Hedge Accounting: What Is An Economic Hedge?

Economic Hedge :Entities enter into hedge arrangements for economic reasons; to protect themselves from financial risks such as currency risk, market price risk, interest rate risk and so on. We termed this as Economic Hedge. Hedge accounting generally results in a closer matching of the statement of financial position effect with the profit or loss effect and protects the statement of comprehensive income from volatility caused by changes in fair value from period to period.

Hedge accounting under IAS 39 will not always result in the same outcome as an economic hedge because the rules in IAS 39 are very prescriptive so that in order to qualify for hedge accounting, entities need to meet strict specified criteria. If these criteria are not met then hedge accounting cannot be applied even if the hedge works from an economic perspective.

Hedge is formed in order to lessen or eliminate economic exposure. It concerned with borrowing in the foreign currency to match the cash flow patterns. Detail hedge accounting is described under IAS 39-Financial Instruments: Recognition and Measurement.

A particular type of hedging transaction is having the objective of managing the foreign currency exposure. These hedges are undertaken for the economic aim of reducing probable loss from foreign exchange fluctuations . However, not all hedges are designated for special accounting treatment.

 The principal objective of hedge accounting is to give an offset to the mark to market movement of the derivative in the profit and loss account or income statement. For a fair value hedge, this is achieved either by marking to market an asset or a liability which offsets the profit and loss movement of the derivative. For a cash flow hedge some of the derivative volatility into a separate component of the entity’s equity called the cash flow hedge reserve. For more detail information on hedge, you can visit other websites on the same topic.

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