Tapping into the global economy can be an effective way to expand business. However, foreign exchange rate volatility plays a vital role in the success of a company's international business, by contributing unexpected profits or losses. Hedge accounting is a flexible tool of profit/loss account management, designed for companies that bear risks associated with currency, commodity or interest rate. By implementing hedge accounting, a company gains a possibility of excluding itself from profit/loss account, and the effects of valuation of instruments are used for hedging purposes. Hedge accounting is permitted in certain cases, where hedging relationships are clearly defined, reliably measured and are actually effective. Hedge accounting is optional and management, while deciding whether to use it or not, should also consider the costs and benefits.

The aim of hedging is to mitigate the impact of economic risks on the entity's performance. Many companies are engaging in hedging activities to limit their exposure to economic risks. This is as simple as borrowing in a foreign currency, where an entity has an anticipated revenue stream in that currency. Many hedging strategies, to reduce economic risks, meet the criteria to qualify for the special accounting treatment identified in IFRS as hedge accounting.

Hedge accounting is a privilege, not a right. It is special accounting treatment for designated hedges that meet the required criteria outlined in the accounting standards. In typical accounting treatment, forex hedges are carried on the balance sheet at their fair market value, with any changes in the carrying value impacting the income statement in each reporting period. Sometimes this typical treatment creates a timing mismatch in terms of, when the forex hedge impacts earnings and when the hedged item impacts earnings. On the other hand, forex hedge accounting overrides the method of recording the effect on earnings in the reporting period, as gain/loss of the hedge items and the gain/loss of the forex hedge, are recorded in earnings at the same time. In other words, hedge accounting modifies the usual accounting treatment of a hedging instrument and/or a hedged item to enable gains and losses on the hedging instrument to be recognized in the income statement in the same period as offsetting losses and gains on the hedged item.

The right to perform special hedge accounting for designated forex hedges must be earned by meeting the required criteria and documentation requirements. It is not an automatic right. Proper documentation is critical in achieving hedge accounting treatment and must be supplied up front before a hedge is initiated. Further, in order to ensure that the hedge is effective both prospective and retrospective assessments of a forex hedge must take place over its lifetime.

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