Financial Reporting · Hedge Accounting

Qualifying Criteria and Hedge Effectiveness under Ind AS 109

Updated 5 October 2026 · Fact-checked

Hedge accounting under Ind AS 109 is allowed only if the hedging relationship is eligible, formally designated and documented at inception, and meets three effectiveness requirements: an economic relationship, credit risk not dominating value changes, and a hedge ratio matching the actual quantities hedged. Check each condition in order, then conclude. If one fails, hedge accounting is not available.

Understand Qualifying Criteria and Hedge Effectiveness

Hedge accounting is optional. Without it, a derivative is measured at fair value through profit or loss, while the item it protects may be measured at cost. This creates a mismatch in profit or loss. Hedge accounting removes that mismatch by matching the gain or loss on the hedging instrument with the loss or gain on the hedged item in the same period.

Because it is a relief, Ind AS 109 allows it only when strict conditions are met. A hedging relationship qualifies only if all the following hold at the start and on an ongoing basis:

The relationship consists only of eligible hedging instruments and eligible hedged items.
At inception there is formal designation and documentation of the relationship, the risk management objective and the strategy.
The relationship meets the hedge effectiveness requirements.

The documentation must identify the hedging instrument, the hedged item, the nature of the risk being hedged, and how the entity will assess effectiveness. This includes the sources of ineffectiveness and how the hedge ratio is determined. Without this paper trail made at inception, you cannot apply hedge accounting, even if the economics are perfect. Hedge accounting is applied prospectively from the date all criteria are met. It cannot be applied retrospectively. If an instrument already exists and the relationship is designated and documented later, the relationship begins on that later date, and hedge accounting begins from then. Gains or losses on the instrument before that date stay in profit or loss.

The effectiveness requirements are three. First, there must be an economic relationship between the hedged item and the hedging instrument. The two should move in opposite directions because of the same risk. Second, the effect of credit risk must not dominate the value changes that result from that economic relationship. Third, the hedge ratio of the designated relationship must be the same as the ratio actually used in the entity's risk management of the quantity hedged. The entity must not deliberately create an imbalance that would produce an accounting outcome inconsistent with the purpose of hedge accounting.

Unlike the old IAS 39, there is no 80-125% bright-line test. Ind AS 109 uses a forward-looking, qualitative or quantitative assessment. It is made at inception and on an ongoing basis, at a minimum at each reporting date or on a significant change in circumstances affecting the effectiveness requirements, whichever comes first. If the risk management objective is unchanged but the hedge ratio is no longer right, the entity rebalances the relationship. If the objective itself changes, or the criteria are no longer met and cannot be restored by rebalancing, hedge accounting is discontinued prospectively.

Key rules to remember

Qualifying criteria (all must be met): Eligible instrument and item + formal designation and documentation at inception + effectiveness requirements met; Failure of any one means no hedge accounting from that point.
Effectiveness requirement 1: Economic relationship: value of hedged item and hedging instrument generally move in opposite directions because of the hedged risk; Can be shown by matching critical terms, qualitative assessment, or a quantitative method such as regression.
Effectiveness requirement 2: Credit risk must not dominate the value changes arising from the economic relationship; Consider the credit risk of both the counterparty and the entity itself.
Effectiveness requirement 3: Designated hedge ratio = ratio actually used for risk management of the quantity hedged; Do not designate a ratio meant to achieve an accounting result that conflicts with hedge accounting.
Hedge ratio: Hedge ratio = Quantity of hedging instrument ÷ Quantity of hedged item; Use this one direction for both the designation and the risk management view. State the direction you use.
Rebalancing rule: Risk management objective unchanged + hedge ratio no longer meets requirement → rebalance (adjust quantities); objective changed → discontinue; Rebalancing is not discontinuation. The relationship continues with an adjusted ratio.
Assessment timing: At inception and on an ongoing basis, at minimum at each reporting date or on significant change in circumstances, whichever is earlier; The assessment is prospective, not a retrospective test of past results.

How to solve Qualifying Criteria and Hedge Effectiveness questions

Use this checklist for any case on qualifying criteria or effectiveness. Write the conclusion for each condition with the case fact that supports it.

1Identify the hedging instrument and the hedged item and the risk hedged. Confirm both are eligible under Ind AS 109.
2Check designation and documentation at inception: relationship, risk management objective and strategy, risk being hedged, and how effectiveness and the hedge ratio will be assessed.
3Test the economic relationship. Ask whether both items respond to the same risk and move in opposite directions. Use critical-terms match if terms are aligned.
4Test credit risk. Ask whether counterparty or own credit deterioration is large enough to dominate the value changes.
5Test the hedge ratio. Compare the designated ratio with the ratio actually used in risk management. Flag any deliberate imbalance.
6If the ratio is off but the objective is unchanged, state that the entity rebalances. If the objective has changed, state that hedge accounting is discontinued prospectively.
7Conclude clearly: hedge accounting applies from the date all criteria are met, or does not apply, and state the resulting accounting in one line.

Quickest way: Four-gate check

When to use it: Use it in 3-4 mark case MCQs or short written parts when you must decide quickly whether hedge accounting is permitted.

Gate 1: Was the hedge designated and documented at inception? If no, stop: no hedge accounting.
Gate 2: Do the instrument and item share the same risk and offset? If no, stop.
Gate 3: Is credit risk dominating? If yes, stop.
Gate 4: Does the hedge ratio match actual risk management? If not, rebalance when the objective is unchanged, or discontinue when it has changed.
Write the answer as provision, fact, conclusion.

Common mistakes in Qualifying Criteria and Hedge Effectiveness

Quoting the 80-125% effectiveness test as the Ind AS 109 requirement.
Old IAS 39 notes and AS-based coaching material still circulate.
Fix: State that Ind AS 109 has no bright-line threshold. It requires economic relationship, credit risk and hedge ratio, assessed prospectively.
Applying hedge accounting from the date the documentation is prepared late and treating earlier periods as hedged.
Students focus on the economics and forget that documentation must exist at inception.
Fix: The relationship is designated, and hedge accounting begins, only when the criteria, including documentation, are met. It is not retrospective.
Treating a change in hedge ratio as discontinuation.
Students confuse rebalancing with termination of the relationship.
Fix: If the risk management objective is unchanged, rebalance. Discontinue only if the objective changes or the criteria cannot be restored.
Ignoring credit risk because the derivative is with a bank.
Credit risk seems irrelevant when the counterparty is strong.
Fix: Still state the test. Say credit risk does not dominate unless the facts show serious deterioration of either party.
Designating a hedge ratio different from the actual quantities hedged to reduce volatility or get a better accounting result.
Students think the ratio is a free accounting choice.
Fix: The designated ratio must reflect the ratio actually used for risk management. An intentional imbalance that conflicts with the purpose of hedge accounting is not allowed.
Saying effectiveness is tested only at inception.
The word 'inception' dominates documentation rules.
Fix: State that the assessment is made at inception and on an ongoing basis, at a minimum at each reporting date or on a significant change in circumstances.

Worked examples

Example 1

Alpha Ltd, an Ind AS company, expects to import machinery in 6 months for USD 1,00,000 and enters a 6-month forward contract to buy USD 1,00,000. The treasury team prepares the hedge documentation and designates the relationship only after 2 months, recording the objective, instrument, item and risk. The critical terms match and the bank is of high credit quality. From which date can Alpha apply hedge accounting?

Show the solution

Provision: Hedge accounting needs formal designation and documentation at inception of the hedging relationship, along with meeting the effectiveness requirements.
Economic relationship: the forward and the forecast payment share the same currency risk and offset, as the amounts and timing match.
Credit risk: the counterparty is a high-quality bank, so credit risk does not dominate.
Hedge ratio: USD 1,00,000 forward against USD 1,00,000 exposure gives 1:1, which equals the actual risk management ratio.
Documentation: the forward was already in place, but the relationship was designated and documented only after 2 months. The criteria were therefore not all met from the date the forward was entered into.
Conclusion: the hedging relationship is designated, and hedge accounting begins, on the later documentation date. The forward will usually have a non-zero fair value on that date, which is a possible source of ineffectiveness. Gains or losses on the forward in the first 2 months remain in profit or loss.

Answer: Alpha can apply hedge accounting only prospectively from the date the relationship was designated and documented (after 2 months). For the first 2 months the forward is measured at fair value through profit or loss and those gains or losses stay there. Its fair value at the designation date is a possible source of ineffectiveness.

Example 2

Beta Ltd forecasts 1,000 tonnes of copper purchases. Its documented risk management objective is to hedge 800 tonnes of those purchases, and it holds copper futures for 800 tonnes. To make the hedge look complete, it designates the hedged item as 1,000 tonnes of purchases against the 800 tonnes of futures. Later, with the objective unchanged (hedge 800 tonnes of purchases), the relationship between the futures price and its purchase price shifts, so 800 tonnes of purchases now need only 720 tonnes of futures. Comment on both situations.

Show the solution

Situation 1: the ratio actually used in risk management is 800 tonnes of futures ÷ 800 tonnes of purchases = 1:1. The designation of 800 ÷ 1,000 = 0.8 does not match it, because it covers 200 tonnes that are not actually hedged.
Provision: the designated hedge ratio must equal the ratio actually used for risk management of the quantity hedged. It must not be set to create an accounting outcome inconsistent with hedge accounting.
Conclusion for Situation 1: the designation as drafted (1,000 tonnes of purchases against 800 tonnes of futures) is not permitted. Beta must correct it so that the designated hedged quantity reflects the 800 tonnes actually hedged, that is, 800 tonnes of purchases against 800 tonnes of futures. The corrected relationship can then be tested against the other criteria.
Situation 2: the objective is unchanged, but the relationship has changed so the ratio no longer meets the requirement. The required ratio is now 720 ÷ 800 = 0.9 futures tonnes per tonne of purchases.
Provision: the entity rebalances by adjusting the designated quantities of the hedged item or the hedging instrument, so the relationship continues.
Conclusion for Situation 2: Beta rebalances to the 0.9 ratio, for example by designating 720 tonnes of futures against 800 tonnes of purchases. Discontinuation is not required, since the objective is unchanged.

Answer: In Situation 1, the designation as drafted is not permitted, because the 0.8 ratio does not reflect the 1:1 ratio used in risk management. Beta must correct it to 800 tonnes of purchases against 800 tonnes of futures. In Situation 2, Beta rebalances to a ratio of 0.9 (720 tonnes of futures against 800 tonnes of purchases) and continues hedge accounting, as the risk management objective has not changed.

Exam tips

For case MCQs, look for the one fact that breaks a criterion: late documentation, mismatched quantities, or a changed objective.
Never write 80-125% as the Ind AS 109 test. Examiners reward the three-part effectiveness requirement.
Always separate rebalancing from discontinuation in your answer. The test is whether the risk management objective has changed.
Write answers as provision, fact, conclusion. Use the case numbers in the fact line.
Mention that hedge accounting is prospective and optional. This short line often earns a mark.

Practice questions from Hedge Accounting

Qualifying Criteria and Hedge Effectiveness: frequently asked questions

What are the hedge effectiveness requirements under Ind AS 109?

There are three: an economic relationship between the hedged item and the hedging instrument, credit risk not dominating the value changes, and a hedge ratio that matches the ratio actually used in risk management. These are assessed prospectively, at inception and on an ongoing basis.

What must hedge documentation contain?

It must identify the hedging instrument, the hedged item, the nature of the risk hedged, and the risk management objective and strategy. It must also state how effectiveness will be assessed, including the sources of ineffectiveness and how the hedge ratio is determined. It must be in place at inception.

How do I assess the economic relationship?

Check whether both items respond to the same risk and move in opposite directions. If critical terms such as amount, currency and maturity match, a qualitative assessment is usually enough. Otherwise a quantitative method such as regression can be used.

What is rebalancing of a hedge ratio?

Rebalancing means adjusting the quantities of the hedged item or hedging instrument to restore a compliant hedge ratio. It applies when the risk management objective is unchanged. The hedging relationship continues, and it is not a discontinuation.