Question

In Cash Flow Hedge (a type of derivative), where is the G/L (Gain/Loss) recognized?

1) Income Statement
2) Balance Sheet
3) Statement of Cash Flows
4) None of the above

Answer 1

The G/L from a Cash Flow Hedge is initially recognized in OCI on the balance sheet, and then it's reclassified into earnings when the hedged transaction impacts earnings. The ineffective portion is recognized immediately in the income statement.

Step-by-step explanation:

In the context of hedge accounting under International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP), the treatment of the gains or losses (G/L) from a Cash Flow Hedge depends on the effectiveness of the hedge. If the hedge is effective, the portion of the gain or loss on the derivative that is effective is recognized in Other Comprehensive Income (OCI) and reported in the equity section of the balance sheet, not in the income statement. It is later reclassified into earnings in the same period(s) in which the hedged forecasted transaction affects earnings. The ineffective portion, if any, is recognized immediately in the income statement.

An example of this would be if a company is hedging a forecasted purchase of raw materials in six months, the effective gains or losses are reported in OCI until the purchase occurs. When the company buys the raw materials, the amounts accumulated in OCI are removed and recognized in the income statement, impacting the cost of goods sold.