What Is Hedge Accounting?
Hedging accounting is an accounting practice. Many financial institutions and companies (entities) use derivative financial instruments to hedge different risks (such as interest rate risk, foreign exchange risk, commodity risk, etc.).
Hedge accounting
- Chinese name
- Hedge accounting
- Foreign name
- Hedge accounting
- Hedging accounting is an accounting practice. Many financial institutions and companies (entities) use derivative financial instruments to hedge different risks (such as interest rate risk, foreign exchange risk, commodity risk, etc.).
- Through hedging accounting, the accounting recognition of gains and losses of financial market hedging is deferred until the corresponding gains and losses of underlying risk exposures are recognized. Because this approach enables companies to factor the cost of hedging into the cost basis of exposures, companies generally prefer to use it. This method matches the gain and loss write-offs, thereby reducing the volatility of profits and meeting the purpose of hedging.
- Certain types of entities that hedge transactions can engage in objectives to manage foreign exchange risk. These hedgers assume the economic purpose of reducing the potential loss of foreign exchange rate fluctuations. However, not all hedges are designated as special accounting treatment. Accounting standards allow three different designated foreign exchange hedgings for hedge accounting:
- Cash flow packages can be designated as expected transactions that are likely to occur, the company promises (not recorded in the balance sheet), confirmed assets or liabilities, or forecast foreign currency cash flows for intercompany transactions.
- Fair value hedging can be designated as a confirmed commitment (unrecorded) or a foreign currency cash flow for a recognized asset or liability.
- Net investment hedges can be designated as net investments for overseas operations.
- The purpose of hedge accounting is to provide an offset to the market, a movement derived in the income statement. For fair value hedging, this is achieved both by marking the asset entering the market or by offsetting the liability's profit and loss movement. For some cash flow hedging, some derivatives fluctuate into the cash flow hedging reserve of an independent component of the so-called physical equity.
- Where hedging relationships are valid (to meet the 80% -125% rule), most of the fluctuations in the derivatives market will be offset in the profit and loss account.
- In order to achieve hedging accounting, a large number of records are required, and the hedging relationships involved, both forward-looking and retrospective, prove that hedging relationships are effective compliance work.