Cash Flow Hedge Accounting under Ind AS 109 (CA Final)

Understand Cash Flow Hedge Accounting

Key rules to remember

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.

How to solve Cash Flow Hedge Accounting questions

1. 1Identify the hedged item, the hedged risk and the hedging instrument. Confirm the forecast transaction is highly probable and the hedge meets the qualifying criteria.
2. 2Compute the fair value of the hedging instrument at each date. Find the cumulative gain or loss since inception.
3. 3Compute the cumulative change in the present value of the hedged item's expected cash flows since inception. If the question gives hypothetical derivative values, use them.
4. 4Apply the lower-of test on absolute cumulative amounts. The lower figure is the required reserve; the excess of the instrument's movement is ineffective.
5. 5Find the period entries: OCI = closing reserve less opening reserve; P&L ineffectiveness = cumulative ineffectiveness less amount already taken to P&L.
6. 6Post the journal entries: Dr or Cr Derivative, with Cr or Dr Cash flow hedge reserve (OCI) and P&L for the ineffective part.
7. 7On the hedged transaction, reclassify the reserve: add to the cost of a non-financial asset or liability, or transfer to P&L when the hedged cash flows affect P&L.
8. 8Settle the derivative and close the reserve fully. Check that the reserve is nil and the net effect matches the hedged rate.

Quickest way: Cumulative table shortcut

Common mistakes in Cash Flow Hedge Accounting

• Taking the whole derivative gain or loss to OCI.

  Students assume a designated hedge is 100% effective and skip the lower-of test.

  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.

  Year-wise tables tempt you to compare each year's movement alone.

  Fix: Compare cumulative figures since inception. Then find the period entry by subtracting the opening balance.

• Reclassifying the reserve to P&L when the hedged item is inventory or PPE.

  Students remember 'reclassify to P&L' as a general rule.

  Fix: For a forecast purchase resulting in a non-financial asset, include the reserve in the asset's initial cost. It then reaches P&L through depreciation or cost of sales.

• Mixing up cash flow hedge with fair value hedge treatment.

  Both use derivatives, but the double entry differs.

  Fix: In a cash flow hedge, the hedged item is not remeasured and the reserve sits in OCI. In a fair value hedge, the hedged item's carrying amount is adjusted and gains and losses go to P&L.

• Ignoring sign and comparing the derivative's gain with a hedged-item loss as if they were the same direction.

  Students compare signed numbers and pick the smaller number.

  Fix: Compare absolute values. The reserve takes the sign of the derivative's movement.

• Leaving a balance in the reserve after the hedged transaction occurs.

  Students forget the final reclassification entry.

  Fix: Close the reserve fully at the event. Check that it ends at nil.

Worked examples