📌 Note for CIMA students
Hedge Accounting IFRS 9 Explained: Hedge accounting was removed from the CIMA exam syllabus in 2019 and is no longer examinable in any CIMA paper. This article is a professional knowledge resource for finance practitioners and those studying financial reporting standards more broadly. For current CIMA F3 exam preparation, please visit our F3 course page.
Hedge accounting sits at the intersection of risk management and financial reporting. When a company hedges its exposure to interest rate or currency risk, the accounting treatment for that hedge — how gains and losses are recognised and when they flow through the financial statements — can have a significant impact on reported profit.
Under IFRS 9, three types of hedge are recognised, each with its own accounting treatment. Getting the classification right is the foundation of everything else. This article walks through all three types, explains the logic behind each treatment, and covers what changed when IFRS 9 replaced the older IAS 39 standard.
Hedging means taking a deliberate action to remove or reduce your exposure to an externally set price — most commonly an interest rate or an exchange rate, though in principle it could be the price of any globally traded commodity such as oil or gold.
The mechanism is straightforward: you create a second transaction whose value moves in the opposite direction to your underlying exposure. If the underlying position generates a loss, the hedge generates an offsetting gain — and vice versa. Gains and losses cancel each other out, replacing uncertainty with a known outcome.
The most common exposures hedged by businesses are interest rate risk (the risk that borrowing costs or investment returns move unfavourably) and foreign exchange risk (the risk that exchange rate movements affect the value of overseas transactions or assets).
Before looking at the accounting treatment, it helps to understand the instruments used to construct a hedge. Under IFRS 9, any of these can form part of a designated hedging relationship.
A bespoke, over-the-counter agreement — typically with a bank — to buy or sell a fixed amount of currency or to fix an interest rate on a specific future date. Both parties are named and the rate is fully locked in. No flexibility once agreed.
A standardised forward contract traded on an exchange, covering standard amounts and expiry dates. Because it is standardised it can be bought and sold before expiry — but this introduces a small degree of basis risk.
Give the holder the right — but not the obligation — to transact at a set rate. A put option is the right to sell; a call option is the right to buy. Flexibility comes at a cost: a non-refundable upfront premium.
Two parties exchange payment obligations — most commonly fixed for variable interest (interest rate swap), or cash flows in one currency for another (currency swap). Usually arranged through a bank to reduce counterparty risk.
IFRS 9 recognises three distinct types of hedge, each with its own accounting treatment. The classification depends on one central question: what exactly is the hedging instrument protecting?
A fair value hedge protects an existing asset or liability that is already on the balance sheet. A classic example: a company has sold goods to an overseas customer and has a trade receivable denominated in foreign currency. The receivable is already recognised, but its sterling value will fluctuate as exchange rates move. A forward contract taken out to fix the exchange rate is a fair value hedge.
Accounting treatment: Both the hedging instrument and the hedged item are remeasured to fair value at each reporting date. The resulting gains and losses go directly to the profit and loss account (P&L). Because the two sides move in opposite directions, they largely cancel out — which is precisely the point.
An important practical nuance: fair value hedging also allows a company to revalue a hedged item upwards even where it would not normally do so — for example, inventory where the underlying commodity price is being hedged. The corresponding loss on the hedging instrument offsets the gain on inventory, leaving P&L relatively stable.
Key identifier: existing recognised asset or liability.
A cash flow hedge protects a probable future transaction that has not yet occurred — for example, a sale expected next quarter in a foreign currency, or a variable-rate interest payment due in six months.
The problem that arises here is one of timing. At the reporting date you already have the hedging instrument in place, but the underlying transaction has not happened yet. Under the default fair value approach, you would remeasure the instrument at the reporting date and put the result through P&L — creating volatility in reported profit even though no actual transaction has occurred. That is the opposite of what a hedge is supposed to achieve.
Accounting treatment: The effective portion of gains and losses on the hedging instrument is deferred in Other Comprehensive Income (OCI) — a holding area that sits outside the main P&L. It stays there until the underlying transaction actually occurs, at which point the deferred amount is recycled from OCI into P&L. The timing of the hedging gain or loss is therefore matched to the timing of the hedged transaction.
Key identifier: probable future transaction not yet on the balance sheet.
This type of hedge applies when a company has an investment in an overseas subsidiary or operation — a business, factory, or other asset whose value is denominated in a foreign currency. A common approach is to fund that investment with a loan in the same foreign currency: as the foreign currency weakens and the asset’s reported value falls, the liability of the loan falls by a corresponding amount.
Accounting treatment: All remeasurement gains and losses — on both the overseas investment and the hedging instrument — are taken to OCI and remain there until the overseas operation is disposed of. Nothing passes through P&L while the hedge is in place. This is the most conservative of the three treatments.
Key identifier: investment in an overseas operation, offset by a liability in the same foreign currency.
| Hedge type | What is being hedged? | Where do gains/losses go? | Typical example |
|---|---|---|---|
| Fair value hedge | Existing asset or liability on the balance sheet | Profit and loss account (P&L) | Foreign currency receivable hedged with a forward contract |
| Cash flow hedge | Probable future transaction not yet recognised | OCI until the transaction occurs, then recycled to P&L | Anticipated future sale in USD hedged with a currency future |
| Net investment hedge | Investment in an overseas operation | OCI — stays there until the operation is disposed of | Overseas subsidiary hedged with a foreign currency loan |
Quick reference — classifying a hedge
• Existing asset or liability on the balance sheet → Fair value hedge → P&L
• Probable future transaction not yet recognised → Cash flow hedge → OCI first, recycled to P&L when it happens
• Investment in an overseas operation → Net investment hedge → OCI only
Under the previous standard, IAS 39, companies had to prove that a hedge was effective using a precise numerical test. The ratio of the gain on the hedging instrument to the loss on the hedged item (and vice versa) had to fall within a specific corridor: 80% to 125%. If effectiveness fell outside this range — even slightly — the company lost the right to apply hedge accounting treatment.
IFRS 9 replaced this rigid corridor with a principles-based approach. Companies must still assess and document the hedging relationship and demonstrate that it is economically sound, but there is no longer a fixed numerical threshold. The 80–125% rule is gone.
If a hedge is working correctly and the gains and losses are genuinely offsetting one another, you might ask: why does it matter how they are accounted for?
The answer is timing. Without hedge accounting designation, gains and losses on a hedging instrument are recognised as they arise — potentially in a different period to the underlying transaction they are protecting. The result is artificial volatility in reported profit that misrepresents the company’s actual risk position. Hedge accounting rules exist to correct this: they align the recognition of the hedge’s gain or loss with the recognition of the exposure it is protecting.
This matters in practice for any finance professional reviewing or preparing financial statements that include hedging activity. Understanding which treatment applies — and why — is essential to interpreting whether the reported numbers reflect the economic substance of the company’s risk management strategy.
Supporting copy: Work through our full CIMA F3 course — covering financial strategy, risk management, and valuation, all aligned to the current syllabus.
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