This can be either a debt or equity security, for which there is an intent to sell in the short term for a profit. If so, only recognize a loss in earnings when there is an other-than-temporary decline in the hedging instrument’s fair value. When such an investment is being hedged, there may be a change in the fair value of the paired forward contract or purchased option. This is a debt instrument for which there is a commitment to hold the investment until its maturity date. The following additional rules apply to the accounting for derivative instruments when specific types of investments are being hedged: Held-to-Maturity Investments Speculative activities imply that a derivative has not been paired with a hedged item. Recognize in earnings all subsequent changes in the fair value of the derivative. If the instrument has been paired with a hedged item but the hedge is not effective, then recognize these fair value changes in earnings. Recognize all subsequent changes in the fair value of the derivative. Subsequent Recognition (Ineffective Portion) If the instrument has been paired with a hedged item, then recognize these fair value changes in other comprehensive income. Recognize all subsequent changes in the fair value of the derivative (known as marked to market). Subsequent Recognition (Hedging Relationship) When it is first acquired, recognize a derivative instrument in the balance sheet as an asset or liability at its fair value. The essential accounting for a derivative instrument is outlined in the following sections. The second is that ongoing changes in the fair value of derivatives and the hedged items with which they are paired may be parked in other comprehensive income for a period of time, thereby removing them from the basic earnings reported by a business. The first is that ongoing changes in the fair value of derivatives not used in hedging arrangements are generally recognized in earnings at once. There are two key concepts in the accounting for derivatives. A derivative is a financial instrument whose value changes in relation to changes in a variable, such as an interest rate, commodity price, credit rating, or foreign exchange rate.
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