The paper "Australian Hedge Accounting" is a good example of a finance and accounting case study. Business organizations operating in both domestic and international markets often utilize hedge accounting in order to minimize or eliminate business risk brought about by the changes in foreign exchange rates. However, in Australia business organizations are supposed to meet some conditions in order to apply the hedge accounting. Hedge accounting is stipulated in AASB 139. AASB 139 is an Australian accounting standard which generally gives guidance on recognition and measurement of financial instruments. Hedging includes actions taken by business organizations through entering into a contract pertaining to foreign currency.
The major objective of such relationships between organizations is to mitigate possible negative financial effects brought by changes in foreign exchange rates. Business organizations or rather the parties involved in such relationships are required to meet various conditions prescribed in AASB 139 (Australian Accounting Standards Board). Which items can be hedged? According to AASB 139, items to be hedged can be divided into various categories. To start with, a hedged item can be a single asset, firm commitment or liability.
Moreover, In this category of single items, net foreign investment operation and highly probable forecast transaction can also be hedged. Secondly, a group of items such assets, liabilities, net foreign investment operations and groups of other items as described in single item category can also be hedged to enable a business organization to minimize or fully eliminate the risk of foreign exchange rate changes. However, it must be noted that in order for business organizations to hedge a group of items, the items must possess similar risk characteristics. Items which don’ t possess similar characteristics should not be grouped for hedging purposes.
Thirdly, a hedged item can be in a portfolio hedge regarding the risk of interest rate only. Besides, a portion of a portfolio of financial liabilities or assets with a common risk can be subjected to hedging accounting (Australian Accounting Standards Board). In the 78th paragraph of the AASB 139, firms or entities are prohibited from hedging an item which results from the firms’ commitment to acquire a business entity in a business combination. However, the standard allows an exception for the business organizations to recognize such items as hedged items the purpose of reducing the risk of foreign exchange.
The reason behind this is that the other risks can not be specifically measured or even identified. Moreover, paragraph 80 of the AASB 139, states that in financial statements which are consolidated, the foreign currency risk of a high possible forecast intra-group proceedings or transactions qualifies for hedging purposes in a cash flow hedging category. However, the AASB provides a further condition that such a transaction can only qualify for hedging if it is denominated in a different currency from the functional currency of the party entering into such a transaction (Australian Accounting Standards Board). What are the qualifications for hedging? Australian Accounting Standard Board has established various accounting policies which need to be adhered to by all business organizations operating in the region.
Qualification for business organizations to practice hedging is one of critical standard which was established by the board. Various conditions have been laid down to ensure that business organizations do not engage in unethical or fraudulent acts in the name of hedging their assets or liabilities.
The first major condition as described in AASB 139 is that, for hedging of assets or liabilities to take place, there must be involvement of external party to the entity. In other words, a business organization which is interested in hedging its assets or liabilities must have an agreement with an external organization or any other external party wishing to take the benefits and the risks associated with the hedging process (CPA Australia).
Australian Accounting Standards Board. Financial Instruments: Recognition and
Measurement. 7 November 2008. 14 April 2009. au/admin/file/content105/c9/AASB139_07-04_COMPoct08_07-08.pdf>. CPA Australia. AASB 139 Financial Instruments: Recognition and measurement. 31 December 2007. 14 April 2009. xbcr/SID-3F57FECB AD7B69C3/cpa/AASB139_factsheet_ recognition_180208.pdf
CPA Australia. AASB 139 Financial Instruments: Recognition and measurement. 31
December 2007. 14 April 2009. xbcr/SID-3F57FECB AD7B69C3/cpa/AASB139_factsheet_ recognition_180208.pdf