What financial statements are impacted by hedge accounting?

Hedge accounting is designed to manage the volatility that can arise from fluctuations in the fair value of financial instruments and the cash flows associated with them. When a company applies hedge accounting, it aligns the timing of recognizing gains and losses on hedging instruments with the losses and gains on the items being hedged, which affects both the income statement and the balance sheet.

The income statement is impacted because the results of the hedging transactions will be recorded in the same period as the losses or gains on the underlying exposure. This synchronization helps in reducing volatility in reported earnings, enabling a more accurate reflection of a company's financial performance.

On the balance sheet, hedges can result in adjustments to the carrying amounts of the assets or liabilities being hedged. For instance, when a cash flow hedge is accounted for, the effective portion of the gain or loss on the hedging instrument is initially recorded in other comprehensive income and later reclassified to profit or loss as the hedged transaction affects earnings. This treatment alters the equity section of the balance sheet as well.

In summary, hedge accounting modifies the recognition of gains and losses for hedging activities, impacting both the income statement and the balance sheet, thereby achieving a smoother reporting of financial performance and reducing volatility in financial statements.