Question

What is hedge accounting and, under US GAAP, what conditions must be met before it can be used?

Define “cash flow hedge,”“fair value hedge,” and state their differences.

State the difference between “accounting exposure” and “transaction exposure.”

What are the differences and similarities in treating translation of foreign currency financial statement between US GAAP and IFRS?

Answer 1

Solution:

1. A hedge is a financial instrument that mitigates risk . An accounting practice which provides an offset to the Mark-to-Market (MTM) movement of the derivative in the P&L a/c is known as Hedge Accounting.

2. Cash flow hedge: A cash flow hedge may be designated for a highly probable forecasted transaction, a firm commitment (not recorded on the balance sheet), foreign currency cash flows of a recognized asset or liability, or a forecasted intercompany transaction.

Fair value hedge: A fair value hedge may be designated for a firm commitment (not recorded) or foreign currency cash flows of a recognized asset or liability.

Differences

Sl.No.	Difference of Points	Cash flow hedge	Fair value hedge
1	Mitigation of Risk	It manages the risk associated with cash flows rather than asset or liability values.	It mitigates the risk of changes in the fair (market) value of an asset, a liability of an unrecognized firm commitment.

3. Accounting Exposure is a disclosure of the hedging transactions through passing an accounting entry that may not have economic risk.

Transaction Exposure is an identifier for the profit or loss from a hedging transaction  that may have economic impact on the business.