In hedge accounting, the fair value of derivative entries are adjusted and includes the value of opposing hedge for security (or) hedge accounting modifies the standard method of recognition of gains/losses on security and hedging instruments used to hedge position.
In the same accounting period Position being hedged and the hedge are recorded. Sometimes these may differ from other accounts (those wont record hedges). Hedge accounting is mainly used by companies which affect their balance sheet due to significant market risk (interest rate, stock market, foreign exchange risks).
Value hedging instruments change according to market movements which can affect income statements and earnings.
According to IAS 39, derivatives are recorded on mark to market basis which means it records when profit is taken and when loss is taken on derivative. If the same derivative is used as a hedging tool and treated the same under IAS 39. Sometimes it may have volatility and losses.
The qualifying criteria for hedge accounting under the Indian accounting standards 39 (IAS-39) are as follows−
Accepted classification and reporting of
Hedging relationship consists of both eligible hedging instruments and eligible hedged items.
Requirements for effectiveness of hedge are as follows−
Hedge accounting can be voluntarily discontinued.
If a company holds one marketable security position which is a long position in S&P 500 index worth of $6 million. Now the company decides to hedge his position by buying a put option position on S&P 500 worth $2 million and long the 40 year US. Treasury for a position worth of $4 million.
Journal entry for marketable security entry would include only hedging done through derivative instruments. In the above example hedge is done through a long put option on S&P 500. Hedge uses the 40 year US. The Treasury will not receive hedge accounting under IAS 39 because it is not a derivative position.
It includes a $6 million long position in S&P 500 and $2million long position long put option on S&P 500. The final value of $8 million is valued at journal entry.