What Is Hedge Accounting?

Hedge accounting is an optional treatment under IFRS 9 that matches the timing of the gain or loss on a hedging instrument with the timing of the loss or gain on the item being hedged. Without it, a derivative used to manage risk could create artificial volatility in profit or loss.

Why do companies want it?

A derivative is normally measured at fair value through profit or loss. If the hedged item is not, the two move through the accounts at different times, making the results look more volatile than the economic reality. Hedge accounting corrects that mismatch — but only if strict criteria are met.

The three hedge types under IFRS 9

• Fair value hedge — the gain or loss on both the instrument and the hedged item goes to profit or loss, offsetting each other.
• Cash flow hedge — the effective portion of the gain or loss goes to other comprehensive income and is recycled when the hedged cash flow affects profit or loss.
• Net investment hedge — treated like a cash flow hedge, for a foreign operation.

The qualifying conditions

To apply hedge accounting you need a formally documented hedging relationship at inception, an eligible hedged item and instrument, and an economic relationship between them (the effectiveness requirement). Miss the documentation and you lose the treatment.

In SBR, hedge accounting questions reward candidates who state the type, justify the criteria and apply the correct routing of gains and losses to the scenario. Marking a full answer against the official ACCA scheme with The 50% Club shows you exactly where those application marks are won or lost.