I. Accounting Classification and Division of Hedging

1. Hedging

Definition of hedging in accounting standards for business enterprises;

-In order to avoid foreign exchange risk, interest rate risk, commodity price risk, stock price risk, credit risk, etc. , the enterprise specifies one or more hedging instruments to change the fair value or cash flow of the hedging instruments, and it is expected to offset all or part of the changes in the fair value or cash flow of the hedged items.

2. Classification of hedging (three categories)

(1) Fair value hedging

-Hedging changes in the fair value of recognized assets and liabilities, unconfirmed firm commitments or part of them.

For example:

● The enterprise hedges the risk of fair value change of fixed-rate liabilities or investment in fixed-rate assets;

-Hedging risk is interest rate risk.

● An airline signed a contract (unconfirmed firm commitment) three months later to buy an aircraft with a fixed foreign currency amount, so as to hedge the foreign exchange risk of firm commitment and avoid foreign exchange risk;

-Hedging risk is foreign exchange risk.

● A power company buys coal at a fixed price after signing a contract for 6 months (unconfirmed firm offer commitment), in order to avoid the risk of price change, it offsets the price change risk of firm offer commitment;

-Hedging risk is price risk.

(2) Cash flow hedging

-Hedging the cash flow of confirmed assets and liabilities, expected transactions or part of them.

It is suggested that cash flow hedging should pay more attention to the impact of expected transactions on future cash flows and hedge this impact.

For example:

● Enterprises hedge the risk of cash flow changes in floating-rate debt or floating-rate bill investment;

● Airlines hedge to avoid the risk of cash flow changes related to the purchase of aircraft, which is expected to occur after 3 months;

● Commercial banks have hedged the risk of cash flow changes related to the disposal of available-for-sale financial assets, which is likely to occur after 3 months;

Prompt the enterprise to buy an available-for-sale financial asset, and if the price fluctuation is hedged, it belongs to fair value hedging; If the cash flow in the disposal stage is hedged, it belongs to cash flow hedging.

(3) Hedging of net investment in overseas operations

-Hedging the exchange rate fluctuation risk of net investment in overseas operations, and hedging points to specific risks.

It is suggested that the net investment in overseas business includes:

Long-term equity investment, short-term long-term receivables without recovery plan (in essence, it constitutes a net investment in overseas operations of subsidiaries)

Second, hedging instruments

Hedging tools and their characteristics

● Hedging tools

—— The changes in the fair value or cash flow of the derivative instruments designated by the enterprise for hedging are expected to offset the changes in the fair value or cash flow of the hedged items.

When hedging foreign exchange risks, non-derivative financial assets or non-derivative financial liabilities can also be used as hedging tools.

● Features of hedging instruments:

(1) Derivatives can usually be used as hedging tools.

Not all derivatives are suitable for hedging instruments.

(2) Non-derivative instruments usually cannot be used as hedging instruments.

Not all non-derivative instruments cannot be used as hedging instruments.

For example, non-derivative instruments can be used to hedge foreign exchange risks.

(3) Whether derivative instruments or non-derivative instruments are used as hedging instruments, the fair value must be measured reliably.

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Investment in equity instruments without quotation in an active market cannot be used as hedging instruments;

The enterprise's own equity instruments are neither financial assets nor financial liabilities of the enterprise, and cannot be used as hedging instruments.

(4) The hedging instrument must involve an entity other than the reporting entity, and relevant instruments can be used as hedging instruments.

2. Setting of hedging instruments

(1) Hedging instruments are usually designated as a whole, and a certain proportion of futures and options can also be designated as hedging instruments.

For example, when an enterprise buys an option contract, it now designates 80% as hedging and 20% as non-hedging.

-80% is treated as hedge accounting and 20% as speculative trading.

It is suggested that a certain proportion of futures and options can be designated as hedging instruments, but in general, some futures and options cannot be designated as hedging instruments, that is, they cannot be divided. Except for the following two cases:

Option: An enterprise can separate the intrinsic value and time value of the option and only designate the option as a hedging tool for the change of intrinsic value (regardless of time value).

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Intrinsic value refers to the value of immediate exercise of options;

The fair value MINUS the intrinsic value of the option is the time value of the option;

The time value of options can also be simply understood as the expected value of the future.

② Forward contract: An enterprise can separate the interest of the forward contract from the spot price, and only designate the forward contract as a hedging instrument for the spot price change.

(2) An enterprise can usually designate a single derivative to hedge one risk, but it can designate a single derivative to hedge more than one risk if the following conditions are met:

① All hedging risks can be clearly identified;

② The effectiveness of hedging can be proved;

③ It can ensure that there is a specific designated relationship between derivative instruments and different risk positions.

(3) An enterprise may designate a combination of two or more derivatives or a certain proportion of the combination as hedging instruments.

(4) Although an enterprise can designate a certain proportion of the overall hedging instruments as hedging instruments, it cannot designate a certain period within the remaining term of the hedging instruments in the hedging relationship.

3. Hedged items (non-derivative instruments)

1. Hedging items and their characteristics

● Hedging project

—— The following items that expose the enterprise to the risk of changes in fair value or cash flow and are designated as hedged objects:

(1) Assets, liabilities, firm commitments, expected probable transactions or net investment in overseas operations;

(2) A set of confirmed assets, liabilities,

Determine commitments, possible expected transactions or net investment in overseas business;

(3) A part of a financial asset or financial liability portfolio that shares the interest rate risk in the same hedging (only applicable to fair value portfolio hedging of interest rate risk).

Firm commitment refers to a legally binding agreement to exchange a specific amount of resources at an agreed price on a specific date or period in the future;

● Expected transactions refer to transactions that have not been promised but are expected to occur.

● Features of the hedging project:

(1) The general operating risk of an enterprise cannot be used as a hedging object. (because it can't be pointed accurately and measured reliably)

(2) Derivatives cannot be used as hedging objects. (Derivatives are inherently risky and are often used as hedging instruments)

(3) Held-to-maturity investment is a financial asset. As a hedged item, we should pay attention to the following differences:

◢ Hedged risk is credit risk or foreign exchange risk, and held-to-maturity investment can be designated as hedged item;

◢ Hedging risk is interest rate risk or prepayment risk, and held-to-maturity investment cannot be designated as hedged item.

For example, if an enterprise buys US Treasury bonds, whether it can repay them in the future and the exchange rate changes are uncertain, we can take it as the risk of hedging.

(4) Long-term equity investment: Long-term equity investment in joint ventures and associated enterprises cannot be used as hedged items (because only the investment income is recognized under the equity method, and the overall fair value change is not recognized), and the investment of the parent company in subsidiaries cannot be used as hedged items.

(5) Only those assets and liabilities, firm commitments, etc. Items outside the reporting entity can be set as hedged items. Not in the body of the report.

2. Setting of hedging items

(1) Designate financial items as hedging items.

① For financial assets or financial liabilities, there are many options to designate them as hedged items.

As long as the hedging risk can be identified and the hedging effectiveness can be measured, only the risk related to part of the cash flow or fair value of financial assets or financial liabilities can be regarded as hedging risk. Therefore, related financial assets or financial liabilities can be designated as hedged items.

② When a part of the cash flows of financial assets and financial liabilities are designated as hedged items, the cash flows of the designated part shall be less than the total cash flows of the financial assets or financial liabilities.

③ In the fair value hedging of interest rate risk of financial assets or financial liabilities portfolio (also limited to this kind of hedging), an enterprise can designate a certain monetary amount (such as RMB, USD or Euro) instead of a single asset or liability as a hedged item to hedge the interest rate risk related to it.

(2) Designate non-financial items as hedged items. Hedging risk should be all risks or foreign exchange risks related to non-financial assets or non-financial liabilities.

(3) Designate the combination of multiple projects as hedged projects (the project combination must be related to a single project, and the risk of the combination cannot be too far from the risk of a single project).

● When hedging a portfolio of assets or liabilities with similar risk characteristics, each individual asset or liability in the portfolio should bear the hedging risk at the same time, and the change in the fair value of each individual asset or liability in the portfolio caused by hedging risk should be expected to be basically proportional to the change in the overall fair value of the portfolio caused by hedging risk.

● Determine the hedging effectiveness by comparing the fair value or cash flow changes of hedging instruments (or a group of similar hedging instruments) and hedged items (or a group of similar hedged items). Therefore, when applying hedge accounting method, enterprises cannot designate the net position formed by financial assets and financial liabilities as hedged items.

Generally speaking, the net amount after the combination of financial assets and financial liabilities is offset cannot be used as a hedged item, because the effectiveness of hedging cannot be calculated.