment in foreign operation; Item must be reliably measurable and involve an external party. A forecast transaction must be highly probable.
Risk component rule: Financial item: any separately identifiable, reliably measurable component. Non-financial item: foreign currency risk or contractually specified component only; Component can be less than the total change in fair value or cash flows. A crude oil component of aviation fuel qualifies only if it is contractually specified.
Group of items: Group qualifies if each item is individually eligible, the items are managed together on a group basis for risk management, and the change in fair value attributable to the hedged risk for each item is expected to be approximately proportional to the group's overall change; For cash flow hedges of a net position, specific designation and disclosure conditions apply.
Qualifying criteria (all must be met): Eligible instrument and item + formal designation and documentation at inception + effectiveness requirements met; Failure of any one means no hedge accounting from that point.
Effectiveness requirement 1: Economic relationship: value of hedged item and hedging instrument generally move in opposite directions because of the hedged risk; Can be shown by matching critical terms, qualitative assessment, or a quantitative method such as regression.
Effectiveness requirement 2: Credit risk must not dominate the value changes arising from the economic relationship; Consider the credit risk of both the counterparty and the entity itself.
Effectiveness requirement 3: Designated hedge ratio = ratio actually used for risk management of the quantity hedged; Do not designate a ratio meant to achieve an accounting result that conflicts with hedge accounting.
Hedge ratio: Hedge ratio = Quantity of hedging instrument ÷ Quantity of hedged item; Use this one direction for both the designation and the risk management view. State the direction you use.
Rebalancing rule: Risk management objective unchanged + hedge ratio no longer meets requirement → rebalance (adjust quantities); objective changed → discontinue; Rebalancing is not discontinuation. The relationship continues with an adjusted ratio.
Assessment timing: At inception and on an ongoing basis, at minimum at each reporting date or on significant change in circumstances, whichever is earlier; The assessment is prospective, not a retrospective test of past results.
Hedging instrument: Gain or loss on hedging instrument → Profit or loss; Exception: if the hedged item is an equity instrument at FVOCI, the hedging gain or loss goes to OCI.
Hedged item: Gain or loss on hedged item due to hedged risk → adjust carrying amount, and recognise in profit or loss (exception: equity instrument at FVOCI, where it stays in OCI); Applies even if the item is normally carried at cost or amortised cost. For an equity instrument at FVOCI, no separate carrying amount adjustment arises because the item is already at fair value. The hedged-risk gain or loss stays in OCI as part of the FVOCI remeasurement.
Firm commitment: Cumulative change in fair value of commitment due to hedged risk = recognised asset or liability, with the other side in profit or loss; Not recognised otherwise, because a firm commitment is an unrecognised contract.
Acquisition on fulfilment: Initial carrying amount of asset or liability = Normal initial amount ± cumulative commitment adjustment; The commitment asset or liability is derecognised against the asset or liability acquired.
Net profit or loss effect: Net P&L effect = Gain or loss on instrument + Gain or loss on hedged item (hedged risk); A perfect offset gives nil. Any balance is hedge ineffectiveness.
Amortisation of adjustment: Adjustment to an amortised-cost instrument is amortised to profit or loss using a recalculated effective interest rate; Amortisation may start as soon as an adjustment exists and must start no later than when the item stops being adjusted for hedging gains and losses.
Discontinuation: Hedge accounting stops prospectively when the qualifying criteria are no longer met (after any rebalancing), or the instrument expires, is sold, terminated or exercised; Voluntary revocation of the designation is not allowed while the criteria are still met.
Lower-of test (cash flow hedge reserve): Reserve (cumulative) = Lower of [absolute cumulative gain/loss on hedging instrument ; absolute cumulative change in fair value of hedged item (PV of expected cash flows)]; Both are measured from hedge inception. Compare absolute amounts, and the reserve takes the sign of the hedging instrument's movement. If the hedged item's change is the larger one, the whole instrument movement goes to OCI and no ineffectiveness is recognised in P&L.
Ineffective portion: Amount to P&L = Cumulative instrument gain/loss − Cumulative amount in reserve; Work on cumulative figures, then find the current period charge by deducting what was already recognised. This is nil when the hedged item's cumulative change is the larger one, because the reserve then equals the instrument's full movement.
Current period OCI: OCI for the period = Closing required reserve − Opening reserve (before reclassification); Adjust for any amount reclassified in the period.
Reclassification (non-financial item): Initial cost of asset/liability = Purchase price + Reserve amount removed; Applies when the forecast transaction leads to a non-financial asset or liability. Remove the reserve directly from equity.
Reclassification (other cases): Reclassify reserve to P&L in the period the hedged cash flows affect P&L; Example: the reserve moves to revenue when the hedged sale is recognised, or to finance cost as hedged interest accrues.
Reserve not to be recovered: If a loss in reserve will not be recovered in one or more future periods, reclassify that amount to P&L immediately; Applies when all or a portion of a cash flow hedge reserve loss is not expected to be recovered in future periods.
Net investment hedge: effective portion: Effective portion to OCI (FCTR) = lower of (cumulative gain or loss on instrument, cumulative change in value of hedged net investment), in absolute terms; Excess on the instrument is ineffective and goes to profit or loss. Cumulative amounts are reclassified to profit or loss on disposal.
Reclassification on disposal: Full reclassification to P&L on loss of control, loss of joint control or loss of significant influence: effective hedge amounts and FCTR on the operation, and the cost of hedging reserve; Partial disposal of a subsidiary with control retained: the proportionate share goes to NCI, not P&L. Partial disposal of an associate or joint arrangement with significant influence or joint control retained: the proportionate share is reclassified to P&L.
Option time value: Hedging instrument = intrinsic value of option; change in aligned time value to OCI (cost of hedging reserve); any excess to P&L; Applies once only intrinsic value is designated (Ind AS 109, para 6.5.15). Only the aligned time value, the part that relates to the hedged item, goes to OCI. Any excess of actual time value over the aligned time value goes to profit or loss.
Forward element: Forward contract: designate spot element only; change in forward element to OCI (cost of hedging reserve) if elected; Forward element is the difference between forward and spot price. The OCI treatment is optional and is elected hedge by hedge (Ind AS 109, para 6.5.16). If the forward element is not excluded, the whole forward is the hedging instrument.
Discontinuation triggers: Stop prospectively if: qualifying criteria not met after rebalancing (including a change in the risk management objective), OR instrument expires, sold, terminated or exercised; Voluntary revocation is not allowed while the objective remains the same and the criteria are still met. Replacement or rollover of the instrument is not an expiry or termination if it is part of the documented objective and the hedging relationship continues. For a net investment hedge, amounts already in the reserve stay in OCI until disposal of the foreign operation.
Qualifying criteria: Eligible hedging instrument + eligible hedged item + formal documentation + effectiveness (economic relationship, credit risk not dominant, hedge ratio); Effectiveness is assessed prospectively at inception and at each reporting date. There is no 80-125% bright line.
Cash flow hedge reserve roll-forward: Closing reserve = Opening reserve + Effective hedging gain/(loss) recognised in OCI − Amount reclassified to profit or loss − Amount removed and included in the initial cost of a non-financial hedged item; Use the same sign convention throughout (credit as positive). Ineffective portion goes to profit or loss, never to the reserve. Tax effects, if given, are shown separately.
Weighted average hedged rate: Average rate = Σ(Nominal amount × Contract rate) ÷ Σ Nominal amount; Compute separately for each time band and each risk category. Give the nominal amount and the average rate or price side by side.
Hedge ineffectiveness in profit or loss (cash flow hedge): Cumulative effective amount = Lower, in absolute terms, of (cumulative gain/loss on the hedging instrument since inception) and (cumulative change in present value of the expected future cash flows of the hedged item since inception); OCI for the year = Cumulative effective amount − Amount recognised in OCI in earlier periods; Ineffective portion for the year = Gain/loss on the hedging instrument for the year − OCI for the year; The lower-of test is applied on a cumulative basis from inception, not on the year's movement alone. First find the cumulative effective amount, then deduct what was recognised in OCI in earlier periods to get the current-year OCI. The ineffective portion goes to profit or loss and its line item must be disclosed. If the hedging instrument's cumulative gain is the lower amount, the whole of it is effective and no ineffectiveness arises from this test.
Three-block disclosure structure: Strategy → Amount, timing, uncertainty → Effects on position and performance; Use this as your answer skeleton. Disclose by risk category, with fair value, cash flow and net investment hedges shown separately.

Quick revision

Hedge accounting is optional and applies only when the qualifying criteria are met.
Aim: match the timing of gains and losses on the instrument and the hedged item.
Three types: fair value hedge, cash flow hedge, net investment in a foreign operation.
Criteria: formal designation and documentation, economic relationship, credit risk not dominating, and a suitable hedge ratio.
Ind AS 109 has no fixed 80%-125% test. Effectiveness is judged prospectively against the criteria.
Fair value hedge: instrument gain or loss and hedged item adjustment both go to profit or loss. Exception: where the hedged item is an equity instrument designated at FVOCI, both go to OCI.
Cash flow hedge: the effective part goes to OCI in the cash flow hedge reserve and the ineffective part goes to profit or loss.
Cash flow hedge reserve is the lower, in absolute amount, of (a) the cumulative gain or loss on the hedging instrument and (b) the cumulative change in the present value of the expected future cash flows on the hedged item (often measured using a hypothetical derivative), from inception of the hedge.
Overhedge: if the instrument's cumulative gain or loss exceeds the hedged item's cumulative change, the excess is recognised in profit or loss. Underhedge: if the hedged item's change exceeds the instrument's, the reserve equals the instrument's amount and no ineffectiveness is recognised.
If a hedged forecast transaction results in a non-financial asset or liability, or a firm commitment for which fair value hedge accounting is applied, the reserve amount is removed and included directly in its initial cost.
If the reserve is a loss and you expect that all or part of it will not be recovered in one or more future periods, reclassify that unrecovered amount to profit or loss immediately.
Net investment hedge: accounted for similarly to a cash flow hedge. The effective part goes to OCI (foreign currency translation reserve) and the ineffective part goes to profit or loss. The OCI amount is reclassified to profit or loss on disposal of the foreign operation, or on partial disposal in line with Ind AS 21. Where control is retained on a partial disposal, the proportionate share is reattributed to NCI instead.
Hedge accounting is discontinued prospectively, and only when the relationship stops meeting the qualifying criteria (after any rebalancing) or the instrument expires, is sold, terminated or exercised. Voluntary revocation of the designation is not permitted.
On discontinuation of a cash flow hedge, the amount in the cash flow hedge reserve stays there until the hedged cash flows occur if they are still expected to occur. It is reclassified to profit or loss immediately if the hedged cash flows are no longer expected to occur.
Ind AS 107 requires disclosure of risk management strategy, the amount, timing and uncertainty of future cash flows, and the effects on the financial statements.

Common mistakes

Saying hedge accounting is mandatory whenever a derivative is held. Fix: State that it is optional and needs designation and meeting the qualifying criteria. Otherwise the derivative is at FVTPL under normal rules.
Saying the purpose is to eliminate the economic risk. Fix: The economic risk is reduced by the hedge itself. Hedge accounting only fixes how gains and losses are shown.
Treating a standalone written option as a valid hedging instrument. Fix: Remember that a written option qualifies only when it offsets a purchased option. Otherwise the loss exposure is unlimited and it does not hedge.
Designating an intragroup derivative as a hedge in consolidated financial statements. Fix: In consolidated statements, only instruments and items with parties external to the group qualify. Intragroup balances are eliminated.
Quoting the 80-125% effectiveness test as the Ind AS 109 requirement. Fix: State that Ind AS 109 has no bright-line threshold. It requires economic relationship, credit risk and hedge ratio, assessed prospectively.
Applying hedge accounting from the date the documentation is prepared late and treating earlier periods as hedged. Fix: The relationship is designated, and hedge accounting begins, only when the criteria, including documentation, are met. It is not retrospective.
Taking the hedging gain or loss to OCI or a hedge reserve in a fair value hedge. Fix: In a fair value hedge both sides go to profit or loss. The only exception is a hedged equity instrument at FVOCI, where the hedging gain or loss goes to OCI.
Adjusting the hedged item for its total change in fair value. Fix: Adjust only for the change attributable to the hedged risk. If only the copper price or the benchmark rate is hedged, ignore other factors.
Taking the whole derivative gain or loss to OCI. Fix: Always compute both cumulative figures and take the lower. The excess of the derivative's movement goes to P&L.
Applying the lower-of test on the period change instead of cumulative amounts. Fix: Compare cumulative figures since inception. Then find the period entry by subtracting the opening balance.

Exam tips

In a theory question, start with the accounting mismatch. Examiners reward that link between purpose and treatment.
Always say hedge accounting is optional and needs designation and qualifying criteria. This one line often earns a mark.
For para 21A, write its three parts: risk management strategy, effect on future cash flows, effect on the financial statements.
In case MCQs, check whether the entity has actually applied hedge accounting before deciding that the para 21A disclosures apply.
Use Ind AS 109 and Ind AS 107 terms only, and do not slip in Ind AS 39 rules.
Write a short two-line answer for each side: hedged item first, then hedging instrument. Examiners reward the clear separation.
For questions on component hedging, always state whether the item is financial or non-financial before answering.
Mention the external party condition when the case includes group entities or intragroup contracts.