Hedge Accounting for CA Final Financial Reporting (Ind AS 109 and Ind AS 107)

What this chapter covers

Hedge Accounting: topics in the order to study them

1. 1Hedge Accounting Objective and ScopeStart here to understand the accounting mismatch problem and why hedge accounting is optional, so every later rule makes sense.
2. 2Hedging Instruments and Hedged ItemsYou must know what can be hedged and what can hedge before you can test any relationship.
3. 3Qualifying Criteria and Hedge EffectivenessEntries are allowed only if the criteria are met, so this is the gate to the three hedge types.
4. 4Fair Value Hedge AccountingIt is the simplest type to learn, because both sides normally go to profit or loss and the hedged item is adjusted. The one exception is a hedged equity instrument at FVOCI, where both go to OCI.
5. 5Cash Flow Hedge AccountingIt is the most examined type and needs the reserve and OCI logic, so study it after the fair value hedge for contrast.
6. 6Net Investment Hedge and Discontinuing Hedge AccountingA net investment hedge is accounted for similarly to a cash flow hedge: the effective part is held in OCI (foreign currency translation reserve) and the ineffective part goes to profit or loss. The amount in OCI is reclassified on disposal of the foreign operation, or on partial disposal in line with Ind AS 21 (where control is retained, the proportionate share is reattributed to NCI instead). Discontinuation rules then close the loop on all three types.
7. 7Ind AS 107 Hedge Accounting DisclosuresDisclosures are easiest to remember once you know the mechanics they describe, so finish with them.

How to prepare Hedge Accounting

1. Read the objective and write in one line the mismatch that hedge accounting fixes. Use this line to open theory answers.
2. Make a two-column list of eligible hedging instruments and hedged items. Note the exceptions and learn them as short rules. For example, a written option qualifies as a hedging instrument only if it is designated as an offset to a purchased option (including one embedded in another instrument).
3. Learn the qualifying criteria as a checklist: formal designation and documentation, economic relationship, credit risk not dominating, and a hedge ratio consistent with the actual hedge. Apply the checklist to every scenario before any entry.
4. Draw one timeline per hedge type showing where the instrument gain or loss and the hedged item gain or loss go. Then pass entries for the same facts under each type to see the differences.
5. For cash flow hedges, practise the lower-of test. The 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. If (a) exceeds (b), that is an overhedge and the excess goes to profit or loss as ineffectiveness. If (b) exceeds (a), that is an underhedge: the reserve equals (a) and no ineffectiveness is recognised. Then practise the later transfer from the reserve to profit or loss or to the cost of a non-financial asset.
6. Solve scenarios on discontinuation, such as expiry of the instrument or a forecast transaction no longer expected to occur, and state what happens to the reserve. Remember that voluntary revocation of the designation is not permitted.
7. Revise the Ind AS 107 disclosures as a short list, then attempt a mixed scenario that asks for eligibility, entries and a disclosure point.

Common mistakes in Hedge Accounting

• Passing hedge accounting entries without testing the qualifying criteria.

  Fix: Write a one-line checklist first in every answer: designation and documentation, economic relationship, credit risk effect, hedge ratio. Then state your conclusion.

• Mixing up where the gain or loss goes in a fair value hedge and a cash flow hedge.

  Fix: Anchor on the exposure. A fair value hedge covers a recognised item or firm commitment whose value changes, so everything normally goes to profit or loss (the exception is a hedged equity instrument at FVOCI, where both effects go to OCI). A cash flow hedge covers variability in future cash flows, so the effective part waits in OCI.

• Taking the whole gain or loss on the hedging instrument to OCI in a cash flow hedge.

  Fix: Compute both cumulative figures from inception: the gain or loss on the instrument, and the change in the present value of the expected future cash flows on the hedged item (often via a hypothetical derivative). Take the lower in absolute terms as the reserve amount. If the instrument's figure is higher (overhedge), send the excess to profit or loss as ineffectiveness. If the hedged item's figure is higher (underhedge), the reserve equals the instrument's amount and no ineffectiveness is recognised.

• Reclassifying the reserve at the wrong time or to the wrong place.

  Fix: Ask what the forecast transaction creates. If it creates a non-financial asset or liability, or a firm commitment for which fair value hedge accounting is applied, remove the reserve and include it directly in the initial cost. Otherwise reclassify to profit or loss when the hedged cash flows affect profit or loss. If the reserve is a loss that you do not expect to recover in future periods, reclassify the unrecovered amount to profit or loss immediately.

• Applying the old AS 30 or the 80%-125% bright-line test.

  Fix: Use Ind AS 109 only. Effectiveness is based on the economic relationship, credit risk and hedge ratio, assessed prospectively.

• Treating discontinuation as retrospective, or as a free choice.

  Fix: Discontinue 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 is not permitted. Then treat the cash flow hedge reserve: it remains in OCI until the hedged cash flows occur if they are still expected, and is reclassified to profit or loss immediately if they are no longer expected to occur.

Last-day revision: Hedge Accounting

• ✓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.

Hedge Accounting practice questions

• In the previous year, Sagar Chemicals Ltd applied cash flow hedge accounting to a forecast purchase of imported raw material. In the current…
• Ind AS 107 requires hedge accounting disclosures to provide information about three matters. Which of the following correctly lists one of t…
• Bharat Steel Ltd has a cash flow hedge of forecast dollar purchases. At inception it expects ineffectiveness to arise only from differences …
• Ratna Power Ltd hedged interest rate risk on a floating-rate loan using a swap. During the year, a difference in the reset dates of the loan…
• Mahi Foods Ltd is preparing the narrative part of its hedge accounting disclosures. Which item must the description of the hedging instrumen…
• Veda Textiles Ltd applies hedge accounting to its foreign currency and commodity price exposures. In preparing its Ind AS 107 hedge accounti…
• Sundaram Textiles Ltd applies hedge accounting to forward contracts hedging forecast export sales (cash flow hedges) and to interest rate sw…
• Veda Textiles Ltd applies hedge accounting to its foreign currency and commodity price exposures. In preparing its Ind AS 107 hedge accounti…

Hedge Accounting in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

• CMA FinalAccounting of Financial Instruments
• CA IntermediateAS 3 Cash Flow Statement
• CS ExecutiveAccounting Standards
• CMA IntermediateCash Flow Statement