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11.10 Eligible hedging instruments
Publication date: 14 Oct 2019
us IFRS & US GAAP guide
Several differences exist between the two frameworks as it relates to the eligibility of the hedging instruments.
11.10.1 Eligible hedging instruments - nonderivatives
Both US GAAP and IFRS permit nonderivatives to be designated as hedging instruments in certain cases. IFRS generally permits nonderivatives to be designated as hedging instruments in more instances than US GAAP. Nonderivative financial instruments are most commonly used as hedges in hedge relationships involving foreign currency risk, which is permitted under both frameworks. In this way, US GAAP and IFRS are similar. As a result, there is not a substantive difference in practice in most cases.
US GAAP |
IFRS |
Generally, a nonderivative may not be used as a hedging instrument. However, certain nonderivative financial instruments that may give rise to a foreign currency transaction gain or loss may be designated in a hedge of foreign currency risk in fair value hedges of firm commitments and net investment hedges.
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Nonderivative financial instruments classified at fair value through profit or loss are permitted to be used as hedging instruments for all types of risks (except for financial liabilities when changes in fair value as a result of credit risk are presented in OCI).
The foreign currency component of nonderivative financial instruments can be designated as a hedge of FX risk (except for equity instruments for which changes in fair value are recorded in OCI).
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11.10.2 Foreign currency risk - location of hedging instrument
IFRS permits a parent company to hedge exposures of an indirect subsidiary regardless of the functional currency of intervening entities within the organizational structure. The rules under US GAAP for hedges of foreign exchange risk for forecasted transactions (cash flow hedges) or net investments in foreign operations are prescriptive regarding the functional currency and structure of the entities involved.
US GAAP |
IFRS |
Either the operating unit that has the foreign currency exposure or another member of the consolidated group that has the same functional currency as that operating unit must be a party to the hedging instrument. However, for another member of the consolidated group to enter into the hedging instrument, there cannot be an intervening entity with a different functional currency. Instead, entities may designate intercompany derivatives between the subsidiary with the exposure and the entity that is a party to an offsetting external derivative if certain criteria are met.
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IFRS does not require the entity with the hedging instrument to have the same functional currency as the entity with the hedged item or the operating unit exposed to the risk being hedged within the consolidated group to be a party to the hedging instrument. For example, IFRS allows a parent company with a functional currency different from that of a subsidiary to achieve cash flow hedge accounting for the subsidiary’s transactional foreign currency exposure (i.e., an exposure in a currency other than the subsidiary’s functional currency).
The same flexibility regarding location of the hedging instrument applies to net investment hedges.
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