Fair Value Hedge Accounting under Ind AS 109 (CA Final)

Understand Fair Value Hedge Accounting

Key rules to remember

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.

How to solve Fair Value Hedge Accounting questions

1. 1Identify the hedged item, the hedged risk and the hedging instrument. Confirm that the hedge qualifies: formal designation and documentation, an economic relationship, credit risk not dominating the value changes, and a proper hedge ratio.
2. 2Classify the hedge. Exposure to changes in fair value of a recognised item or firm commitment is a fair value hedge. Variability of future cash flows is a cash flow hedge.
3. 3At inception, record the hedging instrument at fair value. A forward at market terms usually has nil fair value, so there is no entry.
4. 4At each reporting date, compute the change in fair value of the hedging instrument. Book it in profit or loss, as an asset or liability for the derivative.
5. 5Compute the change in fair value of the hedged item that is due only to the hedged risk. Adjust its carrying amount, or book a commitment asset or liability, with the other side in profit or loss.
6. 6Compare the two amounts. The net figure in profit or loss is the ineffectiveness. If the hedged item is an interest-bearing item at amortised cost, plan amortisation of the adjustment.
7. 7On settlement, derecognise the derivative against cash. On fulfilment of a firm commitment, add the cumulative commitment adjustment to the initial carrying amount of the asset or liability acquired.
8. 8Finish by checking that total profit or loss equals the locked-in economic result.

Quickest way: Mirror-entry method

Common mistakes in Fair Value Hedge Accounting

• Taking the hedging gain or loss to OCI or a hedge reserve in a fair value hedge.

  Students mix this up with cash flow hedge accounting, where a reserve is used.

  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.

  The question gives a market price, and students use the full change.

  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.

• Not recognising the firm commitment as an asset or liability.

  A firm commitment is normally off balance sheet, so students leave it out.

  Fix: Under fair value hedge accounting, recognise the cumulative change in its fair value due to the hedged risk as an asset or liability, with a P&L entry.

• Recording the acquired asset at the market price or at the contract price, without the basis adjustment.

  Students forget to link the commitment balance to the final purchase entry.

  Fix: Record the asset at the purchase price paid, plus or minus the cumulative commitment adjustment. A commitment liability reduces the cost; a commitment asset increases it. Derecognise the commitment asset or liability in the same entry.

• Ignoring amortisation of the adjustment on an amortised-cost item.

  Students stop once the adjustment is booked.

  Fix: For items at amortised cost, amortise the adjustment to profit or loss over the remaining life using a recalculated effective interest rate.

• Continuing hedge accounting after the hedge fails the criteria or the instrument is sold.

  Students assume a designation stays in force until the end.

  Fix: Stop hedge accounting prospectively when criteria are no longer met or the instrument expires, is sold, terminated or exercised. Do not restate earlier periods.

Worked examples