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5.8 Economic hedging
Publication date: 31 Jul 2022
us Derivatives & hedging guide
The qualifying criteria for hedge accounting are rigorous and require a commitment of time and resources. To avoid the cost and the risk of misapplication of the rules, reporting entities may choose to not elect hedge accounting even though they have a risk management strategy that involves entering into derivatives.
Economic hedging refers to the use of a derivative that mitigates risk without applying hedge accounting. An entity choosing to treat a transaction as an “economic” rather than an “accounting” hedge will bear the volatility of changes in the fair value of the derivative instrument in its income statement.
5.8.1 Undesignated hedged item is remeasured through earnings
If the risk that is economically hedged pertains to an item that is reported at fair value through earnings based on other applicable GAAP, the effect of measuring the derivative and the hedged item will offset in the income statement (to the extent effective). This accounting is common for instruments such as debt securities classified as trading securities and other balances that are recorded at fair value under GAAP. In these cases, hedge accounting would generally not be permitted. It is also common for economic hedges of the foreign exchange risk on foreign currency-denominated monetary assets and liabilities, which are measured at the end of each reporting period using the exchange rate at that date with the resulting transaction gains and losses recorded in current earnings.
ASC 815-15-25-4 and ASC 825-10-15-4 provide an elective fair value option for certain hybrid financial instruments and certain financial assets and liabilities, respectively. Reporting entities may wish to elect fair value treatment for eligible items to offset the changes in fair value of the derivative instrument serving as an economic hedge.
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