How To Leverage Hedge Accounting to Create a More Stable Earnings Profile for Your Business
Hedging can be a great solution to minimise the volatility that impacts cash flow. However, the accounting treatment of financial instruments under International Financial Reporting Standards (IFRS) can also result in undesirable fluctuations in your profit and loss statement.
The International Accounting Standards Board (IASB) understands companies want to avoid PnL fluctuations, so reporting entities can elect to apply hedge accounting under IFRS 9.
In this article, we’ll explore how your business can leverage IFRS 9 to create a more stable earnings profile….
What is IFRS 9?
IFRS 9 contains three main sections:
how businesses classify and measure financial instruments,
reporting the impairment of financial instruments,
and the use of hedge accounting.
When it comes to creating more stable earnings, if a business is managing its financial market risks with financial derivatives, it really needs to leverage hedge accounting.
Hedge accounting allows you to reclass gains and losses on Forward FX contracts and other cash flow hedges from an account on the PnL to a Hedge Reserve account on the Balance Sheet.
A Cash Flow Hedge Reserve (CFHR) is the Balance Sheet account for which hedge fluctuations are posted while underlying exposures are open. For example, recording a Forward FX derivative might result in a credit to Derivative Liabilities and a debit to Unrealized Losses on the Profit and Loss Statement. IFRS 9 allows your business to remove the Unrealised Loss attributable to the Forward FX contract by crediting the PnL account and debiting a Hedge Reserve account on the Balance Sheet. This creates a zero net impact on your Profit and Loss Statement.
The Benefits of IFRS 9
Implementing IFRS 9 and hedge accounting yields numerous benefits for CFOs. For one, your earnings profile is stabilised. Instead of reporting significant fluctuations in your Gain and Loss account on the PnL Statement, you smooth reporting in the PnL account from the hedge over the hedge's life cycle.
Moreover, you can make more instant, informed decisions by removing the noise of unrealised movements in your hedging instruments. Analysts constantly compare different businesses' financial performance. Hedge accounting improves the optics and financial metrics in your reports. Using undistorted financial statements allows all users of financial statements to make decisions based on the true financial health of your business.
Adopting IFRS 9 and Implementing a Cash Flow Hedge Reserve
IFRS 9 is a powerful tool for CFOs utilising hedges to reduce volatility and minimise risks. Adopting hedge accounting principles allows you to improve your earnings profile and smooth fluctuations in your PnL Statement through a Cash Flow Hedge Reserve Balance Sheet account.
Effective and compliant hedge accounting relies on having defined processes and internal procedures.
For more hedge accounting advice and best practices, read Hedge Accounting Unlocked or book a discovery call with our team.