A cash flow hedge is a hedge of the exposure to variability in the cash flows of a specific asset or liability, or of a forecasted transaction, that is attributable to a particular risk. It is possible to only hedge the risks associated with a portion of an asset, liability, or forecasted transaction, as long as the effectiveness of the related hedge can be measured. The accounting for a cash flow hedge is as follows:
- Hedging item. Recognize the effective portion of any gain or loss in other comprehensive income, and recognize the ineffective portion of any gain or loss in earnings.
- Hedged item. Initially recognize the effective portion of any gain or loss in other comprehensive income. Reclassify these gains or losses into earnings when the forecasted transaction affects earnings.
A key issue with cash flow hedges is when to recognize gains or losses in earnings when the hedging transaction relates to a forecasted transaction. These gains or losses should be reclassified from other comprehensive income to earnings when the hedged transaction affects earnings.
Cash flow hedge accounting should be terminated at once if any of the following situations arises:
- The hedging arrangement is no longer effective
- The hedging instrument expires or is terminated
- The organization revokes the hedging designation