If the underlying risk is a known cashflow, the hedge is referred to as Fair Value Hedge and the result from both the derivative and the item is booked to the Income Statement when it occurs. If the hedge has been effective, the result should be the same from the underlying risk and from the derivative, thus not creating any volatility in the Income Statement. These special accounting rules, which in fact are exceptions to the basic principles in FAS 133, are what people are often referring to when speaking about FAS 133 compliance and what is needed to meet this regulation. This section deals with what is needed to actually comply with the rules for hedge accounting under FAS 133. Before linking the derivative with the hedge item there are several criteria that needs to be fulfilled.
Every hedge needs to be specific.
This means that portfolio hedging, where the netted risk of a portfolio is hedged and monitored is not allowed if you would like to qualify for hedge accounting. Identifying the risk The risk that is hedged needs to be identified and described. Documentation of risk management strategies and objectives If you want to qualify for hedge accounting, there is extensive documentation about your risk management strategies and objectives that needs to be in place. Although this should be stated together with every hedge, it will usually be in the form of a reference from the hedge relation to an overall risk policy for the company or the treasury. Your risk management strategies and objectives need to be clearly defined and the reason for each hedge relation needs to be stated.