How is hedge ineffectiveness measured and reported?

Question

AcadiFi · Accepted Answer

Hedge ineffectiveness is the difference between the change in the derivative's fair value and the change in fair value (or cash flows) attributable to the hedged risk on the hedged item. Prior to the 2017 FASB ASU, ineffective portions had to be measured and reported separately in earnings each period. Post-ASU simplification, the entire change in the designated derivative flows through OCI (for cash flow hedges) without separating out ineffectiveness, provided the hedge remains highly effective.

Stellar uses 120,000 gallons of ULSD futures to hedge 135,000 forecasted gallons. The 15,000 gallon gap is under-hedged — Stellar cannot defer derivative gains on more than the hedged quantity. Post-ASU, if the hedge relationship is designated on the 120,000 gallons, all changes on that portion defer to OCI cleanly.

Ineffectiveness still matters for the 80-125% effectiveness test. If the dollar-offset ratio falls outside this band, the hedge is disqualified going forward (not retroactively). The derivative then stops receiving OCI treatment and flows through P&L.

Disclosure requirements include the location and amount of gains/losses on derivatives, nature and amount of amounts reclassified from AOCI, and a tabular summary of hedging activities. Over-hedging (derivative notional > hedged quantity) creates automatic ineffectiveness on the excess portion, which must be bifurcated and P&L-ed.

How is hedge ineffectiveness measured and reported?

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