Five Common Mistakes Made When Preparing Hedge Documentation
Minneapolis, MN | May 16, 2024 | By: John Trefethen, Director and Co-Founder
Proper hedge documentation is crucial for ensuring that a hedge qualifies for hedge accounting treatment. What follows are five common mistakes made when preparing hedge documentation:
Incomplete or vague documentation. Incomplete documentation can lead to disqualification from hedge accounting, resulting in increased earnings volatility due to the inability to offset changes in the fair value of the hedging instrument against the hedged item.
Failure to specify the risk being hedged. Without a clear specification of the risk, the hedge might not meet the criteria for hedge accounting causing potential misalignment in financial reporting and ineffective risk management.
Inadequate or innacurate effectiveness testing methodology. Using inadequate or inaccurate testing methods can lead to the failure of effectiveness tests, resulting in the hedge not qualifying for hedge accounting and increased volatility in the income statement.
Omission of detailed hedge designation forms. Omitting these details can create ambiguity and reduce the ability to manage and adjust the hedge effectively, potentially leading to disqualification from hedge accounting and increased risk exposure.
Lack of regular updates and reassessments. Failure to update and reassess hedge documentation on a regular basis can result in the hedge no longer meeting the criteria for hedge accounting, causing unexpected financial statement impacts and ineffective risk management.
To avoid these mistakes companies should implement a rigorous documentation process, or utilize an outsourced hedge accounting expert.
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Author: John Trefethen, Director and Co-Founder
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