With global corporate integration enabling exponential growth for Indian companies, exposure to global economic factors is inevitable. Companies engage in global trade or foreign currency transactions to benefit from arbitrage. However, this may have a long-term impact on economic results of business transactions. Some of the common risks that companies face include foreign currency risk, commodity price risk and interest rate risk among others.
While companies’ risk management strategies limit the impact on cash flows, it is the P&L which is considered the pulse of financial health. The accounting technique to link the risk management strategy to the P&L is called ‘hedge accounting’, a privilege accounting under the accounting standards (Ind AS 109 or IFRS 9). When correctly applied, hedge accounting and valuation techniques can smoothen the P&L and maintain a parity between cash flows.
Why is hedge accounting advisory required?
- Accounting mismatch between hedged item and hedging instruments, even if cash flows have been insulated from market variables
- Natural hedging strategies do not reflect in P&L – Owing to different accounting basis of items hedged and the hedging instrument; P&L distortion is inevitable till the transaction is realised
- Hedging instruments for forecast transactions or future commitments – Reflect one-sided exposure in financial statements till the ensued transaction materialises
- Accounting complexity in interpretation and application of guidance on hedge accounting
- Significant pre-requisites to apply hedge accounting (like risk management strategy, hedging relationships – how they qualify for hedge accounting, etc.)
How do we assist?
- Defining hedge management strategies and documentation
- Hedge effectiveness testing at inception and periodically
- Valuation of hedging instruments
- Accounting for hedging transactions and financial reporting on a periodical basis
- Making standard templates for effectiveness testing, accounting and disclosures, for scalable and recurring reporting