In accordance with the "Basic Standard for Enterprise Accounting Standards," the Ministry of Finance issued Enterprise Accounting Standard No. 24 — Hedging on 2006/2/15, effective as of 2007/1/1. (Note: This standard was revised in 2017 and renamed "Hedge Accounting".)
1. Overview of Guidelines
Hedging (short for "hedge") refers to a practice where an entity designates financial instruments as hedging tools to manage exposure to specific risks such as foreign exchange risk, interest rate risk, price risk, and credit risk. The objective is to offset, in whole or in part, changes in the fair value or cash flows of the hedged item with corresponding changes in the fair value or cash flows of the hedging instrument.
Three types of hedges
- • Fair value hedge: A hedge of the exposure to changes in fair value of a recognized asset or liability, an unrecognized firm commitment, or a portion of such items.
- • Cash flow hedge: Hedging against the risk of fluctuations in cash flows.
- • Net investment hedge in foreign operations: Hedging against foreign exchange risk associated with net investments in foreign operations.
2. Hedging Instruments and Hedged Items
Hedging Instrument
Hedging instrument refers to a derivative or non-derivative financial instrument designated by an entity for hedging purposes, whose changes in fair value or cash flows are expected to offset changes in the fair value or cash flows of the hedged item.
Hedged item
A hedged item is an asset, liability, firm commitment, highly probable forecast transaction, or net investment in a foreign operation that exposes the entity to fair value or cash flow variability and is designated as the hedged item. This may also be a group of assets, liabilities, or other items with similar risk characteristics.
3. Conditions for Applying Hedge Accounting
while meeting all of the following conditions
- At the inception of the hedge, the entity formally designates the hedging relationship and documents the hedging relationship, risk management objectives, and hedging strategy.
- The hedge is expected to be highly effective and aligns with the entity's risk management strategy established for this hedging relationship.
- For fair value hedges, the change in fair value of recognized assets or liabilities related to the hedged item, or of unrecognized firm commitments, must be reliably measurable.
Hedge effectiveness assessment
A hedge is highly effective if the changes in fair value or cash flows of the hedging instrument offset changes in fair value or cash flows of the hedged item caused by the hedged risk. Hedge effectiveness shall be within 80% to 125%.
Regulatory Document Attachment
Accounting Standards for Business Enterprises No. 24 — Hedge Accounting (2006 Edition) (PDF)