Question

Discuss/explain the essence of fair value reporting for derivatives and identify concerns associated with it.

Answer 1

Fair value reporting of derivatives :-

There are two types of fair valuation reporting of derivatives those are as follows :-

1. Ongoing changes in the fair value of derivatives not used in hedging arrangements are generally recognised as earnings at once.

2. Ongoing changes in the fair value of derivatives in the head item with which there paid may be park in other comprehensive income for a period of time, thereby removing them from the basic earnings reported by business.

Concerns associated with fair value reporting of derivatives :-

1. Initial recognition when it is first acquired recognise a derivative instrument in the balance sheet as a asset or liability at its fair value

2. Subsequently recognition, recognise all subsequent changes in the value of derivative (known as market to market) if the instrument has been paid with a hedged item recognise this fair value changes in other comprehensive income

3. If hedge is not active then while doing subsequent recognition the fair value changes to be treated as earnings but not as other comprehensive income.

Various instruments having different recognitions are as follows :-

1. Held to maturity investment, this is a debt instrument which has a commitment to hold this type of investment in the maturity. When such investment is being hedged, there may be a change in fair value of paired forward contract or purchase option. It's ok, only recognise the loss in earnings when there is another than temporary decline in in hegding instrument value.

2. Trading securities, this may be debt or equity instruments. if there is any changes in fair valuation of this type of securities then record these changes as changes in earnings but not what in other comprehensive income.

3. Available-for-sale securities, this may be equity or debt instruments. If this type of securities are hedged with some paired instrument. If the changes other than temporary and the change is lost then record it in earnings. Keep the change is is due to temporary decline and record it as other comprehensive income.

Please don't confuse between the classification of changes and treatment of earnings and other comprehensive income. It is very clear in above 3 types of hedging instruments so please go through it carefully.

This is the essence of fair value reporting for derivatives and some of the concerns associated with it.

These are all the information required to solve the given question.

I hope, all the above mentioned information and explanations are useful and helpful to you.

Thank you.