Hedge accounting is the utilization of proper accounting techniques under Statements of Financial Accounting Standards (SFAS) 133. Generally, hedging instruments are considered derivative instruments. Derivative instruments need an underlying price, or rate — a way to measure the units — a settlement amount, and a payment provision. One major quality of hedge accounting is all derivative instruments are first reported at fair value on the firm's financial statements.

Generally, hedge accounting attempts to reduce risk in investments. There are three types of hedge accounting hedges: fair value, cash flow, and foreign currency hedges. Fair value hedges attempt to reduce risk against changes in the fair value of a firm's assets or liabilities. Cash flow hedges attempt to reduce risk against unpredictable changes in future incoming and outgoing cash flows. Foreign currency hedges hedge against changes in value of a foreign currency.

Any change in fair value during the period for a fair value hedge is recorded in earnings on the income statement. Cash flow hedges are divided into two categories: effective and ineffective portions. Accountants determine how to classify a cash flow hedge based on if the hedge did a good job or a poor job of reducing risk. Changes in fair value of the effective portion of cash flow hedges are reported in earnings on the income statement. Also, changes in fair value of the ineffective portions of cash flow hedges are reported as other comprehensive income, which is not included in the income statement's earnings.

Accountants categorize foreign currency hedges into three categories: cash flow, fair value, and net investment in foreign operations hedge. Foreign currency cash flow hedges and fair value hedges attempt to reduce risks pertaining to foreign currency transactions. Account for changes in fair value of hedges is entered as cumulative translation adjustment.

A firm must disclose reasons for holding a hedging instrument, the context to understand their reasons for using a hedging instrument, and their strategy for holding the instrument in the notes to the financial statements. An entity must also disclose its risk management policy in the notes to the financial statement. A firm must disclose the amount of gain in earnings when the hedge no longer qualifies as a hedge for foreign currency fair value hedges. Cash flow hedges must disclose the maximum length of time the firm is using the cash flow hedge and the amount of earnings when the cash flow hedge no longer qualifies as a hedge.

Impairment is also a problem in hedge accounting. Only fair value hedges may become impaired. First, hedge accounting should be applied to any account for the current year's transaction. Then, a person should check if the instrument is impaired — has less fair value then book value. If the fair value hedge is impaired, then the firm must use impairment accounting.