Accounting for a Fair Value Hedge. If the derivative instrument and the hedged item satisfy the above criteria, then the fair value hedge will qualify for special accounting. The gain or loss on the derivative instrument will be recognized currently in earnings, along with the change in value on the hedged item, and an appropriate adjustment to the basis of the hedged item will be recorded. If the cumulative change in the value of the derivative instrument does not exactly offset the cumulative change in the value of the hedged item, the difference is recognized currently in earnings.
Examples of fair value hedges against inventory, a firm commitment, and a fixed interest notes payable follow. Entries for the transaction/commitment are presented side by side with entries for the hedges. All transaction costs are ignored. The examples include the use of derivatives in the form of a futures contract, forward contract, and swap. Note, however, that other types of derivatives could have been used in some of these examples.
The special accounting treatment given a fair value hedge should continue unless:
- The criteria necessary for special accounting treatment are no longer satisfied,
- The derivative instrument expires or is sold, terminated, or exercised,
- The entity no longer designates the derivative instrument as a fair value hedge, or
- The hedging relationship is no longer considered highly effective based on management’s policies.