[Anonymous]

I’m preparing for FAR in a few weeks and I have a question related to accounting for derivatives.

In Becker, Financial 7 (F7-5 to be exact…under B 3. Cash Flow Hedge), it mentions that accounting for a cash flow hedge depends on whether the cash flow was effective or ineffective. Specifically, it says “Gains/losses on the effective portion of a cash flow hedge are deferred and are reported as a component of OCI”. It goes on to say gains/losses on ineffective portions are reported in current income.

My question is what is an effective loss cash flow hedge and what is an ineffective gain cash flow hedge? Seems like the only “effective” cash flow hedge would be one that results in a gain, and vice-versa for ineffective cash flow hedges.

Thanks in advance for any help.

[thorsbew]

Hi Clarkface,

I'm taking FAR on Monday as well. I took this to mean the general effectiveness of the hedge. Effectiveness meaning that it must be between 80% and 120%. So if you had a gain on your stock, your hedge would be at a loss for a similar amount and still be deemed effective.

However, I'm sort of at a loss with you regarding the differentation of which portion is effective and which isn't. Anyone else that can contribute? Is the effective portion the intrinsic value and the ineffective portion is the time value?

Aud - 65 + 79, BEC - 82, REG - 89, FAR - 86

[Zaiitz3]

I would love to bring this question back. I'm currently studying for FAR and I noticed that in the NINJA notes, it states that the Gains or Loss go to OCI for the Cash Flow Hedge. BUT, Becker stated that the ineffective portion of the hedge would go to the Income Statement. Wouldn't that be a loss?

*New York*
AUD 74, 88! 04/02/12
BEC 75! 08/30/12
FAR 68, 73, 83! 10/27/12
REG 80! 11/24/12

DONE!!!

"Be miserable. Or motivate yourself. Whatever has to be done, it's always your choice.” - Wayne Dyer

[Kodiak]

Is it possible to have an effective and ineffective cash flow hedge in the same period– or are the amounts netted?

Just a guess, but could it be that gains always go to OCI and ineffective portions reduce this amount down to 0, in which case any remaining losses would hit the IS? I've completely forgotten the principles reporting these 🙁

AUD - Pass
FAR - Pass
BEC - Pass
REG - Nov

[sbruce810]

You shouldn't think of an effective/ineffective hedges in terms of gains and losses. Instead, you should think of them in terms of terms of tracing the change in fair value of the hedged item. A hedge is considered effective if its offsets the change in value of the hedged item in the range of 80-125%. So, if the hedged item loses 50,000 in value, the hedge would be effective if its value increased in the range from 40,000 – 62,500. The difference between the value of the hedge and hedged item in the range would go to OCI for the period and any difference outside the range would be recognized in earnings.

AUD - Passed
BEC - Passed
FAR - Passed
REG - Passed

Done

[Kodiak]

Thanks for the response.

So in your example above, if the hedged item loses $50,000 but the hedge returns $65,000, $12,250 would be recognized in OCI and and the other $2,500 on the I/S?

AUD - Pass
FAR - Pass
BEC - Pass
REG - Nov

[Author]

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