GOV.UK uses cookies to make the site simpler.Find out more about cookies

This publication is licensed under the terms of the Open Government Licence v3.0 except where otherwise stated. To view this licence, visitnationalarchives.gov.uk/doc/open-government-licence/version/3or write to the Information Policy Team, The National Archives, Kew, London TW9 4DU, or email:.gov.uk.

Where we have identified any third party copyright information you will need to obtain permission from the copyright holders concerned.

Companies will often try to reduce or mitigate the financial effects from risks that could impact upon the companys core business. The company will often enter into derivative contracts which will be structured to minimise these risks. The hedged item is the asset, liability or future transaction whose risk is being mitigated. The hedging instrument is the instrument used to mitigate the risk associated with the hedged item. A hedging relationship is where a company has a hedging instrument to mitigate the risk from the hedged item.

Financial Reporting Standard (FRS) 102 identifies 3 main types of hedging relationships:

fair value hedges are intended to hedge the exposure to variations in the fair value of the hedged item and which could affect profit or loss

cash flow hedges are intended to hedge the exposure to variations in cash flows that are attributable to a risk associated with the hedged item and which could affect profit or loss

net investment hedges are intended to hedge movements in the assets and liabilities held in a foreign investment with foreign exchange movements on the related financing

Not all hedging arrangements qualify for hedge accounting and the following conditions must apply.

a recognised asset or liability – or a component of such an item

an unrecognised firm commitment – or a component of such an item

a highly probable forecast transaction – or a component of such an item

be a financial instrument measured at fair value through profit or loss – unless as a hedge of foreign currency risk

be a contract with a party external to the group or individual entity that is being reported on

not be a written option – unless is an offset to or is combined with a purchased option

consistent with companys risk management objectives

documented by the entity as a hedging relationship so that the risk being hedged, the hedged item and the hedging instrument are clearly identifiable

assessed and documented for causes of hedge ineffectiveness

The effect is to adjust the accounting of the hedging instrument by taking the fair value movements on the hedging instrument attributable to the hedged risk to a cash flow hedging reserve (shown within other comprehensive income). These amounts are then recycled from the cash flow hedging reserve to either the income statement or the carrying value of the asset/liability in line with the hedged risk.

The effect is to adjust the accounting of the hedged item by making an adjustment to the carrying value of the hedged item for the fair value risk being hedged. A corresponding amount in respect of this adjustment is recognised in the income statement.

The accounting similar to a designated cash flow hedge. However, amounts are not subsequently recycled from other comprehensive income.

The commentary above is based on the requirements of Section 12 ofFRS102. Companies which adoptFRS102 have the option of applying the recognition and measurement requirements of International Accounting Standards (IAS) 39 or International Financial Reporting Standard (IFRS) 9. The requirements of these standards do contain certain differences to those contained in Section 12.

Further guidance can be found in the Corporate Finance Manual atCFM27000onwards.

Dont include personal or financial information like your National Insurance number or credit card details.

To help us improve GOV.UK, wed like to know more about your visit today. Well send you a link to a feedback form. It will take only 2 minutes to fill in. Dont worry we wont send you spam or share your email address with anyone.

Prepare your business or organisation for the UK leaving the EU

Continue to live in the UK after it leaves the EU

Transparency and freedom of information releases

All content is available under theOpen Government Licence v3.0, except where otherwise stated