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cannot be voluntarily discontinued unless the risk management objective of entering into the particular hedge is no longer valid or relevant.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.

Accounting for a fair value hedge

Accounting for a fair value hedge How do you account for a fair value hedge? A fair value hedge is accounted for as follows: The gain or loss on the hedging instrument is recognised in profit or loss. If the hedging instrument hedges an equity instrument classified as FVOCI, then it is recognised …
Read More

Time value of forward points in hedge accounting

Time value of forward points in hedge accounting How is the time value of forward points in a derivative contract treated in hedge accounting? An entity is allowed to designate only the change in the intrinsic value of an option contract in a hedging instrument. Similarly, an entity can also designate only …
Read More

Rebalancing to achieve hedge effectiveness

Rebalancing to achieve hedge effectiveness What do you mean by rebalancing and how does it help achieve hedge effectiveness? Rebalancing is a new concept introduced by a major amendment to IFRS 9 during November 2013. Rebalancing means adjustments made to the quantities of the hedged item or the hedging instrument of an …
Read More

Voluntary discontinuation of hedge accounting

Voluntary discontinuation of hedge accounting Can a hedge accounting be voluntarily discontinued and why? As per the new requirements, hedge accounting cannot be voluntarily discontinued. Hedge accounting can be discontinued only if the hedge effectiveness requirements are not met or that the hedging instrument is liquidated. Even when the hedge effectiveness requirements …
Read More

Cash flow hedge Vs fair value hedge

Cash flow hedge Vs fair value hedge What is a cash flow hedge and how is it different from a fair value hedge? A cash flow hedge is a hedge of the exposure to variability in cash flows attributable to a particular risk associated with a recognised asset or liability or a …
Read More

Is hedge accounting mandatory?

Is hedge accounting mandatory? Is hedge accounting mandatory or optional? Hedge accounting is not mandatory. However, considering the benefits of complying with hedge accounting, entities would want to follow hedge accounting when they are in a position to comply with the requirements for hedge accounting. The biggest benefit of hedge accounting …
Read More

Accounting for a cash flow hedge

Accounting for a cash flow hedge How would you account for a cash flow hedge? 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.The amount calculated in step 1 above is taken …
Read More

Reasons for revamping hedge accounting by IASB

Reasons for revamping hedge accounting by IASB What prompted the hedge accounting standard to be revamped by IASB? The main reason for revamping the accounting standards relating to financial instruments by the IASB is the direct outcome of the shock that sent shivers through the spine of several conglomerates as a …
Read More

Rebalancing and discontinuation of cash flow hedge

Rebalancing and discontinuation of cash flow hedge Briefly explain rebalancing and discontinuation of cash flow hedge. If the hedge effectiveness requirements are not met, the entity should adjust the hedge ratio by a process known as ‘rebalancing’ so long as the hedging relationship continues to meet the risk management objective of undertaking …
Read More

Difference between hedging and speculation

Difference between hedging and speculation What is the basic difference between hedging and speculation? If an investor takes a derivative position by holding the corresponding underlying, it is called hedging. The derivative position should be in the opposite direction of the underlying position, eg, if a person holds 100 shares of …
Read More

Difference between speculation and gambling

Difference between speculation and gambling Is there any difference between speculation and gambling? Both speculation and gambling involves taking a position in the derivative segment without having any corresponding underlying. In the case of speculation, the open interest does not exceed the sum total of the underlying outstanding. However, in the …
Read More

Risk management objective & risk management strategy

Risk management objective & risk management strategy Explain the relationship between risk management objective and risk management strategy of an entity. The risk management strategy of an entity should be distinguished from its risk management objective. The risk management strategy is established at the highest level at which an entity determines how …
Read More

Can hedging instrument be a non-derivative

Can hedging instrument be a non-derivative A hedging instrument should necessarily be a derivative. Do you agree? Hedging instrument need not necessarily be a derivative instrument even though mostly derivative instruments are used as hedging instruments. The key feature of a derivative instrument should be that it should help minimise the risk …
Read More

Written options as a hedging instrument

Written options as a hedging instrument Why a written option cannot be used as a hedging instrument? The objective of hedging is to minimise the risk and/or to protect the unrealised profits. A hedging instrument should typically restrict the exposure to loses while at the same time provide scope for unlimited …
Read More

Interest rate swap as a hedging instrument

Interest rate swap as a hedging instrument An interest rate swap is usually designated as a hedging instrument in spite of the fact that the fair value of an interest rate swap oscillates between positive and negative fair values. Explain the anomaly. At the outset, it may seem rather strange that an …
Read More

Hedge ratio in hedge accounting requirements

Hedge ratio in hedge accounting requirements What is meant by hedge ratio and how it is helpful in meeting the hedge accounting requirements? Hedge ratio refers to the number of units that are used as hedging instrument for the purpose of hedging a hedged item. Usually, the ratio is 1:1 for most …
Read More

Existing asset or liability as a hedged item

Existing asset or liability as a hedged item Only an existing asset or liability can be designated as a hedged item in a fair value hedge. Do you agree? This statement is not correct, as the hedged item in a fair value hedge can be in addition to the above an unrecognised …
Read More

Subscribe to our News Letter

Get periodical updates from us

Subscribe to our News Letter

I hope you enjoy reading this blog