accounting for derivatives

2019 curriculum FR&A page 258, A Brief Overview of Accounting for Derivatives:

“Measurement of the mark-to-market value of a derivatives contract creates an asset or liability and subsequently increases or decreases the value of the asset or liability”

“Changes in the value of the asset or liability are recorded either as part of profit and loss on the income statement or as part of comprehensive income, depending on the classification”

Could anyone give an example of each please? I don’t understand the difference of measurement of MTM value and change in value.

Hey mate, so the MTM process will result in (potentially) unrealised gains or losses that need to be accounted for. The process by which these gains or losses are recorded is dependent on whether the derivatives are classified as held for trading, FV through P&L etc etc.

Does that help at all? Sorry if I’ve misunderstood the question!

Will try.through a very crude example… Lets say u sold a share for delivery 6 months hence for USD 100. A month down you have to present p/l and Bal sheet. On the day of drawing your financial results, assume share price is 120. Notional loss is 20, so u have to account ur p/l as loss of $ 20 and create a liability in Bal sheet of 20. In subsequent reporting period if share.moves further up, book loss and increase liability. If share comes.down, book profit and reduce the liability. This process of revaluing contracts to fair value increases p/l volatility. It can be reduced through use of hedge accounting but stringent criteria governs use of hedge accounting

Isn’t that double counting?

No. In p/l ur recognising loss on ur position. Since u have not paid the loss, it is appearing as liability on b/s

If a derivative is accounted for as a cash flow hedge (i.e. hedging some type of exchange rate exposure, interest rate exposure, or commodity exposure), the gain or loss is recognized as part of OCI.

If a derivative is accounted for as a trading asset (i.e. looking for profit from the asset’s underlying moves), the gain or loss is recognized on the IS.

Hence, the classification of the derivative matters. Hope this helps.

My understanding is that only the effective portion of a cash flow hedge (i.e., the gain or loss only up to the amount being hedged) is included in OCI; the ineffective portion is reported on the income statement.