Financial instruments and reporting
The Hedge Classification
Name the hedge and the gain routes itself: fair value to earnings, cash flow and net investment to OCI, undesignated to earnings.
How the exam words it
- -The stem hedges the fair value of a recognized asset or liability and asks where the derivative and hedged-item changes go.
- -It hedges a forecasted transaction or a variable rate and asks where the effective portion is reported.
- -It hedges a net investment in a foreign operation and asks about the translation adjustment.
- -It describes an undesignated or undocumented derivative and asks how its fair value changes are reported.
The playbook
- 1Confirm a derivative exists (an underlying with a notional amount, little or no initial investment, and net settlement) and that hedge accounting was documented at inception.
- 2For a fair value hedge, remeasure both the derivative and the hedged item through earnings, so the two largely offset.
- 3For a cash flow or net investment hedge, defer the effective portion in OCI and reclassify it to earnings when the hedged item affects earnings.
- 4For a speculative, undesignated, or undocumented derivative, run the entire fair value change through earnings each period.
The trap
Routing a cash flow hedge's effective portion to earnings instead of OCI, or forgetting to remeasure the hedged item too in a fair value hedge.
How the exam varies it
The same pattern, re-skinned along these axes:
Fair value versus cash flow versus net investment hedgeA qualifying hedge versus a speculative or undocumented derivativeEarnings now versus OCI deferral and later reclassification
Drill this pattern
8 questions of The Hedge Classification from across the AUD topics. Clear it by getting 5 right with a streak of 3.