Section 707: “Hedging relationship”
1963.This section sets out two cases in which a company is regarded as having a “hedging relationship” for the purposes of this Part. It is based on paragraph 12(14) of Schedule 26 to FA 2002.
1964.The concept of “hedging” has to do with contracts undertaken to protect the company’s assets (or to guard against increase in its liabilities) in a case where there is some form of market volatility associated with the item. The cases described in this section derive from those set out in accounting standards. Paragraph 86 of Financial Reporting Standard 26, the equivalent for UK generally accepted accounting practice of International Accounting Standard 39, describes a hedging relationship as follows:
Hedging relationships are of three types:
fair value hedge: a hedge of the exposure to changes in fair value of a recognised asset or liability or an unrecognised firm commitment, or an identified portion of such an asset, liability or commitment that is attributable to a particular risk and could affect profit or loss.
cash flow hedge: a hedge of the exposure to variability in cash flows that is (i) attributable to a particular risk associated with a recognised asset or liability (such as all or some future interest payments on variable rate debt) or a highly probable forecast transaction and (ii) could affect profit or loss.
hedge of a net investment in a foreign operation as defined in FRS 23.
1965.Paragraph 9 of Financial Reporting Standard 26 also provides definitions of “hedging instrument” and “hedged item”.