What is hedge accounting?

Hedge accounting refers to a method of accounting where entries that are made to adjust the fair value of a security and its opposing hedge are treated the same. Hedge accounting helps reduce volatility created by repeated adjustment to a financial instrument’s value, known as fair value accounting or mark-to-market.

It serves as an alternative to more traditional accounting methods for recording gains and losses. When treating the items individually, such as a security and its associated hedge fund, the gains or losses of each would be displayed individually. In hedge accounting, both the line items are treated as one because the purpose of the hedge fund is to offset the risks associated with the security. Instead of listing one transaction of a gain and one of a loss, the two are examined to determine if there was an overall gain or loss between the two and just that amount is recorded.