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HMRC internal manual

Corporate Finance Manual

Accounting for corporate finance: hedging: cash flow hedge: accounting

This guidance applies to companies which apply IFRS, New UK GAAP or FRS 26.

Accounting for a cash flow hedge

In order to apply hedge accounting, an entity must meet the criteria set out by the relevant standard (CFM27060). Assuming these criteria are met, cash-flow hedges should be accounted for as follows:

  • The hedging instrument is measured at fair value.
  • Gains or losses on the effective portion of the hedging instrument are recognised as other comprehensive income (OCI). These amounts will be taken to a ‘cashflow hedging reserve’ as a separate component of equity.
  • The ineffective portion of the gain or loss on the hedging instrument is recognised in the income statement. Where a non-derivative financial instrument is designated as a hedge of foreign currency risk, only the foreign currency element of change in fair value should be included in the amount taken to OCI.
  • When cash flows relating to the hedged item are reported in profit and loss, amounts in OCI are ‘recycled’ to the income statement. In particular, the amount recognised as a separate component of equity is adjusted to the lesser of:

    • The cumulative gain or loss on the hedging instrument from inception of the hedge;
    • The cumulative change in fair value of the expected future cash flows of the hedged item from the inception of the hedge;

Any remaining gain or loss is recognised in the income statement.

If specific risks are excluded from the hedging relationship, gains or losses arising on the hedging instrument as a result of these risks are recognised in accordance with the instrument’s normal classification.

Where a hedge of a forecast transaction results in the recognition of a financial asset or liability, the gains or losses on the hedging instrument that have previously been recognised in OCI are ‘recycled’ in the same period as the asset or liability affects profit or loss (for example, in the periods when interest expense or income is recognised). However, if an entity expects that any of a loss recognised in OCI will not be recovered in future periods, it should reclassify to profit or loss the amount that is not expected to be recovered.

There is an example at CFM27170.

If a highly probable forecast transactions give rise to non-financial assets or liabilities, such as the cocoa beans (an addition to raw material stocks) acquired by the manufacturer in example 2 of CFM27150, the entity should adopt one of the following approaches as its accounting policy and apply that policy consistently.

  • Reclassify gains and losses previously recognised in OCI to the income statement (‘recycled’) in the same periods as the non-financial asset or liability affects profit or loss (for example, when stock is written off as part of cost of sales). Any losses that are deemed irrecoverable in current or future periods should be recognised in profit or loss immediately.
  • Remove the gain or loss previously recognised in OCI, and include it in the initial cost or other carrying amount of the asset or liability (sometimes referred to as a ‘basis adjustment’.

FRS 102: Under FRS 102 this choice does not exist. The amount recognised in OCI must be included in the initial cost/carrying amount of the asset/liability (as a basis adjustment).

For cash flow hedges other than those covered by the provisions above, the amounts reported in OCI are recycled to the income statement once the hedged transaction affects profit or loss (for example, when a forecast sale occurs).