Question

Describe the accounting for changes unfair value of derivative instruments in following situations: 1) fair value hedge, 2) cash flow hedge,3) foreign currency hedge and 4) not designated as a hedge

Answer 1

Basic- If the derivative instrument does not qualify as a hedge, gains or losses reriecting changes in Tair vaiue ale reported in earnings. However, if the derivative instrument qualifies as a hedge, the accounting varies based on the type of risk being hedged. What is Hedge Accounting - hedge accounting for the following three risks Changes in fair values due to fixed rates or prices: for example, the risk of changes in the fair value of a fixed-rate investment security may be reduced or eliminated by a fair value hedge. . Changes in cash flows due to variable rates or prices: for example, the risk of changes in cash flows from a variable- rate debt obligation may be reduced or eliminated by a cash flow hedge. . Changes in fair values, cash flows, or net investment in foreign operations due to variability of foreign currency exchange rates: for example, the risk of changes in the foreign currency exchange rates inherent in the forecasted purchase of equipment to be paid for in a foreign currency may be reduced or eliminated by a foreign currency hedge. Hedge Accounting treatment- The accounting for fair value hedges, cash flow hedges, and foreign currency hedges is highlighted below recorded in earnings Fair Value Hedges- For fair value hedges, gains or losses on derivative hedging instruments are each reporting period. In addition, gains or losses on the hedged item attributable to the hedged risk are recognized in earnings. Consequently, if gains or losses on the derivative hedging instrument and the related hedged item do not completely offset, the difference (i.e,, ineffective portion of the hedge) is recognize , the reporting of gains or losses on derivative hedging instruments depends Cash Flow Hedges For cash flow hedges, on whether the gains or losses are effective at offsetting changes in the cash flows of the hedged item. The effective n or loss on the derivative hedging instrument is accumulated in other comprehensive income (OCI)

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