The relation between a hedged item and a hedging instrument. Under hedge accounting, a hedged item exposes the entity to the risk of changes (fluctuations) in fair value or future cash flows that could impact an entity’s income statement, in the current period or in a future period. Examples of a hedged item include any items designated as being hedged: assets, liabilities, commitments, investments in a foreign operation or highly probable transactions whereby an entity is exposed to changes in fair value or cash flows.

A hedging instrument is a designated financial instrument whose fair value or related cash flows are meant to offset changes in the fair value or cash flows of a designated hedged item. A hedging instrument could be a financial derivative (e.g., a forward contract), traded for hedging purposes, or a swap in which the entity receives a floating rate and pays a fixed rate.

The hedging instrument creates an offsetting financial position that offsets the corresponding change in the hedged exposure (e.g., a foreign exchange transaction).