INTERMEDIATE ACCOUNTING
TENTH CANADIAN EDITION
Kieso • Weygandt • Warfield • Young • Wiecek • McConomy
CHAPTER 16
Appendix 16A
Hedging
PREPARED BY:
Lisa Harvey, CPA, CA
Rotman School of Management,
University of Toronto
1
Derivatives Used For Hedging
• Organizations face economic and financial
risks
• Hedging is the use of derivatives to hedge
these risks
• Hedging has value because it generally
reduces uncertainty/risk and therefore
volatility
• Must separate the act of hedging (to reduce
economic and financial risks) from the
accounting
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2
Need for Hedge Accounting
Standards
• If symmetry in accounting exists, the
gains/losses created by hedging offset in the
same period
– In this situation, there is no need for special
hedge accounting
• If there is no symmetry in accounting, the
gains/losses created by hedging do not offset
in same period –
– In this situation, companies may choose to apply
hedge accounting so that the gains/losses do
offset
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3
Hedge Accounting
Optional hedge accounting may be available when the
following are met:
1. When the hedge is entered into
• Identify the exposure
• Designate that hedge accounting applied
• Document risk management objectives and strategies
2. Reasonable assurance should exist that the firms’
risk management policy is being maintained
• Hedge effectiveness can be reliably measured
• Hedging relationship is reassessed at regular intervals
• If involves forecasted transactions, probable that
transactions will occur
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4
Hedge Accounting
• Under IFRS, two types of hedges
identified for hedge accounting – fair
value and cash flow hedges
• Under ASPE, only certain transactions
qualify for optional hedge accounting
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5
Hedge Accounting
• Fair Value Hedge
– To offset exposure to fair value changes of
recognized asset or liability
– Under IFRS, hedged item valued at fair value and
gains/losses booked to net income
• Cash Flow Hedge
– Offset risks of future cash flow variability
– Under IFRS, gains/losses on hedging item
reported as part of Other Comprehensive Income
– Under ASPE, not recognized until the transaction
is settled
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6
Fair Value Hedge - Example
• Investment purchased at a cost of $1,000
(designated as FV-OCI under IFRS but is FVNI under ASPE due to an active market):
FV-OCI Investment (IFRS)
FV-NI Investments (ASPE)
Cash
1,000
1,000
1,000
• Option contract to sell shares at $1,000
purchased for $10
Derivatives-Financial Assets/Liabilities
Cash
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10
10
7
Fair Value Hedge - Example
• At year end, assume investment value is
$1,050:
FV-OCI Investment (IFRS)
FV-NI Investments (ASPE)
Unrealized Gain or Loss
50
50
50
Unrealized Gain/Loss
50
Derivatives-Financial Assets/Liabilities 50
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8
Put Option as a Fair Value Hedge
• Under hedge accounting, the gain on the hedged
item and the loss on the underlying derivative are
booked through net income
• The gain is thus offset by the loss on the derivative
• Under IFRS, hedge accounting allows for a
modifying of the way we normally account for a
FV-OCI investment
• Under ASPE, the accounting is symmetrical and
thus the impact is the same despite the fact that
this type of transaction does not quality for hedge
accounting
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9
Cash Flow Hedge – Example
Given:
Jones Corp enters into a 5-year interest rate
swap with B
Terms are:
• Principal sum involved is $1 million
• Jones will make payments at the fixed rate
of 8%
• Jones will receive payments at variable or
floating rates
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Cash Flow Hedge – Example
Cash Interest Rate Swap– Example
A pays B at a fixed (or floating) rate
Party A
Financial
Intermediary
Party B
B pays A using the opposite rate of A
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11
Cash Flow Hedge – Example
• Value of the swap determined at the end of
each year
– Function of the difference between the fixed
(contract) rate and the prevailing rate of interest
• Value of the swap contract reported on the
Statement of Financial Position using
discounted cash flow model
• Under IFRS, any gain on the hedging item is
reported as part of Comprehensive Income
• Under ASPE, the swap contract is not
recognized until it is settled
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Ltd.
12
Forward Contract as a Cash Flow
Hedge
• Forward contracts may be used to hedge
anticipated future transactions (and the
associated cash flow risks) i.e. a purchase
commitment
• Gives the holder the right to purchase at a
preset price
• Under IFRS, recorded in Other
Comprehensive Income
• Under ASPE, not recognized until settled
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Ltd.
13
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