On the date of this standard becoming mandatory, an entity should not reflect in its financial statements a hedging relationship of a type that does not qualify for hedge accounting under this standard (for example, hedging relationships where the hedging instrument is a cash instrument or written option; where the hedged item is a net position; or where the hedge covers interest risk in a held-to-maturity investment). However, if an entity designated a net position as a hedged item under its previous accounting policy, it may designate an individual item within that net position as a hedged item under Accounting Standards, provided that it does so on the date of this standard becoming mandatory.

It, before the date of this standard becoming mandatory, an entity had designated a transaction as a hedge but the hedge does not meet the conditions for hedge accounting in this standard, the entity should apply paragraphs 102 and 112 to discontinue hedge accounting. Transactions entered into before the date of this standard becoming mandatory should not be retrospectively designated as hedges.

Embedded Derivatives

As entity that applies this standard for the first time should assess whether an embedded derivative is required to be separated from the host contract and accounted for as a derivative on the basis of the conditions that existed on the date it first became a party to the contract or on the date on which a reassessment is required by appendix A paragraph A56, whichever is the later date.

Recent Announcement

Notwithstanding the applicability of AS-30, it is very important to understand the impact and effect of this announcement. The announcement on accounting for derivatives issued by ICAI on March 29, 2008, clarifies the best practice treatment to be followed for all derivatives is as follows:

(i) All derivatives except forward contracts covered by AS 11, can be accounted for on the basis of the requirements prescribed in AS 30, Financial Instruments: Recognition and Measurement.

(ii) In case an entity does not follow AS 30, keeping in view the principle of prudence as enunciated in AS 1, ‘Disclosure of Accounting Policies’, the entity is required to provide for losses in respect of all outstanding derivative contracts at the balance sheet date by marking them to market.

The effect of the above announcement is as follows:

(i) In case an entity does not follow AS 30, the losses in respective of derivative contracts at the balance sheet date have to be provided for and disclosed.

(ii) In case an entity follows AS 30, then the effect will be broadly as follows:

In case the derivatives do not meet the hedge accounting criteria as laid down in AS 30, the gains or losses in respect thereof will have to be recognised in the statement of profit and loss. The derivatives will have to be shown as financial assets or financial liabilities on the balance sheet, as the case may be, as per the requirements of the accounting standard.

In case the hedge accounting criteria, e.g., hedge effectiveness, qualifying hedges, documentation etc, as laid down in AS 30 are met, the entity will have to consider, keeping in view the requirements of AS 30, whether the hedge is a fair value hedge or cash flow hedge.

‘Fair value hedge’ and ‘cash flow hedge’ have been explained in AS 30 as follows:

(a) Fair value hedge: A hedge of the exposure to changes in fair value of a recognised asset or liability or an unrecognised firm commitment, or an identified portion of such an asset, liability or firm commitment, that is attributable to a particular risk and could affect profit or loss.

(b) Cash flow hedge: A hedge of the exposure to variability in cash flows that (i) is attributable to a particular risk associated with a recognised asset or liability (such as all or some future interest payments on variable rate debt) or a highly probable forecast transaction and (ii) could affect profit or loss.

As per the standard, a hedge of the foreign currency risk of a firm commitment may be accounted for as a fair value hedge or a cash flow hedge.

Fair value hedges are accounted for as follows:

The gain or loss for re-measuring the derivative hedge instruments at fair value should be recognised in the statement of profit and loss, and

The gain or loss on the hedged items (the underlying) should adjust the carrying amount of the said items and be recognised in the statement of profit and loss.

Cash flow hedges are accounted for as follows:

(i) In case of effective cash flow hedges, the gain or loss on the hedging derivative is recognised directly in an appropriate equity account, say, hedge reserve account (the ineffective hedge portion is recognised in the statement of profit and loss account).

(ii) If a hedge of a forecast transaction subsequently results in the recognition of a financial asset or a financial liability, the associated gains or losses that were recognised directly in the appropriate equity account in accordance should be reclassified into, i.e., recognised in the statement of profit and loss in the same period or periods during which the asset acquired or liability assumed affects profit or loss (such as in the periods that interest income or interest expense is recognised).

(iii) If a hedge of a forecast transaction, subsequently results in the recognition of a non-financial asset or a non-financial liability, or a forecast transaction for a non-financial asset or non-financial liability becomes a firm commitment for which fair value hedge accounting is applied, then the entity should adopt (a) or (b) below:

(a) It reclassifies, i.e., recognises, the associated gains and losses that were recognised directly in the appropriate equity account into the statement of profit and loss in the same period or periods during which the asset acquired or liability assumed affects profit or loss (such as in the periods that depreciation expense or cost of sales is recognised).

(b) It removes the associated gains and losses that were recognised directly in the equity account, and includes them in the initial cost or other carrying amount of the asset or liability.

An entity should adopt either (a) or (b) as its accounting policy and should apply it consistently to all hedges to which (iii) above relates.

(iv) For cash flow hedges, other than those covered by paragraphs (ii) and (iii) above, amounts that had been recognised directly in the equity account should be reclassified into, i.e., recognised in the statement of profit and loss in the same period or periods during which the hedged forecast transaction affects profit or loss (for example, when a forecast sale occurs).

The above is only a summary. For the detailed application, Accounting Standard (AS) 30 should be referred to.

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