Difference Between Fair Value Hedge and Cash Flow Hedge

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Difference Between Fair Value
Hedge and Cash Flow Hedge
Difference 71
Between Fair Value

Hedge and Cash
Flow Hedge
Posted in: IFRS Accounting
Posted by: Silvia M.
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The first thing you need to do before you

even start to play with hedge accounting
is to determine the TYPE of hedge
relationship that youre dealing with.
Why?
Because: the type of hedge determines

your accounting entries. Make no
mistake here. If you incorrectly identify
the type of the hedge, then your hedge
accounting will go totally wrong.
But heres the thing:
Although all types of hedges are neatly

defined in IAS 39/IFRS 9, we all struggle
with understanding the differences and
distinguishing one type from the other
one.
A few weeks ago I was giving a lecture

about hedge accounting to the group of
auditors. Most of them were audit
managers and seniors so not really
freshmen, but experienced and highly
qualified people.
Yet after about 5 or 10 minutes of

speaking about different types of
hedges, one audit manager interrupted
me with the question:
converted by Web2PDFConvert.com
Silvia, I get the definitions. I just dont
get the difference. I mean the real
substance of a difference between fair
value hedge and cash flow hedge. It
looks the same in many cases. Can you
shed some light there?
Of course.
What types of hedges

do we have?
Although I clearly explain a hedge
accounting in details in my IFRS Kit, let
me shortly explain what type of hedges
we have:
1. Fair Value Hedge;
2. Cash Flow Hedge, and
3. Hedge of a Net Investment in a

Foreign Operation but we will not
deal with this one here, as its
almost the same mechanics as a
cash flow hedge.
First, lets explain the basics.
What is a Fair Value

Hedge?
Fair value hedge is a hedge of the
exposure to changes in fair value of a
recognized asset or liability or
unrecognized firm commitment, or a
component of any such item, that is
attributable to a particular risk and could
affect profit or loss.
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Thats the definition in IFRS 9 and IAS

39.
39.
So here, you have some fixed item

and youre worried that its value will
fluctuate with the market. Ill come back
to this later.
How to Account for a Fair

Value Hedge?
OK, lets not go into details and lets just
assume that your fair value hedge meets
all criteria for hedge accounting.
In such a case, you need to make the

following steps:
Step 1:
Determine the fair value of both
your hedged item and hedging
instrument at the reporting date;
Step 2:
Recognize any change in fair value
(gain or loss) on the hedging
instrument in profit or loss (in most
cases).
You need to do the same in most
cases even if you dont apply the
hedge accounting, because you
need to measure all derivatives
(your hedging instruments) at fair
value anyway.
Step 3:
Recognize the hedging gain or loss
on the hedged item in its carrying
amount.
To sum up the accounting entries for a

fair value hedge:
Description Debit Credit

Hedging instrument:
Loss on the P/L FV FP
hedging loss on Financial
instrument hedging liabilities
instrument from
hedging
instruments
OR
Gain on the FP P/L FV
hedging Financial gain on
instrument assets from hedging
hedging instrument
instruments
Hedged item:
Gain on the FP P/L Gain
hedged item Hedged on the
item (e.g. hedged
inventories) item
OR
Loss on the P/L Loss FP
hedged item on the Hedged
hedged item (e.g.
item inventories)
Note: P/L = profit or loss, FP = statement

of financial position.
What is a Cash Flow

Hedge?
Cash flow hedge is a hedge of the
exposure to variability in cash flows
that is attributable to a particular risk
associated with all or a component of a
recognized asset or liability or a highly
probable forecast transaction, and could
affect profit or loss.
Again, thats the definition in IAS 39 and

IFRS 9.
Here, you have some variable item

and youre worried that you might get
less money or have to pay more money
in the future than now.
Equally, you can have a highly probable

forecast transaction that hasnt been
recognized in your accounts yet.
How to Account for a

Cash Flow Hedge?
Assuming your cash flow hedge meets all
hedge accounting criteria, youll need to
make the following steps:
Step 1:
Determine the gain or loss on your
hedging instrument and hedge item
at the reporting date;
Step 2:
Calculate the effective and
ineffective portions of the gain or
loss on the hedging instrument;
Step 3:
Recognize the effective portion of
the gain or loss on the hedging
instrument in other comprehensive
income (OCI). This item in OCI will
be called Cash flow hedge
reserve in OCI.
Step 4:
Recognize the ineffective portion of
the gain or loss on the hedging
instrument in profit or loss.
Step 5:
Deal with a cash flow hedge reserve
when necessary. You would do this
step basically when the hedged
step basically when the hedged
expected future cash flows affect
profit or loss, or when a hedged
forecast transaction occurs but
lets not go in details here, as its all
covered in the IFRS Kit.
To sum up the accounting entries for a

cash flow hedge:
Description Debit Credit

Loss on the OCI Cash FP
hedging flow hedge Financial
instrument reserve liabilities
effective from
portion hedging
instruments
Loss on the P/L FP
hedging Ineffective Financial
instrument portion of liabilities
ineffective loss on from
portion hedging hedging
instrument instruments
OR
Gain on the FP OCI Cash
hedging Financial flow hedge
instrument assets from reserve
effective hedging
portion instruments
Gain on the FP P/L
hedging Financial Ineffective
instrument assets from portion of
ineffective hedging gain on
portion instruments hedging
instrument
Note: P/L = profit or loss, FP = statement

of financial position, OCI = other
comprehensive income.
As you can see, you dont even touch

the hedged item here and you only deal
with the hedging instrument. So thats
completely different from fair value
hedge accounting.
How to Distinguish Fair

Value Hedge and Cash
Flow Hedge?
What Im going to explain right now is my
own logic of looking at this issue. Its not
covered in any book.
Its how I look at most hedging

transactions and this is a very
simplified view. But maybe it opens up
your mind to logical thinking about
hedges.
Please, ask first:
What kind of item are we
hedging?
Basically, you can hedge a fixed item or
a variable item.
Hedging a Fixed Item

A fixed item means that the item has a
fixed value in your accounts and it may
provide or require fixed amount of cash
in the future.
The same applies for unrecognized firm

commitments that have not been sitting
in your accounts yet, but they will be in
the future.
And when it comes to hedging fixed

items, then youre practically dealing with
the fair value hedge.
Why is that?
Well, here, you are worried, that in the

future, you would be paying or receiving
a different amount than the market or fair
value will be. So you dont want to FIX the
amount, you want to GET or PAY exactly
in line with the market.
Im referring to GET or PAY only for

the sake of simplicity. In fact, you dont
even need to get or pay anything in the
future youre just worried that the item
will have a different carrying amount in
your books that its fair value.
Fair Value Hedge Example

You issued some bonds with coupon 2%
p.a.
Its nice that you always know how much

youll pay in the future.
BUT you are worried that in the future,

market interest rate will be much lower
than 2% and you will be overpaying (in
other words, you could get the loan at
much lower interest in the future than
you will be paying at the fixed rate of
2%).
Therefore, you enter into interest rate

swap to receive 2% fixed / pay
LIBOR12M + 0.5%. This is a fair value
hedge you tied the fair value of your
interest payments to market rates.
Hedging a Variable Item

A variable item means that the
expected future cash flows from this
item change as a result of certain risk
exposure, for example, variable interest
rates or foreign currencies.
When it comes to hedging variable items,

youre practically speaking of a cash
flow hedge.
Why is that?
Here, you are worried that you will get or

pay a different amount of moneyin
certain currency in the future that you
would get now.
In fact, in a cash flow hedge, you want to

FIX the amount of money youll get or
pay so that this amount would be the
same NOW and IN THE FUTURE.
Cash Flow Hedge Example

You issued some bonds with coupon
LIBOR 12M+0.5%.
It means that in the future, you will pay

interest in line with the market, because
LIBOR reflects the market conditions.
BUT you dont want to pay in line with

market. You want to know how much you
will pay in the future, as you need to
make some budget, etc.
Therefore you enter into interest rate

swap to receive LIBOR 12 M + 0.5% /
pay 2% fixed. This is cash flow hedge
you fixed your cash flows and you will
always pay 2%.
To Sum This All Up

Now you can see that the same
derivative interest rate swap can be a
hedging instrument in a cash flow hedge
as well as in a fair value hedge.
The key to differentiate is WHAT RISK

you hedge. Always ask yourself, why you
undertake the hedging instrument.
But its not that simple as it seems

because there are some exceptions in
IAS 39 and IFRS 9.
For example, even when you have a

fixed item, you can still hedge it under
cash flow hedge and protect it against
foreign currency risk.
Equally, you can hedge a variable rate

debt against fair value changes and
thats the fair value hedge.
Therefore, please refer to the following

table summarizing the types of hedges
according to risks and items hedged:
Item Risk Type

hedged hedged of
hedge
Fixed-rate Interest Fair
assets and rates, Fair value
liabilities value, hedge
Termination
Options
Fixed-rate Foreign Fair
assets and currency, value
liabilities credit risk hedge
or
cash
flow
hedge
Unrecognized Interest Fair
firm rates, Fair value
commitments value, hedge
Credit risk
Unrecognized Foreign Fair
firm currency value
commitments hedge
or
cash
flow
hedge
Variable-rate Fair value, Fair
assets and termination value
liabilities options hedge
Variable-rate Interest Cash
assets and rates, flow
liabilities foreign hedge
currencies, (most
credit risk cases)
Highly Fair value, Cash
probable interest flow
forecast rates, credit hedge
transactions risk, foreign
currency
Now, Id like to hear from you. Please

leave me a comment and let me know
whether you have dealt with some hedge
accounting in practice, what issues you
accounting in practice, what issues you
faced and how you solved them. Thank
you!
Tags: Financial Instruments IAS 39 IFRS 9
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71 Comments:
anilla May 29, 2014
thank you for this. we
do foreign currency
forwards at the year-
end, cause we buy in
usd. but they are
short-term and we
dont book them as
hedges. is it wrong?
Reply
Silvia M.
May 29, 2014
Hi Anilla, no, its OK.
Hedge accounting
is OPTIONAL, not
obligatory. So if you
prefer to keep it
simple, its OK to
revalue your
forwards to fair
value and thats it.
Mainly when the
forwards expire
within some short
term. S.
Reply
oomesh May 29, 2014

hi silvia, is the posting
of the ineffective
portion a balancing
figure ? oomesh from
mauritius
Reply
Silvia M.
May 29, 2014
Hi, Oomesh, yes,
basically it is. The
gain or loss from
change in FV of
hedging instrument
= effective portion
(to OCI) +
ineffective portion
(to P/L). Take care!
S.
Reply
mayur May 31, 2014

Hi Madam,
Just wanted to ask
what is the specific
difference in hedge
accounting between
Cash flow hedge and
Fair value Hedge.
Silvia M.
June 2, 2014
Mayur, please
revise the 2 tables
above where you
can see the tables
with journal entries
for both hedges.
But the main
difference is, that at
CF hedge you dont
touch the hedged
item and you
revalue only
hedging instrument
+ you need to split
the gain/loss to
effective and
ineffective
portion+effective
goes to OCI and
ineffective to P/L.
At FV hedge, you
revalue both
hedging instrument
and hedged item
and if the hedge is
effective, you put
gain/loss from both
elements to P/L.
S.
Costina Gafita
March 30, 2015
March 30, 2015
Hi Silvia,
in this case with short
term forward
agreements classified
as CF hedge what will
be the accounting
entries? I will go for a
forward agreement for
21 days to buy a fixed
amount of USD
(functional currency is
RSD) in order to pay
for the acquisition of a
PPE (I know the exact
amount of this order).
How can I record the
loss calculated for this
agreement as being
the difference between
spot rate and the
actual exchange rate
at the settlement date?
Many thanks
Reply
oomesh May 29, 2014

hi Silvia, thnks , I did
P2 in 2012 in quite
forgotten some bits ,
thanks once again .
this is a very
challenging IFRS !
BEST REGARDS .
OOMESH .
Reply
raj May 29, 2014

Thanks Sylvia. .
Difficult subject matter
well explained.
Kind regards
Raj..
Reply
James Oguns
May 30, 2014
Thank you very much
Silvia. When are you
going to take us
through Hedge of net
investment in a foreign
operation in this
manner?
Reply
Silvia M.
May 30, 2014
Hi James, well, I did
not want to cover it
here, because once
you see this type of
a hedge, you can
clearly identify it
theres no doubt
about the type of
the hedge But Ill
do it. The thing is
that not many
people are
interested in this
topic, because that
type of hedge is
taken mostly by
bigger companies
or corporations and
some IFRS expert
solves it for them
S.
Reply
Rajesh Thakur
May 31, 2014
Hi Silvia,
Kindly explain the
meaning of effective
and ineffective portion
as I m unable to
understand it.
Reply
mayur May 31, 2014

Hello Madam,
Have a following doubt.
If company has issued
foreign currency fixed
interest rate bond than
and to hedge currency
risk and interest rate
risk it has undertaken
cross currency interest
rate swap than can this
hedge be qualified for
both fair value hedge
(for interest rate
movements) and cash
flow hedge (for cross
currency movements).
If yes than this hedge
will be subject to
cashflow hedge
accounting treatment
for currency
movements and fair
value hedge
value hedge
accounting treatment
for interest rate
movements.
Reply
Silvia M.
June 2, 2014
Hello, Mayur, this is
a great and
interesting
question.
The answer
depends on the
construction of the
hedging
relationship, but to
make it short: what
you described is
totally doable. If
your CCIRS (cross-
currency interest
rate swap) is
constructed in a
way that currency
risk element is
separable from
interest rate risk
element, and if
these two elements
can be separated
and measured
separately also for
your fixed interest
rate bond, then you
can do it. You just
need to designate it
in your hedging
strategy that way.
I have seen that
CCIRS can be used
in various types of
hedges, for
example, pure cash
flow hedge (if swap
is fixed for fixed, just
in a different
currency), also pure
FV hedge (fixed for
floating). By the
way, if you want to
keep your life
easier, you can
designate your
hedge as CF or FV
only, depending on
the type and
conditions of
CCIRS. Have a nice
day! S.
Reply
Fadi Rabadi
June 8, 2014
Thank you Silvia for
the explanations above
, i have one question ,
can we have a fair
value hedge against a
Fixed rate bond
classified At Amortized
cost to hedge the
interest rate risk ?
Reply
Silvia M.
June 8, 2014
Yes, you can. In
that case, any
hedge adjustment is
amortised to profit
or loss based on a
recalculated
effective interest
rate so not right
away to P/L. S.
Reply
Visar June 25, 2014

Thank you very much
Silvia,
Bank A (Subsidiary) in
2006 started to use
Interest Rate Swaps-
The Bank A pays fix
and
receives variable
interest rates from
Bank B (Parent). The
main purpose of these
instruments is to
mitigate the interest
rate risk associated to
the fixed rate lending
(difference between
loans deposits)
For two years
(2006&2007) Bank A
recognized in Income
Statement: Expenses
in IRS SWAP and
Income from SWAP
In 2008 Bank A
recognized Negative
fair value financial
derivative instruments
through profit or loss.
Please can you help in
question below:
According IFRS is
allowed Subsidiary to
allowed Subsidiary to
use Interest Rate
Swaps with Parent
(Related Party)
Is correct to
recognized Negative
fair value financial
derivative instruments
through profit or loss
Can you help how to
calculate fair value for
Interest Rate Swaps
Thank you very much,
Reply
Silvia M.
June 25, 2014
Hi Visar,
OK, let me go
straight to your
questions:
1) Yes, IRS can be
arranged between 2
related parties. But
in this case you
need to make
appropriate
disclosures and
also, you need to
be careful because
IRS between related
parties are not
necessarily
arranged at market
conditions (=fair
values) and as a
result, you would
need to make
appropriate
adjustment to bring
it to the fair value.
Maybe its not your
case though.
2) Of course. Is it
officially designated
and treated as a
cash flow hedge?
Because if not, then
you dont have any
other choice but to
recognize all gains
or losses from
derivative in profit
or loss.
3) This is much
more complex topic.
I have covered it in
my IFRS Kit where I
show how to
calculate the fair
value of plain
vanilla interest rate
swap (same
swap (same
currency, fixed for
floating). However,
the calculation of
IRSs fair value
depends on HOW
exactly it is
constructed and
may require
complex modelling.
Have a nice day!
Silvia
Reply
Visar June 26, 2014

Thank you very much
Silvia,
Just to clarify,
How should Bank A
classify type of hedge
in this scenario?
(Bank A (Subsidiary)
use Interest Rate
Swaps- The Bank A
pays fix and
receives variable
interest rates from
Bank B (Parent).)
Cash flow hedge or
Fair value hedge
I sincerely appreciate
the time you spent in
my issue
Best regards,
Visar
Reply
Silvia M.
June 26, 2014
That would be a
cash flow hedge for
the bank A. If the
swap is opposite (A
pays floating,
receives fixed), then
its a fair value
hedge. S.
Reply
Amit September 17, 2014

Hi Silvia
Wrt your reply to Visar,
wont it be a FV hedge
if Bank A is paying
fixed as per your initial
examples as the Swap
examples as the Swap
is the hedging
instrument in this case.
Regards
Amit
Reply
Silvia M.
September 17, 2014
Yes, Amit, thats
what I wrote above.
Reply

Hi Silvia
Sorry, but I think I
didnt frame my
question correctly
earlier. If bank A is
paying fixed that
means it has a variable
rate liability which it is
hedging. So as per the
example given under
CF hedge above this
should qualify under
CF hedge for Bank A.
Regards
Amit
Silvia M.
September 24, 2014
Hi Amit, my head
turns around now
You see, its usually

not that easy to
realize what risk
were hedging.
So once again:
Hedged item =
variable-rate loan
Hedging instrument
= IRS with pay fixed,
receive variable =>
then pay variable
receive variable
cancel out, so were
left with pay fixed.
Which is CF hedge
as were fixing the
amount of cash to
pay. Hope its clear
now
Visar June 27, 2014
Visar June 27, 2014
Thank you very much
Silvia,
Kind regards
Visar
Reply
SAMBHAV
July 15, 2014
Can you tell me how
many types of risks are
there for which
hedging can be done.
As per me there are
four risks market
price risk, interest rate
risk, credit risk and
Regds
Sambhav
Reply

Hi Sambhav
In my view hedging for
FX Risk, Interest Rate
Risk and Credit Risk
(limited) can be done
by hedging. Other
components of Market
Risk due to
macroeconomic
scenarios can be
managed by
diversification.
Regards
Amit
Reply
Manish
September 20, 2014
Hi Silvia,
Very helpful article and
thanks for explaining
such a complex area in
a very simple manner.
I understand that when
a company goes for
fair value hedge
accounting, they take
the accounting
priviledge on the
hedged item unlike a
cash flow hedge where
the same is taken on
the hedging
the hedging
instrument.
I have couple of
questions;
1. Can a fair value
hedge be applied to
Available for Sale
securities? If yes then
do we take the FV
changes to P/L instead
of OCI?
2. When I am entering
into a FV hedge for a
fixed rate debt (as
mentioned in your
example), I understand
we do a fair valuation
of the interest
component for the debt
(since FV of debt might
also include other
variable factors like
credit risk, liquidity risk
etc). In such case do I
split the FV component
and show them
separately from the
host debt contract?
Many thanks in
advance
Regards,
Manish
Reply
Nena September 23, 2014

Dear Silvia,
I have an ACCA P2
exam in December
2014 and Im a bit
confused with all these
changes lately, so my
q is: which standard we
should refer to when
dealing with financial
instruments in our
exams, IFRS 9 or IAS
39?
Thank you in advance
Reply
Silvia M.
September 23, 2014
Hi Nena, dont worry
about this, you will
be told in the
question what to
use. If not, and the
accounting
accounting
treatment in IAS 39
is different from
IFRS 9, then simply
make your choice
and dont forget to
write it clearly in
your answer.
Remember that
ACCA examiners
give marks for
stating the obvious,
so do it S.
Reply
keti October 6, 2014

Thanks silvia, the topic
is explained in a
perfect manner. Was
very helpful and
interesting.
Reply
hood October 7, 2014

Silvia. I am doing a
college assignment. in
notes of a financial
statement by a
company i saw this
statement
Hedging reserve we
have relates to the
effective portion of the
cumulative net change
in the fair value of cash
flow hedges related to
hedged transactions
that have not yet
occurred.
Can you please tell me
what type of hedging
reserve this is? i find it
a bit confusing. it would
be highly appreciated if
you could give me an
answer today or
tomorrow as my
assignment is due
tomorrow
Reply
Silvia M.
October 7, 2014
Well, when you
account for cash
flow hedges, then
you calculate
effective and
effective and
ineffective portion
of FV change in
your hedging
instrument. The
ineffective portion is
recognized in P/L
and the effective
portion in OCI. This
effective portion in
OCI is then called
hedging reserve
hope thats clearer.
S.
Reply
hood October 10, 2014

Thanks a lot Silvia
it really helped. can
you tell me the
difference between
hedging reserve and
share premium i
know its different but
still need some point
Thanks Again
Reply
Gail October 8, 2014

Silvia,
For a fair value hedge
using an interest rate
swap to hedge
corporate bonds, do
the notional values of
the swap and the
bond(s) have to be the
same? Do the terms of
the swap and the
corporate bonds have
to be the same?
Thank you!
Gail
Reply
Silvia M.
October 9, 2014
Hi Gail,
IAS 39/IFRS 9 do
not state this
requirement.
Notional values can
be different, but in
such a case, youll
have a harder time
to prove that your
hedge is effective
and qualifies for
and qualifies for
hedge accounting
(as the terms in
your hedged item
and hedging
instruments do not
match). But I dont
say its impossible.
S.
Reply
Harry October 10, 2014

Hi Silvia
Lucid explanations to
explain the hedge
treatment. Thank you.
However am not sure
what type of hedge
would i classify a
currency forward to
hedge a payment for
acquiring a fixed asset
in future (the currency
in which the payment is
made is different from
the functional
currency). The
purchase of fixed asset
is committed hence I
could call this
unrecognized firm
committment (hedged
item) and the risk
hedged is the foreign
currency. Looking at
your table where you
have summarized the
types of hedges it
looks like we could use
both Cashflow hedges
or Fair value hedges
which seems to be a bit
confusing. Can you
please clarify this.
Thank you
Harry
Reply
Silvia M.
October 12, 2014
Hi Harry,
it depends on what
you hedge. For
example:
1) If you know your
machine will cost
the exact amount in
the foreign currency
in the future, and
you want to protect
just against foreign
just against foreign
currency rate
movements, then
you can treat as a
cash flow hedge.
2) If youre not sure
about the future
price of your
machine and youre
afraid of the price
increase in the
foreign currency,
then its basically
fair value hedge.
And there are lots
of combinations,
too. Hope its
clearer! S.
Reply

Hi Silvia
Thanks for the
clarifications. Yes the
purchase price
payable is fixed in
foreign currency. Since
the amount payable is
fixed in foreign
currency, since we are
dealing with fixed item i
pretty much concluded
that we are dealing
with the fair value
hedge. Shouldnt this
be the case? Are we
talking about
exceptions here?
Please let me know
Thank you
Warm Regards
Harry
Reply
Silvia M.
October 15, 2014
Dear Harry,
the thing with
unrecognized firm
commitments is that
IAS 39 permits to
hedge foreign
currency risk under
both fair value and
cash flow hedge.
Above, I suggested
to treat it as a cash
flow hedge,
because in your
case, the amount to
pay in the foreign
currency is fixed
thats true, but in
fact, the amount to
pay in your own
currency is variable
as it fluctuates with
the changes in the
foreign exchange
rates. Its very
similar to typical
receivable or
payable.
But as I wrote, IAS
39 allows you to
account for hedge
of unrecognized
firm commitment
under both types of
hedges.
Reply
urgent October 10, 2014

Silvia,
With reasons can you
explain whether
hedging reserve is a
distributable reserve or
non distributable
reserve?
it would be highly
appreciated if you
could give me an
answer today
Reply
Silvia M.
October 10, 2014
Non-distributable.
At some point in the
future, it will reverse
in P/L. S.
Reply

Dear Silvia
Thanks for the
clarifications. I
understand this much
better now. I assume in
such cases that there
are no advantages in
using a particular type
of hedge accounting. If
you think there is there
an advantage in using
a particular type of
a particular type of
hedge accounting, can
you explain with the
reasons.
Regards
Harry
Reply
Nacho Medina
October 19, 2014
We are an European
country (EUR) and we
have a contract in
Middle East (AED) for
the next 5 years (long
term), so our risk is a
foreign currency risk,
thus, Should we do a
cash flow hedge better
than fair valur hedge?
Are there some clues
to identify the choice
(FV hedge or CF
hedge) in this kind of
situations? For
example:
-> Contracts > 1 year
or
-> Hedges > EUR 500k
etc.
You recommend to
work with CF hedge
btter than FV hedge
Thank you.
Reply
saeed bux
October 20, 2014
How to determine the
effective and
ineffective portion of
cash flow hedge.
Thanks
Reply
Anas October 25, 2014

I have same question
Reply
Silvia M.
October 26, 2014
OK, let me reply,
although its not
really a topic to
cover in 1 comment:
You simply need to
You simply need to
compare the
change in FV of
your hedged item
and the change in
FV of your hedging
instrument (in CF
hedges).
Lets say change in
FV of hedging
instrument is +100,
and change in FV
of hedged item is -
90. It means that
this hedge is not
perfectly effective
(in such a case,
change in FV of
hedging instrument
would be 90 and
there would be
100% offset).
However,
percentage of
offsetting is 111%
(100/90) which is
very effective.
Now, the effective
part of change in
FV of hedging
instrument is then
90, and ineffective
part is 10 (100-90).
Is it clear, guys?
Reply
Anas November 3, 2014

Thanks a lot Silvia,
really appreciate it. I
guess its more clear
now. But what if it was
the other way round?
Change in FV of
Hedging instrument
was +90, and change
in FV of Hedge item
was -100.. Then what
will we do?
Thanks again for your
help
Reply
Silvia M.
November 3, 2014
Hi Anas,
above, I described
over-hedge. Here,
you described
under-hedge.
In CF hedges, if
theres under-
hedge, then theres
no ineffective
portion and you
should take all the
change in FV of
hedging instrument
to OCI.
If theres over-
hedge in CF hedge,
then you split
change in FV of
hedging instrument
to effective and
ineffective portion
just as I described
above.
Hope its clearer
now. S.
Manish
November 24, 2014
Hi Silvia,
Very helpful article and
thanks for explaining
such a complex area in
a very simple manner.
It would be great if you
can clear my dobut. I
had asked this before
and guess it was
missed.
I understand that when
a company goes for
fair value hedge
accounting, they take
the accounting
priviledge on the
hedged item unlike a
cash flow hedge where
the same is taken on
the hedging
instrument.
I have couple of
questions;
1. Can a fair value
hedge be applied to
Available for Sale
securities? If yes then
do we take the FV
changes to P/L instead
of OCI?
2. When I am entering
into a FV hedge for a
fixed rate debt (as
mentioned in your
example), I understand
we do a fair valuation
of the interest
component for the debt
(since FV of debt might
also include other
variable factors like
credit risk, liquidity risk
etc). In such case do I
split the FV component
and show them
separately from the
host debt contract?
Many thanks in
advance
Regards,
Manish
Reply
Helena Wu Huie
December 12, 2014
Hi Silvia, thanks for
being helpful and so
clear! In the case of a
variable rate bond, why
would a fair value
hedge be needed?
Since by its very
nature, a variable rate
bond would be at fair
value.
Reply
yette December 18, 2014

Hi Silvia,
Good day!
Would appreciate your
insights on this
Were an importer of
raw materials and pay
the same in USD. We
use FOB Shipping
point terms. To hedge
against the volatility of
Forex we entered into
a Forward contract to
ensure that we already
have a fixed amount of
local currency
equivalent to pay for
the obligation. How
should be clasifty this
transaction? What are
our proposed entries
to record this
transaction? Should we
recognize the RM at
the forward rate
amount or the FOB
date forex.
Thanks in advance
and hope you can help
us.
Reply
Suwin December 19, 2014

Hi Silvia. Your
explanation is great.
However, theres one
thing Id like to ask. If
the an entitys
commitment fixed only
the quantity and date
of the purchase while
the price is fixed on a
certain benchmark, is it
still considered as firm
commitment and
should apply fair value
hedge?
Reply
John December 24, 2014

I have a question
regarding the hedge
relationships, from a
banks perspective,
lets say a bank
provides a interest rate
gurantee on a
mortgage for a period
of 6 months. To reduce
the risk that the bank is
exposed to, the bank
begins to economically
hedge the risk via
derivatives.
Based on this
information would
this be a fair value
hedge relationship?
the hedge item is the
fixed interest rate? or
would the hedge item
be the potential
variable interest rate to
be received when the
customer funds their
mortgage?
thanks
Reply
Silvia M.
January 14, 2015
For me it seems like
it is a fair value
hedge, meaning
that the hedged
item is a fixed-rate
item is a fixed-rate
interest rate.
Reply
Rima January 11, 2015

hi Silvi,
What about commodity
price hedge this i
suppose also can be
either cash flow or fair
value hedge. In this
case the FV of the
hedged instrument will
be the unrealised gain
or loss as per the
broker statement but
what about the gain or
loss of the hedged
item? Will this be the
same?
Eg customer wants to
buy aluminium for USD
2K on 7th Jan and so
supplier hedged the
same quantity of
aluminium at USD 2K
on same date on 7th
Jan. Broker statement
will be USD 10 loss, so
will this also represent
the gain or loss on the
hedged item and
hence no entry will be
passed? Thanx in
advance
Reply
Silvia M.
January 14, 2015
Dear Rima,
it really depends on
the type of the
hedge.
If you have a fair
value hedge, then
you book both FV
gain/loss on
hedging instrument
and FV loss/gain on
hedged item.
In a cash flow
hedge, you need to
measure
effective/ineffective
portion of the
loss/gain on
hedging instrument
and if the hedge is
still effective, you
book ineffective
part in P/L and
part in P/L and
effective part in
OCI.
If I understand it
correctly, the
supplier holds
aluminium for its
client and contracts
price is fixed, so is
supplier hedging
the fair value of its
inventories of
aluminium? If yes,
then its FV hedge.
Reply
ariel January 17, 2015

hi Silvia,
i found some materials
that the change in fair
value of hedge
instrument was
discounted. i.e.
discount period from
closing date till
settlement date.
my question is: when
and/or what type of
hedge do we use
discounting the
changes of FV?
thanks. would be very
helpful.
Reply
Aparna February 4, 2015

Awesome explanation
thanks so much.
Wonder if the
predictability of the
expected future cash
flow is a required for
the hedge accounting
at inception. Say I am
buying Foreign
inventory payable in
their currency and then
If I as a practice keep
taking different
maturities of hedges to
settle that due. My
question is only after i
purchase that
inventory should I take
that hedge can I use
the hedge accounting
or is it just the
predictability of the
forecasted purchase to
offset my currency
exposure (variable
exposure (variable
here). I am assuming
that this is cash flow
hedge
Thank you I stumbled
upon your resource
its brilliant
Reply
Silvia M.
February 5, 2015
Hi Aparna,
thank you!
You can hedge
highly probable
forecast
transactions this
would be your case.
You dont have to
purchase the
inventory in order to
hedge, but the
transaction must be
highly probable.
And yes, that would
be a cash flow
hedge.
S.
Reply
Tony W
February 6, 2015
Hi Silvia. In relation to
an investment in a
foreign currency, does
the hedge term have to
meet the expected life
of the investment. If so,
what would occur if you
cannot get a hedge to
match the expected life
of the asset, or if there
was no defined term
for the life of the asset,
eg if you were buying
property.
Reply
Silvia M.
February 6, 2015
Hi Tony, not
necessarily. If you
can demonstrate
that the hedge will
still be effective and
meets its objective,
then OK. But in this
case, it is very
probable that there
will be some
ineffectiveness in
the hedge, caused
by different
maturity periods of
hedging instrument
and hedged item. S.
Reply
Ferry February 8, 2015

Hi Silva,
Nice reading about
Hedge Accounting,
please help me to have
better understanding, i
want to ask you that:
1.how to calculate
hedge effectiveness at
the first cut off
reporting period,
because we just start
to calculate the fair
value and there is no
changes in fair value
movement?
2.how to calculate the
ineffective portion? For
example when the
calculation set at
130%,is it only the
portion amount of
130%-120% will be
charge at Profit and
Loss?
3.for fair value hedge
at the perfectly match
of Hedge Items versus
Hedge Instruments, is it
always perfectly
offsetting in Profit and
Loss between changes
in Fair value of Hedge
Instruments and Hedge
Items?
4.in a very fluctuative
exchange rate
conditions, our
company set several
CCIRS transactions
where our Hedge items
is bank loan, the main
problem is that our on
balance sheet hedge
items revaluated at
each reporting period
and then the net
settlement from CCIRS
also resulting a foreign
exchange exposure
due to different
between book rate
compare to spot rate
compare to spot rate
when we receive or
pay the CCIRS, is it my
accounting treatment is
not proper?
5. For a perfectly
match condition of
Hedge Items versus
Hedge Instruments,
can we only applied for
critical match method
for hedge accounting?
I would like to thanks in
advance for your
favourable reply.
Rgrds,
Ferry
Reply
Priyanka
February 21, 2015
Hi Silvia,
Needed a clarification:-
In case a Co whose
reporting currency is
INR & has fx risk on
account of export
receivables in USD,
has a fixed rate debt
issued in INR in its
books.
The Co intends to
swap this INR debt with
a CCIRS where it
receives fixed rate INR
Interest & pays floating
libor USD. On the final
prinicipal exchange it
receives INR & pays
USD.
Through this the Co
intends to naturally
offset USD payment
against its forecast
receivables in USD.
Can this CCIRS be put
into a cash flow hedge
against highly probable
forecast exports? The
following issues may
arise:-
1)Through the swap I
am converting a fixed
liability into floating
which will require fair
value hedge
accounting.
2) The risk being
hedged is fx risk for
forecast trnsaction
which will require cash
flow hedge accounting.
3) At the time of taking
3) At the time of taking
the swap, the INR debt
in the books has no
risk involved.
Your guidance on the
same would be
appreciated.
Reply
OLUWASEUN
February 21, 2015
Thanks So Much Silvia.
This Is Hedge
Accounting Made
Easy.
Please i really ned to
get your IFRS KITS,
but i need You to
confirm to me the pric
and the last edition
Specifically, does the
newest dition of the
IFRS KIT covers the
completed version of
IFRS 9- Financial
Instruments.(i.e
Released July 2014).
Please i need a
response as urgent as
possible.
thanks.
Reply
Silvia M.
February 21, 2015
Hi Oluwaseun, Ive
just responded by
e-mail, but to
answer: YES, the
IFRS Kit does
include the newest
version of IFRS 9.
S.
Reply
Sidra February 24, 2015

i want to know about
use of cash flow at risk
in intelligence hedging
decision?can u help
me plz
Reply
Jacinto Cho
March 7, 2015
Hi Silvia, thanks for
such great explanation.
I have been reading
IAS 39, IFRS 7 and 9
and I still did not had
an clear understanding
between Fair Value
and Cash Flow Hedge.
I knew that I have to
identify the risk, the
hedge item, hedge
instrument, strategy,
economic relationship,
effective and inefective
portion and many other
issues.
I work in treasury and
am responsible for the
follow up of financial
instruments and their
accounting/financial
treatment. My industry
is Coffee, a well known
Commodity. So I will
make up the context to
you.
Hedge item: Arabica
Coffee inventory
bought at a fixed price.
Hedge instrument:
Arabica Coffee Futures
Contracts traded in
Intercontinental
Exchange (ICE, NY).
Economic relationship:
the item is arabica
coffee and the
instrument is Arabica
coffee futures. So the
economic principle is
very clear for me.
Strategy: Short
Hedging for selling
commodities.
Risk: possible decline
price
Action: when we buy
the coffee in the cash
market, we hedge the
inventory doing the
oposite in the futures
market (Sell) and
buying futures later
(buy) when is time to
sell.
We do not have risk on
the buying side of
coffee in cash market
since, we buy on spot
price always. We never
buy on a forward or
time in advance later.
In the same day we
make a purchase
contract of coffee(1 lot
375 bags of 46 kg), we
fix a buying price, and
that is the entry price
for us to enter the
futures market and
start the Short hedge
by selling (1 lot 375
bags of 46kg) futures
Arabica coffee
contracts in the futures
market. Giving us a
short position on the
futures market, and
long position on the
cash market.
Now, on the sell side,
we do make forward
contracts to deliver an
exact amount of coffee
(e.g. 5 lots) at an exact
quality(High Grown
European Preparation
HG EP), exact time
(shipment on May N15
July expiration month),
and exact place (Port
FOB). But we do not fix
a price, so we call
these forward
contracts Price to be fix
(PTBF).
Now, that I have
explain you the
context, I will get you to
the big deal I have.
Our company is
implementing IFRS Full
for the first time on
FY14. Our Auditors are
Deloitte. On the
previous year we have
been using Local
GAAP. (Which does
not even know or
recognize financial
instruments accounting
treatment other than
ordinary Assets and
Liabilities.
We have these
Derivaties (Financial
Instruments) and we
use them as hedging
instruments, both item
and instrument are well
defined as I have
mentioned before. Now
lets try to find out if
the hedge item is a Fix
or Variable item.
You mentioned that
inventories are Fix
item. That is ok for
item. That is ok for
inventories of items
that are not listed on
Exchanges. For
example, cars, iPads,
beds, shoes, etc. But
for coffee, we have an
active market (Level
1). The information of
these prices are
available for everyone
and they are a
common ordinary item.
Nonetheless,
commodity prices are
very volatile, and
prices can vary more
than 100% in less than
one year.
We can say we have a
fix item on the buy
side, but as I
mentioned before we
do not make
commitments to buy on
forward prices just spot
prices. And we sell on
PTBF that means our
value of our sales are
unknown, and so are
the cash flows related
to the income of our
physical inventory of
coffee.
My boss financial
controller says that the
inventories are an
asset an therefore
should be treated as a
fair value hedge. The
auditos initially wanted
to treat the inventory
with IAS 2, and Net
realizable Value NRV. I
do not agree. I have
change auditors mind
that commodity
inventories should not
be treated as NRV
since the IAS 2 clear
states it should be
treated as Fair Value.
That is ok if the
inventories were not
hedge. And since we
do not like risk, and we
want to offset market
price risk, we use
coffee futures to
mitigate that risk.
If we had firm
commitments or
contracts that
represent the sale of
our inventory we could
treat them as Fair
treat them as Fair
value less cost to sell.
But since we do not
have a fix price, and
we are hedging them, I
think, understand and
belief they should be
treated as a Cash Flow
Hedge.
To add more context,
we do have the
practice of making the
mark-to-market
valuation approach,
which in other words
represent fair value of
inventories.
As we are hedging the
inventory that Is ready
for sale but with a
PTBF contract, there
should be an account
that records the
variation on fair value
of the hedge item (lets
call PNL of the
inventorie) and should
be recorded against a
reserve of equity,
called (Reserve of PNL
of coffee inventory)
although they are
called PNL that does
not mean I am saying
the effects should be
taken to P/L statement.
On the financial
instrument (derivative)
[by the way I read
commodity contracts
are not financial
instruments how is that
possible or when is
it????] And this should
have an impact on its
fair value depending
on the market price. If
prices goes down I will
have an unrealized
gain, and if prices go
higher I will have an
unrealized loss, ok?
Because the futures
market position is
Short Hedge.
MY approach is the
following.
Any variation of the
hedge item and hedge
instrument should be
taken to :
Price Hedge item Dr.
Cr.
Higher Gain Asset
(Gain inventorie) Cash
(Gain inventorie) Cash
flow Reserve (Gain)
Lower Loss Cash Flow
Reserve (Loss)
Liabilitie (Loss)
Hedge instrument
Higher Loss OCI (Loss)
Liabilitie (Loss)
Lower Gain Asset
(Derivatie gain) OCI
(Gain)
If the hedge is 100%
effective, any
ineffectiveness should
be taken to Income
statement for the FY of
the change in price as
the date of the FP.
We then arrive to the
time to make the sell,
and we have a known
sell price.
Cash market (offset
gain or loss on Cash
Flow reserve Equity)
Future market
(reclassify gain or loss
to income statement
when the price is know,
and we buy the futures
contract we had initially
sold. That exit price will
be my new fix price for
the sale and the PTBF
expires so I do not
need any hedge since
the market price risk
have disappeared.
The main reason for
these treatment I recall
again, is the condition
that I have a variable
item hedge and not a
fix variable hedge
(coffee inventory).
Who makes more
sense, me or my boss?
Or the auditors?
Reply
Silvia M.
March 7, 2015
Dear Jacinto,
thank you for your
comment, and really
let me thank you for
your trust you
placed in me and
for posting me this
question. However,
to answer this
question properly, I
would need to
would need to
dedicate more time
than I currently can
afford. I believe
quick response
would not give you
the quality and
diligence that
everybody (also
you) expect from my
work.
Hence I leave it to
other readers to go
through your
questions and tell
you their opinion.
When I have more
time, I may
eventually come
back to it.
Hope you
understand. S.
Reply
Adam French
March 11, 2015
Hi Silvia, thanks for you
explanation, very
useful. Assuming a
perfect hedge lets say
either in the form of a
cash flow hedge or fair
value hedge. A fair
value hedge will have
zero FX impact
because underlying is
at same spot rate as
hedge and they both
mature at same rate.
For cash flow hedges
the spot will be taken in
advance of the
underlying being on
your balance sheet so
although they mature
on the same date the
initial value will be
different and so FX
gain/loss will be
recognised. Is that a
fair synopsis?
Reply
TEJ March 25, 2015

Hi Silvia, also as you
mentioned For
example, even when
you have a fixed item,
you can still hedge it
under cash flow hedge
and protect it against
and protect it against
Equally, you can
hedge a variable rate
debt against fair value
changes and thats
the fair value hedge.
In this example you
said, we can hedge a
variable debt against
fair value changes and
thats fair value hedge.
This is exceptional,
right. Can you please
explain how are we
hedging this?
Reply
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Home Articles IFRS Accounting

Between Fair Value

Posted by: Silvia M.

The first thing you need to do before you

Because: the type of hedge determines

But heres the thing:

Although all types of hedges are neatly

A few weeks ago I was giving a lecture

Yet after about 5 or 10 minutes of

What types of hedges

1. Fair Value Hedge;

2. Cash Flow Hedge, and

3. Hedge of a Net Investment in a

First, lets explain the basics.

What is a Fair Value

Special For You! Have you already

Thats the definition in IFRS 9 and IAS

So here, you have some fixed item

How to Account for a Fair

In such a case, you need to make the

To sum up the accounting entries for a

Description Debit Credit

Note: P/L = profit or loss, FP = statement

What is a Cash Flow

Again, thats the definition in IAS 39 and

Here, you have some variable item

Equally, you can have a highly probable

How to Account for a

To sum up the accounting entries for a

Description Debit Credit

Note: P/L = profit or loss, FP = statement

As you can see, you dont even touch

How to Distinguish Fair

Its how I look at most hedging

Please, ask first:

Hedging a Fixed Item

The same applies for unrecognized firm

And when it comes to hedging fixed

Well, here, you are worried, that in the

Im referring to GET or PAY only for

Fair Value Hedge Example

Its nice that you always know how much

BUT you are worried that in the future,

Therefore, you enter into interest rate

Hedging a Variable Item

When it comes to hedging variable items,

Here, you are worried that you will get or

In fact, in a cash flow hedge, you want to

Cash Flow Hedge Example

It means that in the future, you will pay

BUT you dont want to pay in line with

Therefore you enter into interest rate

To Sum This All Up

The key to differentiate is WHAT RISK

But its not that simple as it seems

For example, even when you have a

Equally, you can hedge a variable rate

Therefore, please refer to the following

Item Risk Type

Now, Id like to hear from you. Please

Tags: Financial Instruments IAS 39 IFRS 9

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