Hedging(Hedge Accounting)Ind AS-39

Hedging

A process to reduce risk to a low level. It can be done by many methods

Forward contracts Money Market Operation Option contract Future contract Interest rate swaps

Why hedging is required

Where ever any risk of loss is involved. Example if we have to pay 100000 USD 3

months from now and the market is bullish then we are required to hedge our forex exposure.

Example of risk in forex

Indian Entity

Foreign Entity

Provide services

Receive payment

Invoice currency any foreign

currency

Risk of falling of foreign

currency

Example of hedging- Money Market Operation

Indian BankForeign Bank

Foreign EntityIndian Entity

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4

1Billing amounting to $100000

Borrow amount equivalent amount

Repay the borrowing

Convert at spot rate

Risk management strategies

objective strategiesMaintain the 50% debt at floating rate

Designate the interest rate swap for the 50% loan

Hedge currency risk up 80 % of sale

Designate the forward contract for the expected amount

eligible hedged item

recognized asset or liability

unrecognized firm

commitment

highly probable forecast

transaction

net investment in a foreign operation

These should be with anexternal party

Hedge effectiveness test

regression analysis critical terms comparison dollar offset method

Hedge Accounting

Based on matching concept. Hedge accounting modifies the usual accounting treatment of a hedging instrument

and/or a hedged item to enable gains and losses on the hedging instrument to be recognized in the income statement in the same period as offsetting losses and gains on the hedged item

Hedge accounting allows entities to override the normal accounting treatment for derivatives (fair value through profit or loss) or to adjust the carrying value of assets and liabilities.

Derivatives are commonly used to hedge recognized assets and liabilities that are measured at cost, amortized cost or at fair value with gains and losses recognized in equity or items such as forecast transactions or firm commitments that are not recognized in the balance sheet.

This creates a mismatch in the timing of gain and loss recognition. Hedge accounting seeks to correct this mismatch by changing the timing of

recognition of gains and losses on either the hedged item or the hedging instrument.

Fair value hedges

Acquired for the purpose of hedging the fair value of an asset or liability.

An example of a fair value hedge is a fixed-rate loan whose interest rate exposure is converted to floating rates with an interest-rate swap

The hedged asset or liability is adjusted for fair value changes attributable to the risk being hedged, and those fair value changes are recognized in the income statement. The hedging instrument is measured at fair value with changes in fair value also recognized in the income statement.

Cash Flow Hedge

The risk being hedged in a cash flow hedge is the exposure to variability in cash flows that:

is attributable to a particular risk associated with a recognized asset or liability, an unrecognized firm commitment (currency risk only), or a highly probable forecast transaction, and

could affect the income statement. example of cash flow hedge is forward foreign exchange contract hedging forecast future

sales of inventory in foreign currency If the hedge is effective, changes in the fair value of the hedging instrument are initially

recognized in a ‘hedging reserve’ in equity. They are transferred to the income statement when the hedged transaction affects profit or loss.

If a hedged forecast transaction (such as a hedged future purchase of inventory or equipment) results in the recognition of a non-financial asset or liability, the entity has a choice. It can either:

Adjust the carrying amount of the asset or liability by the hedging gain or loss previously deferred in equity (sometimes referred to as ‘basis adjustment’). The hedging gain or loss is automatically recycled to the income statement when the hedged asset or liability is depreciated, impaired or sold; or

Leave the hedging gain or loss in equity and transfer it to the income statement when the hedged asset or liability affects profit and loss.

Hedges of net investment in a foreign operation

An entity may have overseas subsidiaries, associates, joint ventures or branches

It may hedge the currency risk associated with the translation of the net assets of these foreign operations into the group’s presentation currency.

The foreign currency gains or losses on the hedging instrument are deferred in equity, to the extent the hedge is effective, until the subsidiary is disposed of or liquidated, when they become part of the gain or loss on disposal.

Discontinuing hedge accounting

Hedge accounting ceases prospectively when any of the following occurs:› a hedge fails an effectiveness test;› the hedged item is sold or settled;› the hedging instrument is sold, terminated or

exercised;› management decides to revoke the designation; or› for a hedge of a forecast transaction, the forecast

transaction is no longer highly probable.

ThanksCA Mohit Goyal

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