A hedge can work and still put a loss into this period's results, because the derivative is valued at market while the exposure it protects often is not. Hedge accounting moves the timing of that gain or loss, not its size, and IFRS 9 allows it only for a hedge designated and documented when it began.
A hedge can work exactly as intended and still put a loss into this period's results. The derivative is valued at market every reporting date, while the purchase, sale or inventory it protects is often not, so the two halves of one economic position are reported in different periods. Hedge accounting is the election that brings them back into the same period. It changes when a gain or loss is reported, not how large it is, and it is available only to a hedge that was formally designated and documented when it began. A hedge cannot be given that status later, once its result is known.
This article sets out what hedge accounting actually changes: why a working hedge produces a mismatch in the first place, how the two common treatments move a gain or loss to a different period, why the designation has to exist from the first day, what the relationship has to keep showing afterwards, how it ends, and what has to be kept for each relationship before its accounting can be defended. It is written for the people who carry the hedge from the desk into the accounts: the traders who place it, the risk and middle office who match it to the exposure, and the finance teams who designate it, test it and answer for it at the audit.
If the idea is new to you, start with A hedge can work and still put a loss in this period's results. If you already run designated hedges and want the part that goes wrong quietly, start with The relationship has to be written down when the hedge starts, not when its result is known.
The rules quoted here are those of IFRS 9, as adopted for use in the European Union. Companies reporting under other frameworks, including US GAAP, follow different rules, which this article does not describe.
A hedge can work and still put a loss in this period's results
A derivative is measured at fair value, and the change in that value is reported in profit or loss as it happens. The exposure it hedges is often not measured that way at all, so a hedge that offsets the exposure perfectly in cash can still leave one period with a loss and a later period with the matching gain.
Take a company that expects to buy a cargo in three months and fixes the price today by buying futures. If the market falls, the futures lose value and the cargo will be cheaper. Economically the two cancel, which is the point of the hedge. In the accounts they do not, because they are not recognised at the same time. The futures loss is measured at each reporting date and reported now. The cheaper cargo has not been bought yet; it is a forecast, not an asset, and nothing about it appears in this period's results. The saving shows up later, as a lower cost of the goods when they are sold.
The same gap appears in other shapes. Inventory is often carried at cost rather than at market value, so a short futures position against stock in a tank reports its gains and losses each period while the stock it protects does not. A firm commitment to buy or sell at a fixed price is not recognised on the balance sheet at all until delivery, so its hedge again reports alone.
Hedge accounting exists to close that gap. IFRS 9 states its purpose directly: "The objective of hedge accounting is to represent, in the financial statements, the effect of an entity's risk management activities that use financial instruments to manage exposures arising from particular risks that could affect profit or loss" (paragraph 6.1.1). And it is optional. The standard's wording is that "An entity may choose to designate a hedging relationship between a hedging instrument and a hedged item" (paragraph 6.1.2).
Hedge accounting does not make a hedge work. It makes the accounts show that it works, in the period in which it works. A company that never elects it is not hedging less. It is reporting its hedges in a way that separates them from the exposure they cover.
Hedge accounting moves the timing of a gain or loss, not its size
There are two treatments that matter for a commodity business. One moves the hedged item into the period of the hedge; the other moves the hedge into the period of the hedged item. Which one applies depends on whether the exposure is already on the books or still expected.
The first is the fair value hedge. It is used against something the company already has or has firmly committed to: inventory, or a fixed-price purchase or sale agreed but not yet delivered. The derivative's gain or loss is still reported in profit or loss as it happens. What changes is that the hedged item is now remeasured for the hedged risk too, so the two are reported side by side. For a firm commitment, which would otherwise not be recognised at all, IFRS 9 provides that "the cumulative change in the fair value of the hedged item subsequent to its designation is recognised as an asset or a liability with a corresponding gain or loss recognised in profit or loss" (paragraph 6.5.8).
The second is the cash flow hedge. It is used against something that has not happened yet, such as a forecast purchase or a forecast sale. Here the hedged item cannot be remeasured, because there is nothing on the books to remeasure. So the derivative's gain or loss is held back instead. The part of it that is an effective hedge goes to other comprehensive income, into a reserve within equity, and waits there for the hedged transaction (paragraph 6.5.11(b)). When the forecast purchase of a commodity actually happens, the standard requires that "the entity shall remove that amount from the cash flow hedge reserve and include it directly in the initial cost or other carrying amount of the asset or the liability" (paragraph 6.5.11(d)(i)). The hedge result becomes part of the cost of the inventory, and reaches profit or loss as that inventory is sold.
A forecast transaction qualifies only if it is likely. The standard's words are that "If a hedged item is a forecast transaction (or a component thereof), that transaction must be highly probable" (paragraph 6.3.3). A purchase that might happen, depending on how the season goes, is not a hedged item.
In neither treatment does the amount change. A futures loss of a given size is the same loss with or without hedge accounting. What the election decides is which period's results carry it, and whether it is reported next to the thing it was protecting.
The relationship has to be written down when the hedge starts, not when its result is known
Hedge accounting applies only to a relationship that was formally designated and documented at the moment it began. The documentation is not a description of the hedge written afterwards. It is the condition that makes the treatment available at all.
The qualifying criteria are set out in paragraph 6.4.1, and the second of them is the one this section is about. It requires that "at the inception of the hedging relationship there is formal designation and documentation of the hedging relationship and the entity's risk management objective and strategy for undertaking the hedge." The paragraph goes on to say what the record must contain: "That documentation shall include identification of the hedging instrument, the hedged item, the nature of the risk being hedged and how the entity will assess whether the hedging relationship meets the hedge effectiveness requirements", including the sources of ineffectiveness and how the hedge ratio is set.
The timing is what makes this demanding. The trader places the futures on the day the exposure appears, because that is when the price is available. The designation has to exist from that same point. A hedge documented at month-end, after the market has moved, was not designated at inception; for the period between the trade and the document, it was an undesignated derivative, reported in profit or loss like any other.
And the record does not follow from the trades. The futures position is in the trading system, and so is the physical purchase. Which futures are designated against which purchase, how much of the purchase, against which risk, and on what test, exists only if somebody writes it down. A hedge relationship is a separate object from the trades it connects, and it has to be created deliberately. Nothing about booking the two trades creates it.
The test looks forward, and the part of the hedge that does not offset still reaches profit or loss
Designation is not the last condition. The relationship has to keep meeting the effectiveness requirements for as long as it is designated, and hedge accounting does not hide the part of the hedge that fails to offset. That part is reported in profit or loss as it arises.
Paragraph 6.4.1(c) sets out three requirements: that "there is an economic relationship between the hedged item and the hedging instrument", that "the effect of credit risk does not dominate the value changes that result from that economic relationship", and that the hedge ratio designated is the one the company actually uses to manage the risk. The assessment is made at inception and then on an ongoing basis, and the standard is explicit about its direction: "The assessment relates to expectations about hedge effectiveness and is therefore only forward-looking" (paragraph B6.4.12). Nor does it prescribe how the test is done: "This Standard does not specify a method for assessing whether a hedging relationship meets the hedge effectiveness requirements" and "Depending on those factors, the method can be a qualitative or a quantitative assessment" (paragraph B6.4.13).
Passing that test does not make the hedge perfect, and the imperfection is not absorbed. In a cash flow hedge, whatever part of the derivative's gain or loss is not matched by the hedged cash flows "is hedge ineffectiveness that shall be recognised in profit or loss" (paragraph 6.5.11(c)). In a commodity book that part has familiar sources. The futures are dated to a contract month while the cargo prices over a window of dates. The futures reference a benchmark while the cargo carries a differential for its own grade and location. The futures quantity is fixed while the physical volume settles within a tolerance.
The standard offers one way to narrow the gap, and it fits formula-priced physical trade closely. Instead of designating the whole price of a purchase as the hedged risk, a company may designate only a component of it, provided that "the risk component is separately identifiable and reliably measurable" (paragraph 6.3.7(a)). A purchase priced as a benchmark average plus a differential has the benchmark written into its contract. Designating only that benchmark component against benchmark futures removes the differential from the relationship, and with it a source of ineffectiveness.
The differential that a benchmark hedge leaves open is a position of its own. Where it comes from, and why futures cannot reach it, is worked through for physical crude. Crude Oil Trading: Why the Barrel You Hedge Is Not the Barrel You Own
Designating a component does not make the differential go away. It moves it out of the hedge relationship and leaves it as an unhedged exposure, reported as such. Hedge accounting can make a hedge's result line up with its exposure; it cannot make a partial hedge complete.
A rolled hedge can continue, but a designation cannot be dropped at will
Under IFRS 9 a hedge relationship ends when it stops meeting the qualifying criteria, not when the company would prefer it to. Rolling the hedge from one contract into the next keeps it alive only if the roll was part of the documented objective from the start.
The rule on discontinuation is narrow: "An entity shall discontinue hedge accounting prospectively only when the hedging relationship (or a part of a hedging relationship) ceases to meet the qualifying criteria" (paragraph 6.5.6). A relationship that still qualifies, and whose risk management objective has not changed, cannot simply be switched off because its results have become inconvenient.
For a commodity hedge the more common question runs the other way. A long-dated exposure is often hedged in the nearest liquid futures month and rolled forward as each contract approaches expiry. Each roll closes the designated instrument and opens a new one, which looks like the end of the hedging instrument. The same paragraph addresses it: "the replacement or rollover of a hedging instrument into another hedging instrument is not an expiration or termination if such a replacement or rollover is part of, and consistent with, the entity's documented risk management objective." The condition is in the last words. A roll strategy written into the documentation at inception carries the relationship through every roll. A roll that the documentation never mentioned is, for accounting purposes, the end of one hedge and an undesignated new position.
The other ending belongs to cash flow hedges, and it follows the physical business rather than the market. If the forecast purchase or sale stops being expected, a cargo cancelled or a volume that will not be lifted, the amount held in the reserve cannot wait for a transaction that will not happen: "that amount shall be immediately reclassified from the cash flow hedge reserve to profit or loss" (paragraph 6.5.12(b)). The standard draws a line here that matters for physical trade, where volumes and dates move: "A hedged future cash flow that is no longer highly probable to occur may still be expected to occur." A cargo that has slipped and become uncertain can end the hedge relationship without releasing the reserve. A cargo that has been cancelled releases it at once.
The facts that end a cash flow hedge are usually operational. A cancelled nomination, a lifted option or a reduced volume is recorded first by whoever handles the cargo, and it reaches the accounts only when that record reaches the person who keeps the designation.
The trades are in the trading system, and the designation usually sits beside it
The futures and the physical trades that make up a hedge relationship are usually captured in a trading system. The designation that links them, the effectiveness assessment and the record of rolls and changes are commonly kept in spreadsheets and memos maintained by the finance team.
There are good reasons for that arrangement. The documentation is a judgement made by people who answer for the accounts. The effectiveness method is chosen per relationship. The relationships change shape as hedges are rolled, rebalanced and partly closed. A workbook lets the people responsible see and adjust all of it.
What the workbook holds is a reference to the trades, not the trades. A designation names a futures position and a quantity of a physical purchase. When the purchase is amended, split across two cargoes, partly cancelled or repriced, the change happens in the trading system or in the operations mailbox. The designation still names what it named on the day it was written. The hedge relationship is correct when the person who maintains it has heard about every change to the trades inside it, and nothing signals when they have not. A hedge ratio that no longer matches the physical volume, a roll the documentation did not provide for, a forecast cargo that quietly stopped being expected: each looks like a complete file until the next effectiveness assessment or the audit opens it.
One hedge, reported three ways
| Without hedge accounting | Fair value hedge | Cash flow hedge | |
|---|---|---|---|
| What it is used against | Anything; no designation is made | Inventory, or a fixed-price purchase or sale already agreed | A highly probable forecast purchase or sale |
| Where the derivative's gain or loss goes | Profit or loss, each period | Profit or loss, each period | The effective part to a reserve in equity; the rest to profit or loss |
| What happens to the hedged item | Reported on its own basis, often later | Remeasured for the hedged risk and reported alongside the derivative | Nothing until the transaction happens; the reserve then joins its cost |
| When the two results line up | Only when the hedged item is finally reported | Each period | When the hedged transaction reaches profit or loss |
| What can end it early | Nothing to end | The relationship ceasing to meet the qualifying criteria | The same, and the forecast transaction ceasing to be expected |
Read down the second row: the derivative's gain or loss goes to the same place in the first two columns. The difference between them is the third row, whether the exposure is reported beside it. Read along the bottom row: every way a designated hedge can end early depends on facts recorded somewhere other than the hedge documentation.
A hedge relationship has to state seven things before its accounting can be defended
| Field | Why it is load-bearing |
|---|---|
| The date of designation, and the trade dates of the instruments in it | Shows whether the designation existed at inception or was written afterwards |
| The hedging instruments, by trade, and the quantity of each that is designated | A relationship names specific trades; a position total cannot be traced to them |
| The hedged item, the quantity designated, and whether it is firm or forecast | Decides the treatment, and for a forecast, whether it must stay highly probable |
| The risk being hedged: the whole price, or a named component such as the benchmark | Decides which price movements belong inside the relationship and which stay outside it |
| The hedge ratio, and how it was set | Must match the quantities actually used to manage the risk |
| The effectiveness method, and the sources of ineffectiveness it identified | Decides how the ongoing assessment is done, and what it is expected to find |
| The roll strategy, and every roll, rebalancing or partial discontinuation since | Decides whether each roll continued the relationship or ended it |
A relationship carrying all seven can be defended by someone who did not write it. A relationship missing any of them can be defended only by the person who remembers why it was set up.
Questions people ask about this
What is hedge accounting in simple terms?
It is an optional accounting treatment that reports a hedge and the exposure it protects in the same period. Without it, a derivative's gain or loss is reported as its value changes, while the purchase, sale or inventory it hedges is often reported later or on a different basis. Hedge accounting either remeasures the hedged item alongside the derivative or holds the derivative's result back until the hedged transaction happens. It changes when the result is reported, not how large it is.
Is hedge accounting mandatory?
No. Under IFRS 9 a company may choose to designate a hedging relationship, and a company that does not is still allowed to hedge. Its derivatives are then reported in profit or loss as their value changes, independently of the exposures they cover. Many companies elect hedge accounting for some hedges and not others, depending on whether the volatility it removes is worth the documentation and testing it requires.
Why does our hedge show a loss when the physical business is making money?
Because the two are probably reported in different periods. A futures hedge is measured at market each reporting date. A forecast purchase is not on the books at all, and inventory is often carried at cost, so the offsetting gain on the physical side has not been reported yet. Over the life of the hedge the two cancel as intended. Hedge accounting, where it is applied, brings them into the same period; without it, the timing difference shows up as a loss now and a better margin later.
Can we apply hedge accounting to a hedge that is already in place?
Not from its start date. IFRS 9 requires formal designation and documentation at the inception of the hedging relationship, so a hedge cannot be designated after its result is known and treated as though it had been designated from the beginning. A derivative already held can be designated into a new relationship, which then begins on the date it is documented. The standard anticipates this case: a derivative can be in or out of the money when it is designated, and that starting value is something the effectiveness assessment has to take into account.
Is there a percentage range a hedge has to stay within under IFRS 9?
IFRS 9 does not set one in its effectiveness requirements. It requires an economic relationship between the hedge and the hedged item, that credit risk does not dominate the value changes, and that the hedge ratio matches the one actually used to manage the risk. It states that it does not specify a method for assessing those requirements and that the method can be qualitative or quantitative, and it describes the assessment as forward-looking. Whatever is not offset is reported in profit or loss as ineffectiveness.
Can we hedge only the benchmark part of a physical purchase?
Under IFRS 9 a company can designate a risk component of a purchase as the hedged item, provided that component is separately identifiable and reliably measurable within the structure of that market. A physical purchase priced as a published benchmark plus a differential names the benchmark in its contract, which makes it a natural candidate. The differential is then outside the relationship. It remains an exposure, reported as such, and is not hedged by the benchmark futures.
What happens to the hedge accounting if a hedged cargo is delayed or cancelled?
It depends on whether the cargo is still expected. If it is cancelled and the purchase will not happen, the amount held in the cash flow hedge reserve is reclassified to profit or loss at once. If it has slipped and is no longer highly probable but is still expected, the hedge relationship can end while the reserve stays where it is until the purchase happens. A delay that moves the purchase to a different date can also create ineffectiveness, because the hedge is dated to the original timing.
Does rolling a futures hedge from one month to the next break the hedge relationship?
Not if the roll is part of the documented risk management objective. IFRS 9 treats the replacement or rollover of a hedging instrument as not being an expiration or termination when it is part of, and consistent with, that documented objective. The practical consequence is that the roll strategy belongs in the documentation from the start. A roll the documentation does not provide for ends the existing relationship.
Can we stop hedge accounting whenever we want?
Not under IFRS 9. Hedge accounting is discontinued only when the relationship, or part of it, stops meeting the qualifying criteria, including when the hedging instrument expires or is sold, terminated or exercised outside a documented roll. While the relationship still qualifies and the risk management objective is unchanged, it continues. That is a reason to think about each designation before it is made rather than after.
Are our physical forward contracts derivatives for accounting purposes?
They can be. IFRS 9 applies to contracts to buy or sell a non-financial item that can be settled net as if they were financial instruments, except those entered into and held for receipt or delivery in line with the company's expected purchase, sale or usage requirements. The standard treats a contract as outside that exception where the company has a practice of settling similar contracts net, or of taking delivery and selling within a short period to profit from short-term price movements or a dealer's margin. A trading business may therefore find that many of its physical forwards are measured at fair value already. That changes the shape of the mismatch hedge accounting is meant to close, and it is a judgement to make with your auditors contract by contract.
Can we run hedge accounting in spreadsheets?
Many companies do, and the arithmetic is rarely what fails. What fails is that a designation refers to trades held somewhere else, and changes to those trades, a split cargo, a partial cancellation, an unplanned roll, are made in the trading system or in operations without reaching the workbook. The point at which this becomes a problem is the first effectiveness assessment or audit at which the documentation describes a relationship the trades no longer support.
Where this lands in a trading system
Nothing above is an argument for buying software. It is an argument about what a hedge relationship is made of and where each part of it first exists. Some of those parts map onto system capabilities and some do not.
The first conclusion is that the futures and the physical trades a relationship connects have to be held where they can be read together, because the designation refers to both. That is the job of a CTRM/ETRM system providing complete trading lifecycle management for commodity traders, integrating physical trade, financial hedging, risk control, and settlement in one platform; Time Dynamics' Fusion is one, and the parts of it that bear on this article are that complete physical trade lifecycle management and execution and advanced trading management for futures and derivatives markets sit in the same place, with comprehensive risk assessment and monitoring capabilities across both. That is the condition under which a change to a trade inside a relationship can be seen next to the hedge it belongs to.
The second conclusion is that the designation itself, the effectiveness workbook and the record of rolls usually live outside the trading system, in files kept by the finance team. That is a different problem, and it is the one X-Ray addresses: a non-invasive data processing and analysis platform, whose collection toolkit XDK performs non-invasive automated data collection from databases, Excel files, and web interfaces, and which is built to collect data without disrupting existing systems or workflows. The last property is the relevant one, because the hedge documentation is a set of judgements its owners are accountable for, and a plan that begins by taking it out of their hands will not survive the first audit.
The third conclusion is that each relationship has a history, its rolls, rebalancings and partial discontinuations, and that the history is what an auditor asks for. X-Ray's time series database offers unified storage with unlimited scalability for structured and unstructured data. Whether it is used to keep each relationship's history as it changed, rather than only its current state, is a decision about what you choose to store rather than something a platform decides for you, but a dated record of changes to a designated set of trades is an ordinary shape for a time series store, not an exotic one.
The fourth conclusion is that the same hedges have to be read by relationship, by trade and by hedged item, and that these views are usually rebuilt by hand before each assessment. X-Sheet does one-click generation of personalized reports with Excel-like interface.
And here is where it stops. None of this is a hedge accounting module. It does not designate a relationship, it does not choose between a fair value hedge and a cash flow hedge, it does not decide whether a component is separately identifiable or whether a forecast is highly probable, and it does not perform the effectiveness assessment or judge its result. Those are accounting judgements, and they stay with your finance function and your auditors. What a system can settle is narrower and duller than the problem in this article: whether the trades a designation names can be found and read together, whether a change to one of them is visible to the person who keeps the designation, and whether a relationship's history can be shown without reconstructing it from old versions of a workbook. That is a real part of the gap. It is not the whole of it, and it is worth knowing which part you are buying.
A note on the evidence in this article
The rules described here are quoted from the text of IFRS 9 as adopted for use in the European Union, published in Commission Regulation (EU) 2016/2067, and each quotation carries its paragraph number so that it can be checked against the standard. They describe IFRS 9 only. Other frameworks, including US GAAP, have their own hedge accounting rules, and nothing here should be read as describing them. Applying any of it to a particular hedge is a judgement for your finance function and your auditors.
The rest of the argument, about where the facts inside a hedge relationship are kept and how they drift apart, contains no figures. The observations underneath it come from material we are not in a position to publish as a citable figure, and a number nobody could check would make the argument look stronger while making it worth less. So it is meant to be tested against your own hedges. Three tests follow from it: compare the designation date of each live relationship with the trade dates of the instruments inside it; take one rolled hedge and check whether its documentation provided for the roll before it happened; and list the forecast transactions you have designated and ask operations whether each one is still expected. If your hedges answer those differently from what is written here, your hedges are the better evidence.
A hedge is judged by the market every day. It is judged on paper once, on the day it starts.