Financial Reporting · Hedge Accounting

Hedging Instruments and Hedged Items under Ind AS 109

Updated 5 October 2026 · Fact-checked

A hedging instrument is the derivative or other designated item used to offset risk. A hedged item is the exposure being protected. Under Ind AS 109, you check eligibility of each: instrument type, external party, whole or proportion, and for the item, reliable measurability, risk component and group conditions. Then you apply the hedge accounting criteria.

Understand Hedging Instruments and Hedged Items

A hedged item is the exposure that creates risk: a recognised asset or liability, an unrecognised firm commitment, a highly probable forecast transaction, or a net investment in a foreign operation. A hedging instrument is what you use to offset the change in fair value or cash flows of that exposure.

Think of it as two sides. The hedged item carries the risk. The hedging instrument is the shield. Hedge accounting lets you match the gains and losses of both in the same period, so profit or loss is not distorted. It is optional, and you must designate the relationship formally.

Eligible hedging instruments are derivatives measured at fair value through profit or loss (except some written options), and non-derivative financial assets or liabilities measured at FVTPL. The exception is a financial liability designated at FVTPL where the change in its fair value due to own credit risk is presented in OCI. That liability cannot be a hedging instrument. For foreign currency risk only, the foreign currency risk component of other non-derivative financial assets or liabilities can also be a hedging instrument, but not an investment in an equity instrument designated at FVOCI. Only instruments with a party external to the reporting entity qualify. Intragroup items do not qualify in consolidated statements, with limited exceptions for investment entities.

Eligible hedged items must be reliably measurable. Aggregated exposures, groups of items and net positions can qualify under conditions. An entity may also designate a risk component of an item, if the component is separately identifiable and reliably measurable. For financial items, this can be a contractually specified or a non-contractually specified component, such as the benchmark interest rate in a loan. For non-financial items, only foreign currency risk or a contractually specified component can be hedged as a risk component. Hedged items in a hedge relationship must also involve a party external to the entity.

Key rules to remember

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.

How to solve Hedging Instruments and Hedged Items questions

Use this order for any question asking whether something qualifies as a hedging instrument or hedged item.

1Identify the exposure and the risk being hedged: foreign currency, interest rate, commodity price or credit.
2Name the candidate hedged item and classify it: recognised item, firm commitment, forecast transaction or net investment.
3Test the hedged item: reliably measurable, external party, and highly probable if it is a forecast transaction.
4If only part of the item is hedged, check whether it is a proportion or a separately identifiable risk component, and whether the component rule for non-financial items is met.
5Name the candidate hedging instrument and test: derivative or FVTPL non-derivative, external party, and written option conditions.
6Check that the whole instrument or a proportion is designated, not a portion of its life.
7Conclude: state which items qualify, then say that the other criteria (documentation, economic relationship, credit risk not dominant, hedge ratio) must also be met.

Quickest way: Two-column eligibility check

When to use it: Use for MCQs and short case questions where you must quickly decide if an instrument or item qualifies.

Draw two columns: Instrument and Item.
For the instrument, ask three things: Derivative or FVTPL? External party? Not a standalone written option?
For the item, ask three things: Reliably measurable? External party? Highly probable if forecast?
If a risk component is hedged, ask: financial or non-financial item? Non-financial allows only foreign currency or contractual components.
Any single failure means no hedge accounting for that designation.

Common mistakes in Hedging Instruments and Hedged Items

Treating a standalone written option as a valid hedging instrument.
Students assume any derivative qualifies.
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.
It qualifies in the separate statements of the group entity, so students carry it over.
Fix: In consolidated statements, only instruments and items with parties external to the group qualify. Intragroup balances are eliminated.
Hedging a component of a non-financial item, such as the crude oil portion of aviation fuel, without checking the rule.
Students apply the broad financial-item rule to all items.
Fix: For non-financial items, only foreign currency risk or a contractually specified component is eligible as a risk component. Crude oil qualifies only if the fuel contract specifies it.
Designating a hedging instrument for only part of its remaining life.
Students want to match the hedge period with the exposure period.
Fix: You may designate a proportion of the nominal amount, but not a portion of the time period the instrument is outstanding.
Calling any forecast transaction a hedged item.
Students forget the probability threshold.
Fix: A forecast transaction must be highly probable. A merely possible transaction does not qualify.
Confusing the hedged item with the hedging instrument, especially when a loan is hedged by a swap.
Both are financial instruments and the question gives both.
Fix: Ask which one carries the risk. That is the item. The one offsetting it is the instrument.

Worked examples

Example 1

Indus Ltd, an Ind AS company, expects to buy machinery from a US supplier in four months for USD 5,00,000. The purchase is highly probable and the price is fixed in USD. Indus enters a forward contract with a bank to buy USD 5,00,000 in four months. Identify the hedged item and the hedging instrument, and state whether they qualify.

Show the solution

Risk: foreign currency risk on the future USD payment.
Hedged item: the highly probable forecast purchase of machinery in USD. A forecast transaction qualifies if it is highly probable, which is stated here.
The USD price is fixed, so the foreign currency cash flows are reliably measurable. The supplier is an external party.
Hedging instrument: the forward contract. It is a derivative measured at FVTPL and is with an external party (the bank).
The whole forward contract is designated, with no partial-life split.
Conclusion: both qualify for designation. Hedge accounting will apply only if the formal documentation, economic relationship, credit risk and hedge ratio criteria are also met.

Answer: The forecast USD machinery purchase is the hedged item. The forward contract is the hedging instrument. Both are eligible, subject to the other hedge accounting criteria.

Example 2

Kaveri Ltd has a 5-year floating-rate loan of ₹50,00,000 linked to a benchmark rate plus a credit spread. It wants to hedge only the benchmark interest rate risk using an interest rate swap with a bank. Separately, a group company, Kaveri Finance Ltd, has entered a swap with Kaveri Ltd. Can Kaveri Ltd designate the benchmark rate component, and which swap can it use in consolidated financial statements?

Show the solution

The loan is a recognised financial liability, so it is an eligible hedged item.
Benchmark interest rate is a risk component of a financial item. It is separately identifiable and reliably measurable, so it can be designated without hedging the credit spread.
The swap with the bank is a derivative at FVTPL with an external party, so it is an eligible hedging instrument.
The swap with Kaveri Finance Ltd is intragroup. In consolidated statements, it is eliminated and cannot be a hedging instrument.
Conclusion: Kaveri Ltd designates the benchmark rate component of the loan as hedged item and the bank swap as hedging instrument.

Answer: The benchmark rate component of the loan qualifies as a hedged item. Only the bank swap qualifies as a hedging instrument in consolidated statements. The intragroup swap does not.

Exam tips

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.
Close case answers by saying that qualifying instruments and items are only a first step, and that documentation and effectiveness criteria must also be met.
In MCQs, watch for traps: written options, own-credit-risk liabilities at FVTPL, equity investments at FVOCI used as foreign currency hedges, and partial-life designations.

Practice questions from Hedge Accounting

Hedging Instruments and Hedged Items: frequently asked questions

What is the difference between a hedging instrument and a hedged item?

A hedged item is the exposure that carries the risk, such as a loan, a firm commitment or a forecast sale. A hedging instrument is what you designate to offset that risk, usually a derivative. Hedge accounting links their gains and losses in the same period.

Can a non-derivative be a hedging instrument under Ind AS 109?

Yes, if it is a non-derivative financial asset or liability measured at FVTPL. The exception is a financial liability designated at FVTPL whose own-credit-risk change is presented in OCI. For foreign currency risk only, the foreign currency component of other non-derivative financial items can also qualify, but not an equity instrument designated at FVOCI.

Can you hedge only a part of an item?

Yes. You can designate a proportion of the item or a risk component, such as the benchmark interest rate. For non-financial items, a component is allowed only for foreign currency risk or a contractually specified component.

Can a group of items be a hedged item?

Yes, if each item qualifies individually, the items are managed together on a group basis for risk management, and each item's change in value from the hedged risk is expected to be approximately proportional to the group's overall change. Net positions can also be designated in specified circumstances, with extra conditions in cash flow hedges.