Accounting for Fair Value Hedges

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A fair value hedge is a hedge of the exposure to changes in the fair value of an asset or liability or any such item that is attributable to a particular risk and can result in either profit or loss. A fair value hedge relates to a fixed value item.

Fair value hedge pertains to a fixed value item. The basic steps involved accounting for fair value hedges are as follows:

Determine the fair value of both the hedged item and thehedging instrument used on the date of reporting financial statements.

If there is a change in the fair value of the hedged instrument, recognize the profit/loss in the books of accounts

Lastly, recognize the hedging gain or loss on the hedged item in its carrying amount.

Company Fair has an asset with a current fair value of $ 2000 and the management is concerned that the fair value of the hedge will go down to $ 1900. This will result a loss to the company.

To offset this loss, the company enters into an offsetting position through a derivative contract which also has a fair value of $ 2000. Since this is an offsetting position, its fair value will move in the opposite direction as that of the hedged item.

View CourseRelated CoursesUS GAAP CourseCost Accounting CourseIFRS Course

At the time of the closure of books, the following scenarios are possible:

Case 1 Decrease in the fair value of the hedged item and a simultaneous increase in the fair value of the offsetting hedged instrument

Case 2 Increase in the fair value of the hedged item and a simultaneous decrease in the fair value of the offsetting hedged instrument

Accounting for Fair Value Hedges Journal Entries

a) Loss on the hedging item on the reporting date

This will have an effect on the Profit & Loss A/c and reduce the profit of the company.

Since this is an asset, the value of the asset will go down and this will affect the Financial Position i.e. Balance Sheet of the company.

b) Gain on the hedging item on the reporting date

. Since this is an asset, the value of the asset will go up and this will affect the Financial Position i.e. Balance Sheet of the company.

This will have an effect on the Profit & Loss A/c and increase the profit of the company.

a) Loss on the hedging instrument on the reporting date

This will have an effect on the Profit & Loss A/c and reduce the profit of the company.

Since this is an asset, the value of the asset will go down and this will affect the Financial Position i.e. Balance Sheet of the company

b) Gain on the hedging instrument on the reporting date

. Since this is an asset, the value of the asset will go up and this will affect the Financial Position i.e. Balance Sheet of the company.

This will have an effect on the Profit & Loss A/c and increase the profit of the company.

Net effect of both the Hedging Item and the Hedging Instrument

Net loss will decrease the overall profit of the company.

Net reduction in the Net Assets of the company

Net Gain will increase the overall profit of the company.

This has been a guide to accounting for fair value hedges. Here we discuss fair value hedge journal entries along with practical examples. You may learn more about accounting from the following articles

worked as JPMorgan Equity Analyst, ex-CLSA India Analyst ; edu qualification – engg (IIT Delhi), MBA (IIML); This is my personal blog that aims to help students and professionals become awesome in Financial Analysis. Here, I share secrets about the best ways to analyze Stocks, buzzing IPOs, M&As, Private Equity, Startups, Valuations and Entrepreneurship.

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