FSA question: Ineffective Portion of Cash Flow Hedge

For cash flow hedge-

effective portion recognized in equity until actually occured.

Ineffective portion in income statement. Is that correct?

FSA Textbook P341 Q6, Why B is not correct?

B. The ineffective portions of the hedges were recognized in net income.

Good question. I cannot figure it out, can anyone else? It appears to me that both B. and C. are correct.

I’m not entirely sure but I think It’s because the futures contract hasn’t settled yet. It will settle sometime in 2011 and then you know which part is effective and which part is ineffective. Statement 4 basically says at the end of the fiscal year 94% is effective so that goes to equity. Since the contract hasn’t expired yet, the remaining 6% could be either effective or ineffective so you can’t report anything in the Income statement yet.

that kind of makes sense to me at first, but think about it- you gotta find a place to recognize those 6% gain/loss… where is it?

I’m pretty sure the ENTIRE portion of a cash flow hedge is held in OCI until the hedge plays out - so 100% is held until you actually have to pay something out.

Think about this - you’re trying to hedge a 2 year floating rate liability with a swap, with yearly payments. After the first quarter, the company has to report earnings. The value of the swap will have changed, but you’re not sure if its ineffective or effective until you actually have to pay the interest. The fair value of the swap has risen, showing a mark to market adjustment, and the corresponding change is in OCI.

Say the end of the year comes, and the value of the swap has risen to $125. The hedge was effective in offsetting $100 in extra payments due to the floating liability, but now the hedge has caused interest income from the other end of the swap to be over and above the $100 to the tune of $25. $25 income is recognized in earnings. This is a simple example, but hopefully it helps to get the point across (and I have it correct).

Hi guys,

For a derivative designated as hedging the exposure to variable cash flows of a forecasted transaction (referred to as a cash flow hedge), the effective portion of the derivative�s gain or loss is initially reported as a component of other comprehensive income (outside earnings) and subsequently reclassified into earnings when the forecasted transaction affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately.


cash flow hedge: if an entity hedges changes in the future cash flows relating to a recognised asset or liability or a highly probable forecast transaction , then the change in fair value of the hedging instrument is recognised in other comprehensive income to the extent that the hedge is effective until such time as the hedged future cash flows occur;


Considering both, the effective part (which is ALWAYS recognised) goes to the OCI and the ineffective goes to the I/S.