Lesson 17 - Advanced Accounting Course

17. Hedge Accounting under IFRS 9

🔍 What is Hedge Accounting?

Hedge accounting is an accounting method that aligns the accounting treatment of a hedging instrument (like a derivative) with the item it is hedging (like a loan or a forecasted sale).

Its goal is to reduce volatility in profit or loss caused by fluctuations in the value of derivatives, and to reflect the economic reality of risk management strategies.

🔁 Why Is It Important?

Let’s say a company uses a derivative to protect itself from currency risk. Without hedge accounting, the gains/losses from the derivative would appear immediately in the income statement — but the loss/gain from the hedged item might come later. This causes timing mismatches that don't reflect the real economics.

Hedge accounting fixes this by matching the timing of gains and losses.

🔄 Types of Hedges Under IFRS 9

IFRS 9 allows for three types of hedging relationships:

1. ✅ Fair Value Hedge

Used to hedge exposure to changes in fair value of an asset or liability (e.g., a fixed-rate loan).

• Example: A company issues fixed-rate debt and uses an interest rate swap to hedge changes in value due to interest rate fluctuations.
  
  

• Accounting: Gains/losses on both the hedging instrument and the hedged item go to the profit or loss.
  
  

2. ✅ Cash Flow Hedge

Used to hedge future cash flows that are uncertain (e.g., forecasted purchases or variable interest payments).

• Example: A company expects to buy raw materials in USD and uses a forward contract to fix the price.
  
  

• Accounting:
  
  

  • The effective portion of the hedge goes to OCI (Other Comprehensive Income) and is later reclassified to profit/loss when the transaction occurs.
    
    

  • The ineffective portion (if any) goes to profit or loss immediately.
    
    

3. ✅ Net Investment Hedge

Used to hedge the currency risk of investments in foreign operations.

• Example: A European company owns a subsidiary in the US and uses a derivative to hedge exchange rate risk.
  
  

• Accounting: The effective portion of the hedge goes to OCI and is recycled to profit or loss on disposal of the foreign operation.
  
  

🧠 Hedge Effectiveness Under IFRS 9

Unlike the old IAS 39, IFRS 9 makes hedge accounting easier and more aligned with risk management.

Key improvements:

• No need for strict 80–125% effectiveness range.
  
  

• Focus is on economic relationship between hedge and hedged item.
  
  

• The hedge should reduce risk, not be perfect.
  
  

📋 Documentation Requirements

Before applying hedge accounting, a company must document:

1. The hedging relationship.
   
   

2. The risk management objective.
   
   

3. The strategy for the hedge.
   
   

4. How hedge effectiveness will be assessed.
   
   

✅ Benefits of IFRS 9 Hedge Accounting

• Better reflects real-world risk management
  
  

• More flexible rules than IAS 39
  
  

• Reduces unwanted volatility in profit/loss
  
  

• Provides more useful information to investors
  
  

⚠️ Challenges

• Requires good internal systems
  
  

• Complex for large businesses with multiple hedging strategies
  
  

• Need for ongoing monitoring and rebalancing of hedges
  
  

📝 Final Summary