NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONT For the three months ended 31 March 2013 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Initial recognition and subsequent measurement (continued) (h) Derivative financial instruments and hedge accounting (continued) The fair value of commodity purchase contracts that meet the definition of a derivative are recognised in the income statement in cost of sales�  Commodity contracts that are entered into and continue to be held for the purpose of the receipt or delivery of a non-financial item in accordance  with the group’s expected purchase, sale or usage requirements are held at cost� Any gains or losses arising from changes in the fair value of derivatives are taken directly to the income statement, except for the effective portion  of cash flow hedges, which is recognised in other comprehensive income� For the purpose of hedge accounting, hedges are classified as: (a)  Fair value hedges when hedging the exposure to changes in the fair value of a recognised asset or liability or an unrecognised  firm commitment� (b)  Cash flow hedges when hedging the exposure to variability in cash flows that is either attributable to a particular risk associated with a  recognised asset or liability or a highly probable forecast transaction or the foreign currency risk in an unrecognised firm commitment� (c)  Hedges of a net investment in a foreign operation�  At the inception of a hedge relationship, we formally designate and document the hedge relationship to which we wish to apply hedge accounting  and the risk management objective and strategy for undertaking the hedge� The documentation includes identification of the hedging instrument,  the hedged item or transaction, the nature of the risk being hedged and how we will assess the effectiveness of changes in the hedging  instrument’s fair value in offsetting the exposure to changes in the hedged item’s fair value or cash flows attributable to the hedged risk� Such  hedges are expected to be highly effective in achieving offsetting changes in fair value or cash flows and are assessed on an ongoing basis to  determine that they actually have been highly effective throughout the financial reporting periods for which they were designated� Hedges that meet the strict criteria for hedge accounting are accounted for as described below: The change in the fair value of a hedging derivative is recognised in the income statement in finance costs� The change in the fair value of the  hedged item attributable to the risk hedged is recorded as part of the carrying value of the hedged item and is also recognised in the income  statement in finance costs� For fair value hedges relating to items carried at amortised cost, any adjustment to carrying value is amortised through the income statement over  the remaining term of the hedge using the Effective Interest Rate (EIR) method� EIR amortisation may begin as soon as an adjustment exists and no  later than when the hedged item ceases to be adjusted for changes in its fair value attributable to the risk being hedged� If the hedge item is derecognised, the unamortised fair value is recognised immediately in the income statement� When an unrecognised firm  commitment is designated as a hedged item, the subsequent cumulative change in the fair value of the firm commitment attributable to the hedged  risk is recognised as an asset or liability with a corresponding gain or loss recognised in the income statement� Fair value hedges Cash flow hedges The effective portion of the gain or loss on the hedging instrument is recognised directly in other comprehensive income in the cash flow hedge  reserve, while any ineffective portion is recognised immediately in the income statement in other operating expenses� We use forward currency contracts as hedges of our exposure to foreign currency risk in forecasted transactions and firm commitments, as well as  forward commodity contracts for its exposure to volatility in the commodity prices� The ineffective portion relating to foreign currency contracts is  recognised in finance costs and the ineffective portion relating to commodity contracts is recognised in other operating income� Refer to Note 20  for more details� Amounts recognised as other comprehensive income are transferred to the income statement when the hedged transaction affects profit or loss,  such as when the hedged financial income or financial expense is recognised or when a forecast sale occurs� When the hedged item is the cost of a  non-financial asset or non-financial liability, the amounts recognised as other comprehensive income are transferred to the initial carrying amount  of the non-financial asset or liability� If the forecast transaction or firm commitment is no longer expected to occur, the cumulative gain or loss previously recognised in equity is  transferred to the income statement� If the hedging instrument expires or is sold, terminated or exercised without replacement or rollover, or  if its designation as a hedge is revoked, any cumulative gain or loss previously recognised in other comprehensive income remains in other  comprehensive income until the forecast transaction or firm commitment affects profit or loss�  We utilise interest rate swaps to hedge our exposure to cash flow movements in loan movements� See note 20 for more details� 60 Australian Agricultural Company Limited