2 NOVEMBER 2012 NEW ZEALAND GAZETTE, No. 132 3797

c) Derivative financial instruments

Financial derivatives are initially recognised in the Balance Sheet at fair value on the date a derivative contract is entered into and are subsequently measured at their fair value on each reporting date, though the method of recognising the resulting gains and losses is dependent on whether hedge accounting is applied. When derivative contracts are entered into, the Division designates them as either:

• Hedges of the fair value of recognised assets or liabilities (fair value hedge); or
• Hedges of forecast transactions or firm commitments (cash flow hedge) which hedge exposures to variability in cash flows; or
• Other derivative financial instruments not meeting hedge accounting criteria.

The fair values of financial derivatives are determined by using market quoted rates as inputs into valuation models for interest and currency swaps, forwards and options. Changes in fair value of derivatives are recognised:

• For fair value hedges that are highly effective, the movements are recorded in the profit or loss component of the Comprehensive Income Statement alongside any changes in the fair value of the hedged items;
• The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges are recognised in other comprehensive income and accumulated as a separate component of equity in the hedge reserve. The gain or loss relating to the ineffective portion is recognised immediately in profit or loss and is included in the "other losses" expenses line; and
• All other movements in the fair value of derivative financial instruments are recorded in the profit or loss component of the Comprehensive Income Statement.

Cash flow hedges

The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognised in other comprehensive income and accumulated as a separate component of equity in the hedging reserve. The gain or loss relating to the ineffective portion is recognised immediately in profit or loss and is included in the "other losses" expenses line.

Amounts recognised in the hedge reserve are reclassified from equity to profit or loss (as a reclassification adjustment) in the periods when the hedged item is recognised in profit or loss, in the same line as the recognised hedged item.

However, when the forecast transaction that is hedged results in the recognition of a non-financial asset or a non-financial liability, the gain or loss previously recognised in the hedge reserve is reclassified from equity and included in the initial measurement of the cost of the asset or liability (as a reclassification adjustment).

Hedge accounting is discontinued when the Division revokes the hedging relationship, the hedging instrument expires or is sold, terminated, exercised or no longer qualifies for hedge accounting. Any cumulative gain or loss recognised in the hedge reserve at that time remains in equity and is recognised when the forecast transaction is ultimately recognised in profit or loss. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was recognised in the hedge reserve is recognised immediately in profit or loss.