IFRS 9 hedge accounting: rebalancing vs discontinuation, with a worked example
Under IAS 39, a hedge that drifted outside its effectiveness range had one fate: discontinue it and start over. IFRS 9 replaced that bright-line cliff with a judgment call — rebalance the hedge ratio and keep going, provided the risk management objective hasn't changed. The twist is that IFRS 9 is stricter somewhere else: it bans walking away from hedge accounting just because you'd rather not continue. Mixing these two rules up is one of the most common errors in applying IFRS 9's hedge accounting model.
What changed from IAS 39
| IAS 39 | IFRS 9 | |
|---|---|---|
| Effectiveness test | Bright-line 80%–125% dollar-offset test, retrospective and prospective | No bright line — a qualitative/quantitative assessment that an economic relationship exists and isn't dominated by credit risk |
| Ratio drifts outside the expected range | Hedge accounting is discontinued; a new relationship must be redesignated from scratch | The entity rebalances the ratio and the same relationship continues |
| Stopping hedge accounting by choice | Permitted at any time, for any reason | Not permitted while the risk management objective and the economic relationship are both still valid |
When rebalancing applies
Rebalancing only makes sense where basis risk exists between the hedged item and the hedging instrument — if the two always moved exactly in lockstep (a 1:1 hedge with no basis risk), there would be nothing to rebalance. Where basis risk does exist and the hedge ratio has stopped reflecting the real relationship, IFRS 9 treats adjusting the designated quantities of the hedging instrument and/or the hedged item as the required response, not an optional one — as long as the entity's risk management objective for that specific relationship is unchanged. A decision to hedge a different quantity for a different reason isn't rebalancing; it's a new objective, and that does force discontinuation.
Worked example: rebalancing a cocoa butter hedge
A confectionery manufacturer forecasts a highly probable purchase of 200 tonnes of cocoa butter in nine months. Cocoa butter itself has no liquid futures market, so the entity hedges using ICE cocoa bean futures, sized off the industry's typical bean-to-butter extraction ratio of roughly 1.2 tonnes of beans per tonne of butter.
| Inception (day 0) | Amount |
|---|---|
| Forecast hedged item | 200 tonnes cocoa butter @ $8,000/tonne = $1,600,000 forecast cost |
| Hedging instrument designated | 240 tonnes of cocoa futures @ $2,500/tonne = $600,000 notional |
| Designated hedge ratio | 1.2 futures tonnes : 1 butter tonne |
Three months later, a supply-driven "butter premium" widens independently of the raw bean market — a classic basis-risk move. Cocoa butter's forecast price rises to $8,400/tonne while bean futures rise to only $2,650/tonne:
- Cumulative change in the hedged item's expected cash flows: 200 × $400 = $80,000
- Cumulative gain on the hedging instrument: 240 × $150 = $36,000
The under-hedge trap in the cash flow hedge reserve
Under IFRS 9 6.5.11(a), the amount deferred in the cash flow hedge reserve is the lower, in absolute terms, of the cumulative gain on the hedging instrument and the cumulative change in the hedged item's expected cash flows. Here that's the lower of $36,000 and $80,000 — so the entire $36,000 instrument gain is deferred in OCI, and the journal entry is simply: debit futures asset $36,000, credit cash flow hedge reserve $36,000. Zero is recognised in profit or loss, even though the futures are covering only 45% of the economic move. This is the asymmetry that catches people out: under this test, ineffectiveness only ever hits profit or loss on an over-hedge, where the instrument's cumulative gain exceeds the hedged item's. A shortfall from under-hedging produces no P&L charge at all — it just means part of the exposure is sitting unhedged.
Rebalancing the ratio
No P&L ineffectiveness doesn't mean no problem. The three-month data shows bean futures are now passing through only about $150 of the $400 butter-price move — roughly 37.5%, far below the 1:1 pass-through the original 1.2:1 ratio assumed. If that relationship is expected to persist, continuing to hold only 240 tonnes of futures will keep under-hedging the position. The entity rebalances by recalculating the futures quantity needed to track the hedged item: 200 tonnes × ($400 ÷ $150) ≈ 533 tonnes, meaning it adds 293 tonnes of futures, moving the hedge ratio from 1.2:1 to roughly 2.67:1.
Because rebalancing continues the existing relationship rather than closing it, there's no gain or loss recognised from "unwinding" the old designation. Only the newly added 293 tonnes are designated from the rebalancing date, documentation is updated with the revised ratio and sources of ineffectiveness, and the lower-of test resumes on the combined position going forward.
Contrast this with IAS 39: a 45% dollar-offset ratio sits well outside the old 80%–125% band, so the same facts would have forced immediate discontinuation there — the futures would move to fair-value-through-profit-or-loss, the forecast purchase would go unhedged, and the entity would have to build and document an entirely new relationship to get hedge accounting back. IFRS 9's rebalancing mechanism exists specifically to avoid that cliff.
The one thing IFRS 9 won't let you do
None of this flexibility extends to quitting by choice. IFRS 9 bars voluntarily discontinuing a hedging relationship while the risk management objective is unchanged and the relationship still qualifies — a deliberate tightening from IAS 39, which let entities walk away from hedge accounting at will. Discontinuation under IFRS 9 is only available when:
| Trigger | Treatment |
|---|---|
| Ratio no longer reflects the relationship, objective unchanged | Rebalance — continue the same relationship |
| Hedging instrument expires, is sold, terminated or exercised | Discontinue |
| Forecast transaction is no longer highly probable (cash flow hedge) | Discontinue |
| Economic relationship breaks down, or credit risk starts to dominate fair value changes | Discontinue — fails the qualifying criteria |
| The entity's risk management objective itself changes | Discontinue |
| The entity would simply prefer to stop; objective and relationship both still valid | Not permitted |
Common mistakes
- Treating any ratio drift as an automatic discontinuation trigger — that's the IAS 39 reflex; IFRS 9 requires rebalancing instead, as long as the objective hasn't changed.
- Assuming an under-performing hedge always produces a P&L ineffectiveness charge. Under the cash flow hedge "lower of" test, a shortfall produces none; only an excess does.
- Treating rebalancing as optional once the ratio stops minimising expected ineffectiveness and the objective is unchanged — it's the required response, not a free choice to leave the ratio as-is.
- Assuming hedge accounting can be dropped whenever it's administratively convenient. That option existed under IAS 39; IFRS 9 removed it.
These mechanics sit alongside the rest of the financial instruments material tested in the IFRS 9 Financial Instruments quiz, including classification, impairment staging, and derecognition. For the full citation index across every standard the question bank uses, see the ASC & IFRS standards index.
This is educational material, not accounting or legal advice — apply the standard's full text and current interpretive guidance to your own facts and circumstances.
Source: IFRS 9 Financial Instruments (IFRS Foundation, as amended), hedge accounting paragraphs 6.5.5–6.5.7 (rebalancing and discontinuation) and 6.5.11(a) (cash flow hedge reserve), as summarised in BDO's and Grant Thornton's IFRS 9 hedge accounting technical guidance and cpdbox.com's rebalancing analysis; the cash flow hedge reserve "lower of" mechanic cross-checked against HMRC's Corporate Finance Manual (CFM27080, CFM27210) and IASB staff meeting papers.