If the derivative instrument and the hedged item satisfy the qualifying criteria, then the cash flow hedge will qualify for special accounting. The gain or loss on the derivative instrument will be reported in other comprehensive income (OCI),7 and the ineffective portion, if any, will be recognized currently in earnings. As with fair value hedges, a portion of the derivative instrument’s gain or loss may be excluded from the assessment of effectiveness. That portion of the gain or loss will be recognized currently in earnings rather than as a component of other comprehensive income.
The gain or loss on a cash flow hedge is reported as OCI, rather than recognized currently in earnings, because the hedged forecasted cash flows have not yet occurred or been recognized in the financial statements. The hedge is intended to establish the values that will be recognized once the forecasted transaction occurs and is recognized. Once the forecasted transaction has actually occurred, the OCI gain or loss will be reclassified into earnings in the same period(s) as the forecasted transaction affects earnings.
For example, assume that a forecasted sale of inventory is hedged. Once the inventory is sold and recognized in earnings, the applicable amount, the OCI gain or loss, will also be recognized in earnings. If the forecasted transaction were a purchase of a depreciable asset, the applicable portion of the OCI would be recognized in earnings when the asset’s depreciation expense is recognized.