The increased volatility of commodity markets, the rapidly evolving corporate governance and financial reporting requirements cause increasing demands on risk management and financial reporting. Combining the two into a single view on risks exposure, realized and unrealized profit & loss is a challenge that commodity trading companies face daily.

To comply with the rules and regulations associated with the different accounting standards starts with the hedging activities of a company  related to managing foreign currency exposure, or to lock in a desired price or to speculate. However not all hedges are designated for special accounting treatment. Accounting standards enable hedge accounting for three different designated hedges:

• A cash flow hedge
• A fair value hedge
• A net investment hedge

Hedge accounting represents a number of provisions that allow companies to match the changes in value of their hedge contracts to the changes in  value of the item being hedged. Hedge accounting rules enable companies to either:

• Defer the P&L impact of a hedge contract to a future period, or
• Bring forward the P&L impact of a hedged item to an earlier period.

The aim of hedge accounting is to provide an offset to the mark-to-market movement of the derivative in the profit and loss account. Where a hedge relationship is effective (meets the 80%–125% rule), most of the mark-to-market derivative volatility will be offset in the profit and loss account.

To achieve hedge accounting requires a large amount of compliance work involving documenting the hedge relationship and both prospectively and retrospectively proving that the hedge relationship is effective.