Accounting for Fair Value Hedges

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 necessary steps involved accounting for fair valueAccounting For Fair ValueFair value accounting is the process of maintaining items in financial statements at their fair value and current valuation. Mark to market mechanism is applied at specified periods to change the value of items and show them as per their fair value in the market.read more hedges are as follows:

  • Determine the fair value of both the hedged item and the hedgingHedgingHedging is a type of investment that works like insurance and protects you from any financial losses. Hedging is achieved by taking the opposing position in the market.read more 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.

Accounting for Fair Value Hedge Example

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 in a loss to the company.

To offset this loss, the company enters into an offsetting position through a derivative contractDerivative ContractDerivative Contracts are formal contracts entered into between two parties, one Buyer and the other Seller, who act as Counterparties for each other, and involve either a physical transaction of an underlying asset in the future or a financial payment by one party to the other based on specific future events of the underlying asset. In other words, the value of a Derivative Contract is derived from the underlying asset on which the Contract is based.read more, 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.

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

Accounting for Fair Value Hedges Video

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 –

  • Hedge Ratio DefinitionWhat is Carrying Amount?Accounting for DerivativesStatement of Comprehensive Income