Financial Reporting · Hedge Accounting

Net Investment Hedge and Discontinuing Hedge Accounting (Ind AS 109)

Updated 5 October 2026 · Fact-checked

A net investment hedge protects the parent from exchange differences on its net assets in a foreign operation. The effective part of the hedge gain or loss goes to OCI (foreign currency translation reserve) and moves to profit or loss on disposal. Hedge accounting stops prospectively only when the criteria are no longer met, or the instrument expires, is sold or terminated.

Understand Net Investment Hedge and Discontinuing Hedge Accounting

A net investment in a foreign operation is your share of the net assets of a subsidiary, associate, joint arrangement or branch whose functional currency differs from yours. When you consolidate it, translation creates exchange differences. These go to OCI and sit in the foreign currency translation reserve (FCTR). They do not hit profit or loss until disposal. A net investment hedge protects against this translation risk.

The accounting works like a cash flow hedge. The effective portion of the gain or loss on the hedging instrument goes to OCI and is accumulated in the FCTR, where it offsets the translation difference on the net assets. The ineffective portion goes to profit or loss. On disposal of the foreign operation, the cumulative amounts in OCI are reclassified to profit or loss as a reclassification adjustment. Full reclassification applies on loss of control, loss of joint control or loss of significant influence. On any other partial disposal of a subsidiary, where control is retained, the proportionate share of the cumulative amounts is attributed to NCI and not reclassified. On a partial disposal of an associate or joint arrangement where significant influence or joint control is retained, the proportionate share is reclassified to profit or loss.

The hedged risk is only the foreign exchange risk between the functional currency of the foreign operation and the functional currency of the parent. You cannot hedge the operation's profit, and you cannot hedge for translation into a presentation currency alone. The hedging instrument can be a derivative or a non-derivative such as a foreign currency borrowing. It can be held by any group entity, if the hedge is documented and effective.

Options. When you designate an option, you may designate only its intrinsic value as the hedging instrument. Once you do, only the part of the change in time value that relates to the hedged item (the aligned time value) is recognised in OCI and accumulated in a cost of hedging reserve (Ind AS 109, para 6.5.15). Any excess of the option's actual time value over the aligned time value goes to profit or loss. How the reserve is released follows the nature of the hedged item:

For a transaction-related hedged item, the aligned time value is removed from the reserve when the hedged transaction affects profit or loss, or is included in the initial carrying amount of a non-financial asset or liability.
For a time-period related hedged item, the original aligned time value is amortised to profit or loss on a rational basis over the hedge period.
For a net investment hedge, the amounts accumulate in OCI and are reclassified on disposal of the foreign operation.

Forwards and basis spreads. The forward element of a forward contract, and the foreign currency basis spread of a financial instrument, can also be excluded from the designation. For these, taking the change in value to OCI and holding it in the cost of hedging reserve is optional (Ind AS 109, para 6.5.16). If you do not elect it, the change goes to profit or loss. The election is made on a hedge-by-hedge basis. It is not an entity-wide policy applied to all hedges.

Discontinuing hedge accounting. Under Ind AS 109 you cannot discontinue voluntarily by simply revoking the designation while the risk management objective is unchanged. Discontinuation is prospective. It applies when the hedging relationship, or part of it, no longer meets the qualifying criteria after any rebalancing. This includes a change in the risk management objective for the relationship. It also applies when the hedging instrument expires, or is sold, terminated or exercised. Expiry or termination of the instrument does not include a replacement or rollover that is part of the documented risk management objective, provided the hedging relationship continues. If the relationship does not continue, hedge accounting stops. For a net investment hedge, the amounts already in the reserve stay in OCI after discontinuation until the foreign operation is disposed of.

Key rules to remember

Net investment hedge: effective portion: Effective portion to OCI (FCTR) = lower of (cumulative gain or loss on instrument, cumulative change in value of hedged net investment), in absolute terms; Excess on the instrument is ineffective and goes to profit or loss. Cumulative amounts are reclassified to profit or loss on disposal.
Reclassification on disposal: Full reclassification to P&L on loss of control, loss of joint control or loss of significant influence: effective hedge amounts and FCTR on the operation, and the cost of hedging reserve; Partial disposal of a subsidiary with control retained: the proportionate share goes to NCI, not P&L. Partial disposal of an associate or joint arrangement with significant influence or joint control retained: the proportionate share is reclassified to P&L.
Option time value: Hedging instrument = intrinsic value of option; change in aligned time value to OCI (cost of hedging reserve); any excess to P&L; Applies once only intrinsic value is designated (Ind AS 109, para 6.5.15). Only the aligned time value, the part that relates to the hedged item, goes to OCI. Any excess of actual time value over the aligned time value goes to profit or loss.
Forward element: Forward contract: designate spot element only; change in forward element to OCI (cost of hedging reserve) if elected; Forward element is the difference between forward and spot price. The OCI treatment is optional and is elected hedge by hedge (Ind AS 109, para 6.5.16). If the forward element is not excluded, the whole forward is the hedging instrument.
Discontinuation triggers: Stop prospectively if: qualifying criteria not met after rebalancing (including a change in the risk management objective), OR instrument expires, sold, terminated or exercised; Voluntary revocation is not allowed while the objective remains the same and the criteria are still met. Replacement or rollover of the instrument is not an expiry or termination if it is part of the documented objective and the hedging relationship continues. For a net investment hedge, amounts already in the reserve stay in OCI until disposal of the foreign operation.
Qualifying criteria: Eligible hedging instrument + eligible hedged item + formal documentation + effectiveness (economic relationship, credit risk not dominant, hedge ratio); Effectiveness is assessed prospectively at inception and at each reporting date. There is no 80-125% bright line.

How to solve Net Investment Hedge and Discontinuing Hedge Accounting questions

Use this order for any question on net investment hedges, cost of hedging or discontinuation.

1Identify the hedged item: is it a net investment in a foreign operation (net assets), and in which functional currency?
2Identify the hedging instrument: forward, option or foreign currency borrowing. Check which element is designated (spot, intrinsic value, whole instrument).
3Compute the change in value of the hedging instrument and the translation change on the net investment, both in the parent's functional currency.
4Take the lower of the two absolute amounts as the effective portion. Put it in OCI (FCTR). Put any excess in profit or loss.
5Separate the excluded element. The time value change of an option (when only intrinsic value is designated) goes to OCI under cost of hedging reserve. A forward element or basis spread goes to OCI under cost of hedging reserve only if the entity elects so; otherwise it goes to profit or loss.
6Check each reporting date whether the qualifying criteria still hold or whether the instrument has expired, been sold or terminated. If so, stop hedge accounting prospectively.
7On loss of control, joint control or significant influence, reclassify the cumulative hedging reserve, FCTR and cost of hedging reserve to profit or loss. On other partial disposals, apply the NCI or proportionate rule.
8Write the answer as provision, facts, conclusion, with the journal entries.

Quickest way: Three-bucket split for hedge gains and losses

When to use it: Use when the question gives instrument gain or loss and asks where each part is recognised.

Bucket 1 is effective part: lower of instrument change and net investment change. It goes to OCI and is accumulated in the FCTR.
Bucket 2 is excluded element. Aligned option time value goes to OCI (cost of hedging reserve). Forward points or basis spread go to OCI (cost of hedging reserve) if elected, otherwise profit or loss.
Bucket 3 is the remainder, the ineffective part. It goes to profit or loss.
For discontinuation, ask: did the criteria fail (including a change in the risk management objective), or did the instrument end without a documented replacement that continues the relationship? If yes, stop from that date. Amounts already in the reserve stay in OCI until the foreign operation is disposed of. On disposal, reclassify in full on loss of control, joint control or significant influence. On a partial disposal of a subsidiary with control retained, attribute the proportionate share to NCI. On a partial disposal of an associate or joint arrangement with influence or joint control retained, reclassify the proportionate share to profit or loss. If the criteria still hold, continue.

Common mistakes in Net Investment Hedge and Discontinuing Hedge Accounting

Taking the whole hedging gain or loss to OCI.
Students forget the lower-of test and treat all derivative movements as effective.
Fix: Always compare the instrument change with the net investment change. Only the lower amount goes to OCI. The excess goes to profit or loss.
Reclassifying hedge gains to profit or loss at year end.
Students confuse net investment hedges with cash flow hedges where the reserve is recycled when the item affects profit or loss.
Fix: For a net investment hedge, the reserve stays in OCI until disposal of the foreign operation (loss of control, joint control or significant influence), or the proportionate share on other partial disposals.
Discontinuing hedge accounting retrospectively or voluntarily.
Students think the entity can simply cancel the designation at will.
Fix: Discontinuation is prospective and applies only when the qualifying criteria are not met (including a change in the risk management objective) or the instrument expires, is sold, terminated or exercised. A voluntary revocation is not allowed while the criteria are met.
Treating time value of an option as part of the hedging instrument when only intrinsic value is designated.
Students ignore the designation wording in the question.
Fix: Read which element is designated. If only intrinsic value, put the time value change in OCI under cost of hedging reserve, not in profit or loss.
Applying the old 80-125% effectiveness test.
Students remember the old rule from earlier standards.
Fix: Ind AS 109 requires an economic relationship, credit risk not dominating, and a hedge ratio consistent with the actual risk management. Cite those three.
Hedging the presentation currency translation or the profit of the foreign operation.
Students assume any currency exposure of the group can be hedged.
Fix: Only the exchange risk between functional currencies of the foreign operation and the parent on the net assets is eligible.

Worked examples

Example 1

Parent A Ltd (functional currency ₹) has a US subsidiary with net assets of USD 10,00,000. At the start of the year the rate is ₹80 per USD, at the end ₹84. A Ltd designates a USD 10,00,000 borrowing as a hedge of the net investment. Compute the amounts in OCI, ignoring tax.

Show the solution

Translation gain on net assets = USD 10,00,000 × (₹84 − ₹80) = ₹40,00,000, credited to OCI (FCTR).
Exchange loss on USD borrowing = USD 10,00,000 × (₹84 − ₹80) = ₹40,00,000.
Instrument change and net investment change are equal in absolute terms, so the hedge is fully effective.
Effective portion = lower of ₹40,00,000 and ₹40,00,000 = ₹40,00,000. The loss goes to OCI (FCTR) and not to profit or loss.
Net effect in OCI is nil. Profit or loss has no exchange loss on the borrowing.

Answer: The borrowing loss of ₹40,00,000 goes to OCI and offsets the translation gain of ₹40,00,000. Profit or loss shows no exchange difference. Both amounts stay in FCTR until disposal of the subsidiary.

Example 2

B Ltd hedges a net investment in a foreign subsidiary using a forward contract. Over the year the forward contract shows a loss of ₹12,00,000, of which ₹10,00,000 relates to the spot element and ₹2,00,000 to the forward element. B Ltd designates only the spot element and elects to take forward element changes to cost of hedging reserve. The net investment has a translation gain of ₹9,00,000. Show the treatment.

Show the solution

Hedging instrument is the spot element only. Its loss is ₹10,00,000.
The net investment has a translation gain of ₹9,00,000. This is credited to OCI and accumulated in the FCTR.
Effective portion = lower of ₹10,00,000 and ₹9,00,000 = ₹9,00,000. The effective hedge loss of ₹9,00,000 is recognised in OCI and accumulated in the FCTR. It offsets the translation gain, so the net balance in the FCTR from these two items is nil.
Ineffective portion = ₹10,00,000 − ₹9,00,000 = ₹1,00,000 loss, charged to profit or loss.
Forward element loss of ₹2,00,000 is debited to OCI under the cost of hedging reserve, which is kept separate from the FCTR, because B Ltd has elected this treatment.
Reconciliation of the forward's loss: OCI effective hedge loss (FCTR) ₹9,00,000 + profit or loss ₹1,00,000 + cost of hedging reserve ₹2,00,000 = ₹12,00,000, which equals the total loss on the forward.

Answer: Translation gain of ₹9,00,000 is credited to OCI (FCTR) and the effective hedge loss of ₹9,00,000 is also recognised in OCI and accumulated in the FCTR, so the net in the FCTR is nil. Profit or loss: ₹1,00,000 ineffective loss. Cost of hedging reserve (separate from the FCTR): ₹2,00,000 loss. The total of ₹12,00,000 equals the forward's loss. The OCI amounts stay in equity until disposal of the foreign operation.

Exam tips

In case MCQs, identify the hedge type first. Net investment hedges follow cash flow hedge mechanics but recycle only on disposal.
Always write the lower-of test in a written answer. Examiners look for it.
For discontinuation questions, state three things: prospective, the trigger, and what happens to amounts already in OCI.
Show a journal entry for each of OCI, profit or loss and cost of hedging reserve. Check that the total equals the instrument's fair value change.
If the question mentions time value or forward points, check which element is designated before computing.

Practice questions from Hedge Accounting

Net Investment Hedge and Discontinuing 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 FinalDerivatives and Hedge Accounting

Net Investment Hedge and Discontinuing Hedge Accounting: frequently asked questions

Can a foreign currency loan hedge a net investment?

Yes. A non-derivative financial liability can be a hedging instrument for foreign currency risk. For a net investment hedge, the exchange difference on the loan goes to OCI to the extent it is effective. The excess goes to profit or loss.

When is the net investment hedge reserve recycled to profit or loss?

It is reclassified, along with the related FCTR, on disposal of the foreign operation that results in loss of control, joint control or significant influence. It is not recycled at each reporting date. On a partial disposal of a subsidiary without loss of control, the proportionate share is attributed to NCI instead. On a partial disposal of an associate or joint arrangement, the proportionate share is reclassified.

Can an entity stop hedge accounting whenever it wants?

No. Under Ind AS 109 discontinuation applies only when the qualifying criteria are no longer met (including a change in the risk management objective), or the instrument expires, is sold, terminated or exercised. Voluntary revocation is not allowed while the criteria are met. The effect is prospective.

Where does the time value of an option go?

If only intrinsic value is designated, changes in the time value relating to the hedged item must be recognised in OCI and accumulated in the cost of hedging reserve (Ind AS 109, para 6.5.15). This is not optional. For a net investment hedge it stays there until disposal of the foreign operation. Any part that does not relate to the hedged item goes to profit or loss. Only the forward element and basis spread treatment is optional, hedge by hedge.