What Is a Cash Flow Hedge?

Cash flow hedge is a hedge of cash liquidity risks, that is, avoiding future cash flow risks. Cash flow hedging refers to the hedging of the risk of changes in cash flows. Such changes in cash flows result from the recognition of assets or liabilities (such as all or part of future interest payments on floating rate debt), and expected transactions that may occur (Such as expected purchases or sales), and will affect the company's profit or loss.

Cash flow hedging

Bank A and Bank B conducted in February 2006

Differences in cash flow hedging

Comparison of fair value hedging and cash flow hedging

Different cash flow hedging economy

(1) The economic nature of the risks avoided by the two is different. Fair value hedging is the hedging of the fair value risk of recognized assets and liabilities, unrecognized confirmed commitments and identifiable parts of these asset and liability determination commitments, rather than hedging of cash flow risks, that is, fair value What hedging is price risk. Cash flow hedging is a hedge of cash liquidity risks, that is, avoiding future cash flow risks.

Different cash flow hedging applications

(B) The scope of application of the two is different. Fair value hedging is mainly applicable to hedging the risks of changes in fair value of existing assets and liabilities and identifiable parts of existing assets and liabilities. At the same time, the hedging to determine commitments also applies to fair value hedging. For example: US A company and UK B company signed an order contract. After 6 months, a special equipment was purchased from UK B company at a purchase price of 8,000. US A company will be affected by changes in exchange rates. Therefore, before the transaction is completed, its future sterling price may increase or decrease. Therefore, the US company A purchases the equivalent value of the pound that is settled after 6 months and determines the hedging commitment for this. The foreign currency determines the commitment hedging. It can be calculated using fair value hedge accounting. The cash flow hedge is mainly applicable to the hedging of expected transactions. For example: A company is expected to purchase fixed assets with a current price of USD 100,000 after 4 months. At the same time, in order to avoid future increases in fixed assets, a four-month forward contract to sell equivalent fixed assets is signed with a company B . Assuming that this forward contract has no costs incurred at the time of signing, the fixed asset price will increase by US $ 5,000 at the end of the year, and the forward contract will appreciate by US $ 6,000.

(3) The fair value hedging changed the accounting treatment of the hedged item, and the cash flow hedging changed the accounting treatment of the hedging instrument, so that the gains or losses of the hedging instrument and the hedged item were matched in the same period, reflecting that The actual offsetting result of the hedge accounting. Since hedging instruments are basically derivative financial instruments, they are generally classified as transactional financial assets. Therefore, the application of hedging accounting for fair value hedging does not actually change the accounting treatment of hedging instruments, but changes some Accounting for hedged items. When both the hedging instrument and the hedged item are measured at fair value, and the corresponding profits are included in the current profit and loss, hedging accounting is not required because the gains and losses have been matched in the same period. When the hedged item is measured at amortized cost or cost, or at a fair price but the gain or loss attributable to the hedged risk is not recognized or recognized in the owner's equity, the gain or loss of the hedging instrument or hedged item is not In the same period, the traditional accounting failed to reflect the offsetting result, so the hedged items (including inventories that are subsequently measured at the lower of cost and net realizable value), financial assets that are subsequently measured at amortized cost, or Gains or losses from the sale of financial assets due to hedged risks shall be included in the current profit and loss, and the principle of adjusting the book value of the hedged item shall be treated at the same time. The cash flow hedge accounting does not actually change the accounting treatment of the hedged item, but changes the accounting treatment of the hedging instrument. Because the gain or loss of the hedging instrument is not fully accounted into profit or loss in the current period, it is divided into the effective part and the invalid part and accounted for separately. When the hedged item affects the company's profit and loss in the same period, the owner's equity is transferred out and included in the current profit and loss, so that the gain or loss of the hedging instrument is consistent with the gain or loss of the hedged item at the recognition time to reflect The result of offsetting or hedging the cash flow hedge against profit or loss. However, when non-financial assets or non-financial liabilities are recognized after hedging of expected transactions, cash flow hedge accounting may indeed affect the book value of the liabilities or assets generated by the hedged project.

Cash flow hedge accounting is different

(4) The accounting of the two is different. Fair value hedging and cash flow hedging are companies' hedging of the risks of changes in future fair value and cash flow, respectively. The general accounting principles of the two are the same, that is, the profit or loss of the hedging instrument and the hedged item is recognized in the same accounting period to reflect the nature of the hedge accounting and reflect the hedging results and effectiveness of the hedge. However, there are differences between the two in terms of specific accounting treatments.

1. The accounting of hedging instruments is different. In fair value hedging, CAS24 believes that if the hedging instrument is a derivative instrument, the gain or loss resulting from the change in the fair value of the hedging instrument should be included in the current profit and loss; if the hedging instrument is a non-derivative instrument, the carrying value of the hedging instrument is due to the exchange rate Gains or losses arising from the changes shall be included in the current profit and loss. In other words, the hedging instrument under fair value hedging is measured on the basis of fair value, and the relevant profit or loss is recognized in the current profit and loss. In cash flow hedging, the gain or loss of the hedging instrument is an effective part and should be directly recognized as the owner's equity ( other comprehensive income ) and reflected in a separate item; the part of the invalid hedging (that is, after deducting the direct recognition as the owner's equity) Other gains or losses) shall be included in the current profit and loss. It can be seen that the treatment of gains or losses of hedging instruments is inconsistent: the gains or losses of hedging instruments under fair value hedging are not deferred; and the gains or losses of hedging instruments under cash flow hedging ( The effective part) is deferred and is included in the owner's equity and transferred to profit or loss.

2. The accounting of hedged items is different. Under fair value hedging, the gain or loss of the hedged item due to the hedging risk shall be included in the current profit and loss, and the book value of the hedged item shall be adjusted. In other words, the hedged item under fair value hedging needs to adjust its book value at fair value, and the relevant profit or loss is recognized in the current profit and loss. Cash flow hedging is mainly applicable to expected transactions. For hedged items that are expected to be traded and lead to the recognition of financial assets or financial liabilities, no basis adjustment is performed (for expected transaction hedging, the confirmed in the owner's equity The hedging gain or loss is recognized as part of the initial book value of the asset or liability when the expected transaction occurs, and is automatically recognized in profit or loss in subsequent periods through depreciation expenses, interest income or expenses, and cost of sales. Because the adjustment of the basis will cause the initial book value of the assets obtained by the expected transaction to depart from the fair value, and therefore ignore the initial fair value measurement requirements of financial instruments. The hedging of the expected transaction that leads to the subsequent confirmation of a financial asset or a financial liability allows the enterprise to choose whether to make a basis adjustment.

3 The boundaries between fair value hedging and cash flow hedging are not absolute, and the two can sometimes be converted. There is international controversy as to what kind of hedging is used to determine the commitment of foreign exchange risk hedging. SFASl33 treats it as a fair value hedging, while IAS39 and CAS24 both believe that the determined foreign exchange risk hedging can be treated as a fair value hedging or as a cash flow hedging. Because foreign exchange risk affects both the cash flow of the hedged item and the fair value of the hedged item.