Write the accounting entries for cash flow hedge

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Cash flow risk is defined as the variability of cash flows for an existing asset or liability of future transactions due to particular risk. Cash flow hedges protect margins, revenues and expenses of companies from foreign exchange risk

Facts to know about cash flow hedges are as follows −

  • To receive special accounting treatment, hedged exposures must meet specific guidelines.
  • Exposure Timing and probability are very important.
  • Birth of cash flow exposure.
  • Reduces derivative trading volume for exposure maturity of hedging cash flows.

Account for cash flow hedge

  • Step 1 − At reporting date gain or loss on hedging instrument and hedged item is determined.
  • Step 2 − Both effective and ineffective portions of gain or loss on the hedging instrument are calculated.
  • Step 3 − Effective portion of gain or loss on hedging instrument is recognized in OCI (Other comprehensive income) and called as cash flow hedge reserve in OCI
  • Step 4 − Ineffective portion of gain or loss on hedging instrument is recognized in profit/loss.
  • Step 5 − If necessary, deal with cash flow hedge.

The accounting entries for cash flow hedge are explained below −

ParticularsDebitCredit
If there is any loss (effective portion)
In other comprehensive income, cash flow hedge reserve.
In the balance sheet, financial liabilities from hedging instruments.
If there is any loss (ineffective portion)
In profit and loss account, infective portion loss on hedging instruments.
In the balance sheet, financial liabilities from hedging instruments.
If there is any gain (effective portion)
In the balance sheet, financial assets from hedging instruments.
In other comprehensive income, cash flow hedge reserve.
If there is any gain (ineffective portion)
In the balance sheet, financial assets from hedging instruments.
In profit and loss account, ineffective portion of gain on hedging instrument.

Differences

  • Hedged items are key differences between cash flow hedge and fair value hedge.
  • In cash flow hedge, changes in cash inflows and inflows of asset/liabilities are hedged whereas fair value hedge helps in mitigating the exposure to change in value of assets/liabilities.
  • Cash flow hedges are suitable for variable rates and fair value hedges are suitable for fixed rates.
raja
Published on 05-Jul-2021 13:34:12
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