Strategic Business Reporting (International) · Financial instruments

Hedge Accounting under IFRS 9: Fair Value, Cash Flow and Net Investment Hedges

Updated 11 October 2026

Hedge accounting under IFRS 9 matches the gain or loss on a hedging instrument with the loss or gain on the hedged item in the same period. It applies only if criteria are met. Fair value hedges go through profit or loss. Cash flow and net investment hedges put the effective part in OCI.

Understand Hedge Accounting

Normally a derivative is measured at fair value through profit or loss, while the item it protects may be at cost or may not yet be recognised. The gain on one and the loss on the other then hit profit in different periods. This creates volatility that does not reflect the entity's real risk position. Hedge accounting is an option that fixes this mismatch.

You can only use it if the hedge relationship qualifies. It needs three things: the hedging relationship consists only of eligible hedging instruments and eligible hedged items; there is formal designation and documentation at inception (risk management objective, strategy, the hedged item, the instrument and how effectiveness will be assessed); and the effectiveness requirements are met.

The effectiveness requirements under IFRS 9 are: there is an economic relationship between the hedged item and the hedging instrument; the effect of credit risk does not dominate the value changes; and the hedge ratio reflects the quantities actually used for risk management. IFRS 9 has no 80-125% bright line. That was IAS 39. If the risk management objective is unchanged but the hedge ratio is out of line, you rebalance. If the objective changes or the criteria stop being met, you discontinue hedge accounting prospectively.

There are three types. A fair value hedge covers exposure to changes in fair value of a recognised asset or liability, or an unrecognised firm commitment. A cash flow hedge covers variability in cash flows, such as a forecast highly probable transaction or floating rate interest. A hedge of a net investment in a foreign operation covers the foreign exchange exposure on the parent's net assets in a foreign operation, accounted for like a cash flow hedge.

In a fair value hedge, the gain or loss on the instrument goes to profit or loss. The carrying amount of the hedged item is adjusted for the hedged risk, also through profit or loss. In a cash flow hedge, the effective portion goes to OCI (cash flow hedge reserve) and the ineffective portion goes to profit or loss. When the hedged item affects profit, or becomes a non-financial asset or liability, the amount is removed from the reserve. For a forecast purchase of a non-financial item, the amount is included in the initial cost of the asset (basis adjustment). In IFRS 9 the cash flow hedge reserve is limited to the lower of the cumulative gain or loss on the instrument and the cumulative change in fair value of the hedged item (present value basis).

Key rules to remember

Qualifying criteria: Eligible instrument and item + formal documentation at inception + economic relationship, credit risk not dominant, appropriate hedge ratio; All three groups must be met. Effectiveness is assessed prospectively, with no 80-125% test in IFRS 9.
Fair value hedge: Dr/Cr P&L and Cr/Dr derivative; Dr/Cr hedged item carrying amount and Cr/Dr P&L, for the hedged risk; Both sides go to P&L, so the net effect is the ineffectiveness. If the hedged item is an equity investment at FVOCI, both go to OCI.
Cash flow hedge reserve (OCI): Reserve = lower of (cumulative gain/loss on instrument) and (cumulative change in PV of expected future cash flows on hedged item); Compare the two cumulative movements in absolute terms. The reserve is the lower of the two. If the instrument has moved more (over-hedge), the excess goes to P&L as ineffectiveness. If the hedged item has moved more (under-hedge), the whole instrument movement goes to OCI and no ineffectiveness is recognised in P&L for a cash flow hedge.
Cash flow hedge reclassification: Reserve moves to P&L when the hedged cash flows affect P&L, or is added to the cost of a non-financial asset or liability; The basis adjustment for non-financial items is required in IFRS 9 and is not a reclassification adjustment in OCI.
Net investment hedge: Effective portion to OCI (translation reserve); ineffective portion to P&L; Only the effective portion accumulated in the translation reserve is reclassified to P&L on disposal of the foreign operation. The ineffective portion has already been recognised in P&L, so it is not reclassified from reserves.

How to solve Hedge Accounting questions

Use this order for any hedge accounting question, whether it is a calculation or a discussion.

1Identify the exposure: a recognised asset or liability or firm commitment (fair value), a forecast transaction or variable cash flow (cash flow), or a foreign operation's net assets (net investment).
2Check the criteria: eligible item and instrument, documentation at inception, economic relationship, credit risk, hedge ratio. State briefly which are met in the scenario.
3Work out the fair value or cash flow movement on the derivative at each date. Use the rates given and discount if the question requires it.
4Work out the movement on the hedged item for the hedged risk only.
5Apply the type rules. Fair value hedge: both to P&L. Cash flow hedge: apply the lower-of test, take the lower cumulative amount to OCI, and any excess of the instrument's movement over the item's (over-hedge) to P&L. Net investment hedge: effective part to OCI (translation reserve), ineffective part to P&L.
6Post the journals and show the statement of financial position and P&L effect. Show derivative as asset or liability.
7State what happens at settlement or when the hedged item hits profit (reclassification or basis adjustment).
8Add a short comment on the quality of the hedge, ineffectiveness or any discontinuation.

Quickest way: Three-line classify, measure, post

When to use it: Use when time is short and the question gives clear numbers for the derivative and the hedged item.

Write the type and where gains go: fair value, both to P&L; cash flow or net investment, effective part to OCI.
Calculate cumulative gain or loss on the instrument and on the hedged item. In a cash flow hedge take the lower of the two cumulative amounts (in absolute terms) to OCI. Any excess of the instrument's cumulative movement over the hedged item's goes to P&L (over-hedge). In an under-hedge the whole instrument movement goes to OCI.
Write the journals in a small table of Dr and Cr. Finish with one line on the criteria and documentation, since marks are often given for them.

Common mistakes in Hedge Accounting

Applying hedge accounting automatically because a derivative exists.
Students forget it is optional and needs formal designation and documentation.
Fix: Always state the criteria first. Without documentation at inception, the derivative is just at FVTPL.
Quoting the 80-125% effectiveness test.
It was taught under IAS 39 and many resources still use it.
Fix: Quote the three IFRS 9 requirements: economic relationship, credit risk not dominant, hedge ratio. Mention rebalancing.
Putting the whole derivative gain in OCI in a cash flow hedge.
Students forget the lower-of test and the ineffective portion.
Fix: Compare cumulative movement on instrument and hedged item. Take the lower to OCI. Any excess of the instrument's movement over the item's goes to P&L (over-hedge). In an under-hedge the whole instrument movement goes to OCI.
Taking fair value hedge adjustments to OCI.
Confusion between the two main types.
Fix: Fair value hedge: both the derivative and the hedged item adjustment go to P&L. The exception is an equity investment elected at FVOCI.
Forgetting the reclassification or basis adjustment when the hedged transaction occurs.
Students stop at the year-end entries.
Fix: Finish the question: remove the reserve into P&L, or into the asset cost if a non-financial item was purchased.
Treating a net investment hedge like a fair value hedge.
It involves a recognised amount of net assets.
Fix: Remember it is accounted for like a cash flow hedge. Effective part to OCI and recycled on disposal. The ineffective part goes to P&L at once and is not recycled.

Worked examples

Example 1

On 1 October 20X1 Alpha, a manufacturer with a 31 December year end, holds 10,000 tonnes of inventory at cost $400,000. It is not exposed to a loss in cost but is exposed to a fall in market price. Alpha enters a forward contract to sell 10,000 tonnes on 31 March 20X2 and designates a fair value hedge, with documentation. At 31 December 20X1 market prices have fallen, so the forward has a fair value asset of $30,000. The fall in fair value of the inventory due to the hedged price risk is $28,000. Explain the criteria and show the accounting at 31 December 20X1.

Show the solution

Criteria: the inventory is an eligible hedged item for price risk and the forward is an eligible instrument. Designation and documentation exist at inception. Alpha needs an economic relationship, credit risk not dominant and a hedge ratio matching the 10,000 tonnes hedged. All look met.
Type: it is a fair value hedge, so both movements go to profit or loss.
Derivative: a sell forward gains when the price falls. Dr Derivative asset $30,000, Cr P&L (gain) $30,000.
Hedged item: Dr P&L (loss) $28,000, Cr Inventory $28,000. The inventory carrying amount is now $400,000 − $28,000 = $372,000.
Net P&L effect is a $2,000 gain ($30,000 − $28,000). This is the ineffectiveness.

Answer: P&L shows a $30,000 gain on the forward and a $28,000 loss on writing down the inventory, so a net gain of $2,000 (ineffectiveness). Inventory is $372,000 and the derivative asset is $30,000.

Example 2

Beta, with a 31 December year end, expects with high probability to buy machinery on 31 March 20X2. The machine is priced in a foreign currency and Beta's functional currency is not that currency. Beta designates a forward contract as a cash flow hedge of the currency risk. All amounts below are in functional currency units (FC). The cost originally expected was FC 2,000,000. At 31 December 20X1 the forward has a fair value gain of FC 60,000. The present value of the cumulative increase in the expected cost is FC 55,000. On 31 March 20X2 the forward gain totals FC 90,000 and the cumulative increase in the machine's cost is FC 90,000. Beta buys the machine on 31 March 20X2 at a spot cost of FC 2,090,000. Show the accounting at both dates.

Show the solution

Type: cash flow hedge of a forecast purchase. Criteria are assumed met.
At 31 December 20X1 compare the cumulative gain on the forward (FC 60,000) with the cumulative change on the hedged item (FC 55,000). The lower is FC 55,000, so the reserve is FC 55,000 and the excess of FC 5,000 is ineffectiveness (over-hedge).
31 December 20X1: Dr Derivative asset FC 60,000, Cr OCI (cash flow hedge reserve) FC 55,000, Cr P&L FC 5,000.
At 31 March 20X2 the cumulative gain on the forward is FC 90,000 and the cumulative increase in the cost of the hedged item is also FC 90,000. The two are equal, so the reserve is FC 90,000 and the cumulative ineffectiveness is nil. The FC 5,000 gain taken to P&L in December is therefore reversed by a FC 5,000 debit to P&L.
31 March 20X2: the forward gain in the period is FC 90,000 − FC 60,000 = FC 30,000. The reserve rises from FC 55,000 to FC 90,000, a credit of FC 35,000. Dr Derivative asset FC 30,000, Dr P&L FC 5,000, Cr OCI FC 35,000. The entry balances at FC 35,000 each side.
Settlement of the forward: Dr Cash FC 90,000, Cr Derivative asset FC 90,000.
Purchase of machinery at the spot cost: Dr PPE FC 2,090,000, Cr Cash FC 2,090,000.
Basis adjustment to remove the reserve: Dr Cash flow hedge reserve FC 90,000, Cr PPE FC 90,000.
The PPE carrying amount is FC 2,090,000 − FC 90,000 = FC 2,000,000, which equals the hedged cost. Net cash paid is FC 2,090,000 − FC 90,000 = FC 2,000,000. Depreciation is based on the adjusted amount of FC 2,000,000.

Answer: At 31 December 20X1: OCI credit FC 55,000 and P&L gain FC 5,000, with a derivative asset of FC 60,000. At 31 March 20X2 the forward gain of FC 90,000 equals the cumulative increase in cost, so the reserve is FC 90,000 and the FC 5,000 P&L gain is reversed, leaving cumulative P&L ineffectiveness of nil. The machine is first recorded at FC 2,090,000. The FC 90,000 reserve is then taken out of the cash flow hedge reserve and deducted from the machine's cost (basis adjustment), leaving a carrying amount of FC 2,000,000.

Exam tips

Start with the criteria. Marks are given for documentation, economic relationship, credit risk and hedge ratio, so name them in the scenario context.
Always state the hedge type and the reason, using the wording of the scenario. The type drives the whole answer.
In cash flow hedges, show the lower-of test explicitly, with both cumulative figures written down.
Do not forget the end of the story: reclassification, basis adjustment or disposal recycling.
Add professional skills value by commenting on whether the hedge is worth the cost and complexity, or if the entity's treasury policy and documentation are adequate.

Practice questions from Financial instruments

Hedge Accounting: frequently asked questions

What is the difference between a fair value hedge and a cash flow hedge?

A fair value hedge covers changes in the value of an existing asset, liability or firm commitment, and both sides go to profit or loss. A cash flow hedge covers variability in future cash flows, and the effective part goes to OCI. The cash flow type is used for forecast transactions.

Does IFRS 9 still have the 80-125% test?

No. IFRS 9 replaced it with three requirements: an economic relationship, credit risk not dominating the value changes, and an appropriate hedge ratio. Ineffectiveness is still measured and recognised in profit or loss.

Is hedge accounting compulsory?

No, it is optional. An entity must designate the relationship and document it at inception, and then meet the criteria. Without that, the derivative is measured at fair value through profit or loss.

How is a net investment hedge accounted for?

It is treated like a cash flow hedge. The effective portion of the gain or loss on the hedging instrument goes to OCI and sits in the translation reserve. The ineffective portion goes to profit or loss at once. On disposal of the foreign operation, only the effective portion held in the translation reserve is reclassified to profit or loss.