Link between hedge accounting & risk management objective
What is the link between hedge accounting and the risk management objective of an entity?
The objective of hedge accounting is to manage the risk that an entity faces. In the context of hedge accounting, the entity manages effectively the risk by using the appropriate financial instruments thereby moderating or reducing the impact of the same in the profit and loss account. In order to comply with hedge accounting, the basic criterion is that the hedging activity should conform to the risk management strategy of the enterprise. The risk management strategy of an enterprise is effectively achieved through multiple risk management objectives involving different types of financial instruments so as to manage exposures arising from different types of risks that affect the profit and loss account.
Hedge accounting is optional. However, once an entity applies hedge accounting for any relationship, then hedge accounting cannot be voluntarily discontinued unless the risk management objective of entering into the particular hedge is no longer valid or relevant. While the objectives of hedging can be said to be protecting the profit from undue fluctuations (minimising risk) one can say that the objective of hedge accounting is to protect the profit or loss account from unintended fluctuations in the profit or loss account.