Hedge Accounting - Ind AS - Indian Accounting Standards - Companies Law

Hedge Accounting [Chapter 6, Ind AS 109] Meaning - Hedging is a risk management strategy used in limiting or offsetting the probability of loss from fluctuations in the prices of commodities, currencies or securities. Objective - The objective of hedge accounting is to represent, in the financial statements, the effect of an entity's risk management activities that use financial instruments to manage exposures arising from particular risks that could affect profit or loss (or other comprehensive income, in the case of investments in equity instruments for which an entity has elected to present changes in fair value in other comprehensive income). If there is an expected loss from one asset that will be compensated by the hedging instrument; In such case, there may be loss from hedged item which is transferred to OCI and whereas gain from the hedging instrument (call option) is transferred to P L. This accounting leads to mismatches. To avoid this accounting mismatch an entity can, follow hedge accounting. Identification of a Hedged Item A hedged item can be a recognised asset or liability , an unrecognised firm commitment , a forecast transaction or a net investment in a foreign operation . The hedged item can be: a single item; or a group of items. A hedged item can also be a component of such an item or group of items The hedged item must be reliably measurable. If a hedged item is a forecast transaction (or a component thereof), that transaction must be highly probable. An aggregated exposure that is a combination of an exposure that could qualify as a hedged item and a derivative may be designated as a hedged item. This includes a forecast transaction of an aggregated exposure (ie uncommitted but anticipated future transactions that would give rise to an exposure and a derivative) if that aggregated exposure is highly probable and, once it has occurred and is therefore no longer forecast, is eligible as a hedged item. For hedge accounting purposes, only assets, liabilities, firm commitments or highly probable forecast transactions with a party external to the reporting entity can be designated as hedged items. Hedge accounting can be applied to transactions between entities in the same group only in the individual or separate financial statements of those entities and not in the consolidated financial statements of the group, except for the consolidated financial statements of an investment entity, as defined in Ind AS110, where transactions between an investment entity and its subsidiaries measured at fair value through profit or loss will not be eliminated in the consolidated financial statements. Accounting for different types of hedge Fair Value Hedge In this risk being hedged in this type of hedge is a change in fair value of recognized asset or liability or an unrecognized firm commitment (or a component thereof), that is attributable to a particular risk and would affect profit or loss (or, for equity investments accounted for at FVTOCI, could affect OCI). In this hedging is done to protect the fair value of an item. Hedged item is accounted as per respective Ind AS but only fair value Gain/Loss on such hedged item will be recorded through P L. Hedging Instrument is accounted as per derivative contract accounting. Cash Flow Hedge - The risk being hedged is exposure to variability in cash flows attributable to a particular risk associated with all, or a component of, a recognized asset or liability or a highly probable forecast transaction and that could affect profit or loss. In this, hedging is done to protect future cash flows. E.g. Hedging through future contract for receipt in foreign currency of sale of goods on future date. Hedged Item is accounted as per respective Ind AS. Hedging Instrument (e.g. future contract) is accounted as per derivative contract accounting but the fair value Gain/Loss at each balance sheet date will be recorded through Cash Flow Hedge Reserve (OCI) Instead of P L, and later when hedged item recorded in books it will be reclassified to P L. Hedge of a net investment in a foreign operation as defined in Ind AS 21 A net investment in a foreign operation is an eligible hedged item. Such foreign operations might be subsidiaries, associates, joint ventures or branches. An entity might decide to hedge against the effects of changes in exchange rates on its net investment in a foreign operations. In this, Hedging is done to protect receipt in foreign currency of sale of foreign operations by entity. The hedge is accounted for similarly to a cash flow hedge.