Accounting Dictionary

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Hedging

Definition: Hedging is a risk reduction technique whereby an entity uses a derivative or similar instrument to offset future changes in the fair value or cash flows of an asset or liability. A hedged item can be any of the following individually or in a group with similar risk characteristics:

• Highly probable forecast transaction
• Net investment in a foreign operation
• Recognized asset
• Recognized liability
• Unrecognized firm commitment

Hedge effectiveness is the amount of changes in the fair value or cash flows of a hedged item that are offset by changes in the fair value or cash flows of a hedging instrument.

Hedge accounting involves matching a derivative instrument to a hedged item, and then recognizing gains and losses from both items in the same period.