Accounting for a cash flow hedge

Accounting for a cash flow hedge

How would you account for a cash flow hedge?

  1. Get the lower of the cumulative fair value changes to the hedging instrument and the fair value of the hedged item, viz, the present value of expected cash flows.
  2. The amount calculated in step 1 above is taken to ‘Cash Flow Hedge Reserve’.
  3. The difference between the fair value changes to the hedging instrument and the amount taken to Cash Flow Hedge Reserve is taken to the profit and loss account.
  4. Where the hedged item ultimately results in a non-financial asset or a non-financial liability, the balance in the cash flow hedge reserve is adjusted with the carrying value of such item known as ‘Basis Adjustment’.
  5. Where the hedged item ultimately results in actual sales, the balance in the cash flow hedge reserve is reclassified to profit and loss account as ‘Reclassification Adjustment’ during the same period as the hedged item affects the profit and loss account.
  6. Where the hedged item is a financial instrument impacting future cash flows in the form of interest, the balance in the cash flow hedge reserve is reclassified to profit and loss account as ‘Reclassification Adjustment’ during the same period as the hedged item affects the profit and loss account.
  7. If cash flow hedge reserve shows a debit balance and if the loss is not expected to be covered in future cash flows, then to that extent it is immediately taken to the profit and loss account
    1. If the hedged item is an unrecognised firm commitment the cumulative fair value changes of the hedged item is recognised as an asset or a liability. Subsequently this amount gets adjusted with the carrying amount of the asset or liability that ultimately results.

If the hedged item is an existing asset or a liability, then the carrying amount of the hedged item is adjusted for the fair value changes of that instrument. Subsequently this amount is effectively amortised based on the effective interest rate computed after the hedge accounting is discontinued.

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