ASC 815 derivatives and hedging explained

What is a derivative under ASC 815?

A financial instrument or other contract with all three of these characteristics:

• An underlying and a notional amount or payment provision: for example the oil price applied to 10,000 barrels, or an interest rate applied to $10 million.
• No initial net investment, or one smaller than would be needed for contracts with a similar response to market changes.
• Net settlement: the contract can be settled net in cash, through a market mechanism such as an exchange, or by delivering an asset that is readily convertible to cash.

Forwards, futures, swaps and options usually qualify. Every derivative is recognized as an asset or liability at fair value. See ASC 820 fair value measurement.

How does ASC 815 work, step by step?

The steps run in order: a contract that is not a derivative, or falls within a scope exception, is accounted for under other topics; one that is a derivative is measured at fair value with changes in earnings, unless it is designated and qualifies as a hedging instrument.

Which contracts are outside the scope of ASC 815?

• Normal purchases and normal sales: contracts to buy or sell goods in quantities expected to be used or sold in the normal course of business, with physical delivery probable, can be documented as exempt. See commodity contracts and the own use exemption.
• Contracts on the company's own equity that are indexed to its own stock and classified in equity under ASC 815-40.
• Certain insurance contracts, financial guarantees and contracts not traded on an exchange with underlyings such as climatic or geological variables.
• From 2027, ASU 2025-07, issued in September 2025, excludes contracts not traded on an exchange whose underlyings are based on the operations or activities specific to one party, such as its revenue, EBITDA or an emissions target, with some exceptions. It also makes ASC 606 apply first to shares or other equity instruments received from a customer as payment, until the right to them is unconditional. It applies to all entities for fiscal years beginning after December 15, 2026.

When must an embedded derivative be separated?

A derivative feature inside a host contract, such as a commodity-linked repayment in a loan or a currency clause in a supply contract, is separated and accounted for as a derivative when all three are true: its economic characteristics are not clearly and closely related to the host, the whole instrument is not already measured at fair value through earnings, and a separate instrument with the same terms would be a derivative. Companies can often avoid separation by electing the fair value option for the whole hybrid financial instrument.

What are the three types of hedge under ASC 815?

• Fair value hedge: of a recognized asset, liability or firm commitment, such as swapping fixed-rate debt to floating. The derivative and the hedged item, adjusted for the hedged risk, both go through earnings, so they offset.
• Cash flow hedge: of variable cash flows from a forecasted transaction or a floating-rate item, such as a planned fuel purchase. The derivative's gain or loss goes to other comprehensive income and is reclassified to earnings, in the same line as the hedged item, when the hedged transaction affects earnings.
• Net investment hedge: of the currency exposure of a foreign operation. Gains and losses go to the cumulative translation adjustment.

Each needs formal documentation at inception of the risk management objective, the hedging instrument, the hedged item and how effectiveness will be assessed; a relationship expected to be highly effective, generally read as offsetting 80% to 125% of changes in the hedged risk; and, for forecasted transactions, a transaction that is probable. The first assessment is usually quantitative, later ones can be qualitative. See airline fuel hedging and hedge accounting for banks.

ASC 815 in practice: hedging a forecasted oil purchase

In October 2026 a manufacturer forecasts buying 10,000 barrels of oil in March 2027 and enters a forward contract to buy at $70 a barrel, settled net in cash, designating it as a cash flow hedge. At December 31, 2026 the forward price is $76; in March 2027 the spot price is $79, the forward settles and the oil is bought at spot.

Cost of sales carries $700,000, the 10,000 barrels at the hedged price of $70. Without hedge accounting, the $60,000 gain would have gone to 2026 earnings while the higher oil cost hit 2027, reversing the economics of the hedge. Under ASU 2017-12, the whole change in a highly effective hedging instrument's fair value goes to other comprehensive income, with no separate ineffectiveness in earnings. See oil price hedging.

What does ASU 2025-09 change in hedge accounting?

• Groups of forecasted transactions can be hedged together when their risk is similar, not only when it is shared.
• Choose-your-rate debt: forecasted interest on loans where the borrower can switch the index and reset period can be hedged without ending the hedge.
• Nonfinancial forecasted transactions: a pricing component, such as the oil element of a fuel price formula, can be hedged even when it is not specified in the contract.
• Net written options: no longer tested for certain swaps combined with written options used to hedge interest rate risk.
• Foreign-currency debt used both as a net investment hedge and as the hedged item in a fair value hedge of interest rate risk is handled consistently.

ASU 2025-09 was issued on November 25, 2025, and applies to public business entities for annual periods beginning after December 15, 2026, and to others a year later, with early adoption permitted.

How does ASC 815 compare with IFRS 9?

IFRS 9 aligns hedge accounting more closely with risk management: it has no 80% to 125% threshold, allows rebalancing, prohibits voluntary de-designation while the risk management objective is unchanged, and has long allowed hedging of risk components of nonfinancial items that are separately identifiable and reliably measurable, a gap that ASU 2025-09 narrows. US GAAP defines a derivative with a net settlement condition that IFRS 9 does not have. The IASB is reviewing its hedge accounting rules, with comments due by January 26, 2027. See hedge accounting under IFRS 9 and IFRS vs US GAAP key differences.

This guide is general information. It is not tax or legal advice for your situation.