Intermediate

13 Accounting
Canadian Edition, Volume 2
th

Kieso ● Weygandt ● Warfield ● Wiecek ● McConomy

Chapter 16 Appendix A
Hedging

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Chapter 16A: Hedging
After studying this appendix, you should be able to:
5. Understand how derivatives are used in hedging and
explain how to apply hedge accounting standards.

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Derivatives Used For Hedging
• Organizations face economic and financial risks
• Hedging is the use of derivatives to manage risks
o Hedged item: need for hedging based on the risk the
company is exposed to
o Hedging item: derivative to reduce risk
• Perfectly hedged position, economic gain/loss on the
hedging item and the hedged item should be equal and
offsetting.
• Gains and losses may arise on the hedged and hedging
items separately
• But they should offset in the end
• Normal accounting with hedging activity may not show
the offset transparently
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Need for Hedging Accounting Standards
Why doesn’t normal accounting always work for hedging?
• The mixed measurement model for IFRS and ASPE
(choices include fair value, amortized cost, cost)
• Under IFRS, sometimes gains and losses can be booked to
income, and sometimes to OCI
• Existing practice of not recognizing hedging future
transactions on the SFP

Result? No symmetry.
Sometimes gains and losses from the hedged and hedging
items are not booked through the same account and don’t
offset; or are not booked at all
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Five Steps to Determine Whether to
Use Hedge Accounting
1. Identify the hedged item—which risk is being hedged?
2. Identify the hedging item—usually a derivative
instrument
3. Identify how the hedged item is being accounted for
without hedge accounting
4. Identify how the hedging item would be accounted for
without hedge accounting
5. Locate where the recognized gains and losses for the
hedged and hedging items are recognized—net income,
OCI, or perhaps not at all

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Symmetry in Accounting—No Need for
Special Hedge Accounting
PiP 16A.1 Facts: A company has a U.S. $100 receivable due in 30
days; exposes the company to foreign currency risk. To manage
risk, company enters into a forward contract to sell U.S. $100 for
CA$102 in 30 days.
• Dollar depreciates = receivable is worth less = resulting loss is
booked to net income
• Dollar depreciates = forward contract increases in value =
resulting gain is booked to net income
Since the gains and losses from both the receivable and the forward
contract are being booked through net income, they offset.
Hedge accounting is unnecessary.
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No Symmetry in Accounting—Potential
Need for Special Hedge Accounting
PiP 16A.1 Facts: A company has an investment in securities
(shares) valued at fair value through OCI. Company purchases an
option to sell the shares at a fixed price (protection from future
declines in value of the shares).
• Value of shares increases or decreases = gains or losses booked
through other comprehensive income
• Value of shares increases or decreases = value of the option
decreases or increases = gains or losses booked through net
income
The gains and losses do not offset (one goes to OCI and the other goes
to net income).
Hedge accounting is necessary.

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Qualifying for Hedge Accounting
• Is optional and modifies the normal accounting
• Designed to ensure timing of recognition of gains/losses
in net income is the same for both the hedged item and
the hedging item
• Different recognition and measurement
• Hedges qualify for optional hedge account based on the
following criteria
o Identify the exposure
o Designate that hedge accounting will be applied
o Document: risk management objectives and strategies, the
hedging relationship, hedged and hedging items, methods
to assess effectiveness, method of accounting

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Hedge Accounting—After Inception
• At inception and throughout the term—the entity should
have reasonable assurance the relationship is effective
and consistent with risk management policy
o Effectiveness must be reliably measurable
o Relationship should be reassessed regularly
o When forecast transactions are involved, it should be
probable these transactions will occur
• The approaches to hedge accounting differ between ASPE
and IFRS

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Hedge Accounting Under ASPE
• Under ASPE, only certain pre-specified transactions
qualify for optional hedge accounting treatment
o Anticipated purchase/sale of a commodity hedged with a
forward contract
o Anticipated foreign exchange denominated transactions
hedged with a forward contract
o Interest-bearing assets/liabilities hedged with interest-rate
or cross-currency swaps
o Net investments in a foreign subsidiary
• Generally, under ASPE, the hedging item (usually a
derivative) is not recognized on the balance sheet until
the hedging item is settled
• There is no mismatch if the items are off-balance sheet
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Hedge Accounting Under IFRS—Fair
Value Hedge Accounting
• Used to account for hedges of exposures related to
assets/liabilities recognized on the SFP and unrecognized
purchase commitments
• Hedged item must be recognized on the SFP and
measured (or remeasured) at fair value
• Adjusts the hedged item to ensure
o It is recognized and measured at fair value
o Gains/losses are booked so related gains/ losses on hedged
item offset hedging item

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Hedge Accounting Under IFRS—Cash
Flow Hedge Accounting
• A cash flow hedge deals with transactions that offset the
effects of future variable cash flows
• Hedged position is not yet recognized on the SFP
• Gains and losses related to changes in value are not
recognized; so gains and losses on the hedging item
should not be included in income either
• Gains and losses on the hedging items are booked
through other comprehensive income
• Brought into net income in the same (future) period that
the hedged items are booked to net income

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Hedge Accounting Under ASPE—Cash
Flow Hedge Accounting
• On the other hand, under ASPE, the hedging item is not
recognized until the transaction is settled
• A swap contract is when a company has a series of similar
transactions that it wants to hedge
• It consists of a series of forward contracts
• Most common type is the interest-rate swap
• One party makes payments based on a fixed or floating
rate and the other party does the opposite

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Hedged Item and Hedging Item—
Before Hedge Accounting is Applied
PiP 16A.3 Facts: On Jan 1, a company purchases an investment for
$1,000—exposes the company to the risk the shares will decline in value.
It is classified as FV-OCI under IFRS; FV-NI under ASPE. The company
purchases an option for $10 to sell the shares at $1,000.
• To record the original investment

• To record purchase of the option—same for IFRS and ASPE

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Hedges Accounting—Recognized
Assets as Hedged Items (IFRS)
PiP 16A.4 (IFRS) Refer to PiP 16A.3. Assume the fair value of the
investment increased by $7; this would cause a decrease in the value of
the derivative.
• To record the change in value of the investment and the derivative
without hedge accounting
Gain recorded in OCI

Loss recorded in net income

• To apply hedge accounting

Moves the loss on the
derivative to OCI—to offset
the gain on investment in OCI

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Hedges Accounting—Recognized
Assets as Hedged Items (ASPE)
PiP 16A.4 (ASPE) Refer to PiP 16A.3. Assume the fair value of the
investment increased by $7; this would cause a decrease in the value of
the derivative.
• To record the change in value of the investment and the derivative
without hedge accounting
Gain recorded in net income

Loss recorded in net income

• Hedge accounting is not needed because the accounting already

reflects economic reality—gain and loss are offset in net income;
also, is not on the list of allowable transactions
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Hedges Accounting—Purchase
Commitments as Hedged Items
PiP 16A.5 Facts: A company commits to a raw materials purchase at a
fixed price in US dollars. The company removes the foreign currency risk
by entering into a forward contract to fix the exchange rate.
• Under IFRS, this is a fair value hedge
o Needs to be recognized on the SFP
o Will be measured at fair value
o Gains and losses booked through net income
• This might also be treated as a cash flow hedge under IFRS
o Commitment might be difficult to measure
o Purchase commitment is off-balance sheet
o Gains and losses booked through OCI
• This qualifies for hedge accounting under ASPE; but is not
recorded until the goods are delivered and the contract is settled
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Interest Rate Swaps Before Hedge
Accounting is Applied
PiP 16A.6 Facts: Jones • To record the investment
issued $1 million, 5- year,
floating rate bonds on Jan
2. Jones decides to hedge • No entry to record the swap contract
the risk by entering into a
• To record the interest payment to
5-year interest rate swap. bondholders
Jones makes fixed
payments of 8% and
receives floating rates
• To record the settlement payment on
back. On each interest the swap—reduces interest to 8%
payment date Jones and
the counterparty will settle
the difference.
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Interest Rate Swaps as Cash Flow
Hedges
PiP 16A.7 Refer to PiP 16A.6. Assume the fair value of the interest rate
swap has increased by $40,000 by year end.
• This is a cash flow hedge because it relates to a variable interest
rate debt instrument—economic losses on the bond are not
recognized
The unrealized gain will
gradually be reflected in
net income when the
benefit of the lower
interest rate is realized as
reduced interest expense.

o Under ASPE, the swap is not recognized on the balance sheet;

payments/receipts are accrued as interest expense/adjustments
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Interest Rate Swaps as Fair Value Hedges
PiP 16A.8 Refer to PiP 16A.6 and 16A.7. Assume the $1 million debt has a
fixed rate of 8%, but interest rates are falling. The company enters into a
swap contract as protection from increases in the fair value of the debt.
• Under IFRS, this is a fair value hedge because it relates to the risk
that the value of the fixed rate liability is increasing/decreasing
due to declining/increasing interest rates
The liability is revalued to
fair value with the loss on
the bond offset by the
gain on the swap—impact
on net income is zero.

• This is a qualified transaction for hedge accounting under ASPE; no

journal entries are booked, just payments/receipts are booked
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Anticipated Purchases as Hedged Items
PiP 16A.9 Facts: In Sept 2024, AC Company anticipates purchasing 1,000
metric tonnes of aluminum in Jan 2025. To hedge price increases, the
company enters a cash-settled derivative contract. By Jan 2025 the price
increased, so the value of the contract increased by $25,000.

• This is a cash flow hedge under IFRS.

Gains or losses on the
futures contract are
accumulated in OCI until
the period in which the
inventory is purchased. At
that point, the carrying
amount of the inventory
would be adjusted.
• Under ASPE, the gain or loss would be recorded in the future as an
adjustment to inventory; not treated as a derivative if exchange traded

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Purchases as Hedged Items
PiP 16A.10 Facts: Refer to PiP 16A.9. Assume that in 2025 the company
purchases 1,000 metric tonnes for $1,575 per tonne.

Under hedge accounting

the Unrealized Gain or
Loss would be in AOCI
since the settlement
occurred in the following
year.
The net cost for the
inventory has been fixed
at $1,550,000 through the
contract.
• Under ASPE, only two entries are required: The entry to record the
purchases is the same as under IFRS; the other entry is to settle the
contract, with the credit going to Inventory

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Sale of Hedged Goods: Cash Flow
Hedges
PiP 16A.11 Facts: Refer to PiP 16A.9 and 16A.10. Assume that the
inventory becomes part of the cost of goods sold when the product is
converted to finished goods. The total cost of goods was $1.7 million,
and sales were $2 million.
The gain on the futures
contract reduced the
carrying amount of the
inventory when the
derivative contract was
settled, and in turn,
reduced total COGS.

• The journal entries for the sale would be the same under ASPE.

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Copyright
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