I. Hedging and Its Accounting Classification
1. Hedging of net investment in overseas business (avoiding foreign exchange risk of long-term equity investment)
2. Fair value hedging
3. Cash flow hedging
Second, hedging instruments
Hedging tools and their characteristics
(1) Derivatives can usually be used as hedging tools.
(2) Non-derivative instruments cannot be used as hedging instruments, but they can be used as hedging instruments when avoiding foreign exchange risks.
(3) Whether derivative instruments or non-derivative instruments are used as hedging instruments, the fair value must be measured reliably.
(4) The hedging instrument must involve an entity other than the reporting entity, and relevant instruments can be used as hedging instruments.
2. Setting of hedging instruments
(1) When establishing a hedging relationship, an enterprise shall specify the whole hedging instrument or a certain proportion thereof (excluding a certain period within the remaining term of the hedging instrument). But under special circumstances, some of them can be designated as hedging instruments, such as options and forward contracts.
(2) Enterprises can usually designate a single derivative as a hedging risk, but when certain conditions are met, they can designate a single derivative as more than one hedging risk.
(3) An enterprise may designate a combination of two or more derivatives or a certain proportion of the combination as hedging instruments.
(4) Although an enterprise can designate a certain proportion of the overall hedging instruments as hedging instruments, it cannot designate a certain period within the remaining term of the hedging instruments in the hedging relationship.
Third, the hedged item
1. Hedged item
Hedged items refer to the following items that an enterprise faces the risk of changes in fair value or cash flow and is designated as the hedged object:
First, the assets, liabilities, commitments, transactions that are expected to happen or net investment in overseas operations that are confirmed individually;
Second, a group of confirmed assets, liabilities, confirmed commitments, expected transactions that are likely to occur or net investment in overseas operations with similar risk characteristics;
Third, a part of a financial asset or financial liability portfolio that shares the interest rate risk of the same hedging (only applicable to fair value portfolio hedging of interest rate risk).
Among them, firm commitment refers to a legally binding agreement to exchange a specific amount of resources at an agreed price on a specific date or period in the future; Expected transactions refer to transactions that have not been promised but are expected to happen.
Characteristics of hedging projects:
(1) If it cannot be measured separately and its impact on profit and loss cannot be clearly measured, it cannot be regarded as a hedged item.
(2) Derivatives usually cannot be used as hedging items. (Derivatives are inherently risky and are often used as hedging instruments)
(3) Held-to-maturity investment: The hedged risk is credit risk or foreign exchange risk, and the held-to-maturity investment can be designated as a hedged item, while the hedged risk is interest rate risk or prepayment risk, and the held-to-maturity investment cannot be designated as a hedged item.
(4) Long-term equity investment: Long-term equity investment in joint ventures and associated enterprises, if the investment income cannot be used as a hedged item, if the exchange rate risk of net investment in overseas operations can be used as a hedged item.
(5) Only those assets and liabilities, firm commitments, etc. Items outside the reporting entity can be set as hedged items. However, if the exchange gains and losses of monetary items arising from intra-enterprise group transactions cannot be completely offset in the consolidated financial statements, the foreign exchange risk of the monetary items can be designated as hedged items in the consolidated financial statements.
2. Setting of hedging items
(1) Designate financial items as hedging items.
(2) Designate non-financial items as hedged items.
(3) Designate the combination of multiple items as hedged items.
Four. Conditions for using hedging
1. At the beginning of hedging, the enterprise has formally determined the hedging relationship (that is, the relationship between hedging instruments and hedged items) and prepared formal written documents on the hedging relationship, risk management objectives and hedging strategies. The document at least includes hedging instruments, hedging items, the nature of hedging risk and the evaluation method of hedging effectiveness. Hedging must be related to specific identifiable and specified risks and ultimately affect the profit and loss of the enterprise.
2. The hedging expectation is highly effective, which is in line with the risk management strategy originally determined by the enterprise for the hedging relationship.
3. For the cash flow hedging of the expected transaction, the expected transaction should be likely to occur, and the enterprise must bear the risk of cash flow changes that ultimately affect the profit and loss.
4. Hedging effectiveness can be measured reliably.
5. The enterprise shall continuously evaluate the effectiveness of hedging (i.e. past effectiveness and future effectiveness) to ensure that the hedging relationship is highly effective in the specified accounting period.
Verb (abbreviation for verb) hedge accounting
1. Characteristics of fair value hedging accounting treatment
2. The characteristics of cash flow hedging accounting treatment
3. Hedging accounting characteristics of net investment in overseas operations