Accounting for Financial Instruments: Hedging Board Decisions to Date As of June 28, 2017

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Eugene Quinn
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1 On, the Board directed the staff to draft a final Accounting Standards Update for vote by written ballot related to amendments to the hedge accounting guidance in FASB Accounting Standards Codification Topic 815. The Board s decisions are summarized below. See items #26 28 for further information regarding effective dates and early adoption. Nonfinancial Hedges Documentation and Effectiveness Testing 1. For cash flow hedges of nonfinancial items, an entity may designate the variability in cash flows attributable to changes in a contractually specified component as the hedged risk. 2. Initial quantitative testing of all hedges is required unless the hedging relationship meets the requirements for the shortcut method, critical terms match method, or other methods that assume perfect effectiveness at hedge inception. An entity may elect to subsequently assess hedge effectiveness on a qualitative basis. An entity is required to perform subsequent quantitative effectiveness testing if facts and circumstances change such that the entity no longer may assert on a qualitative basis that the hedging relationship was and continues to be highly effective. An entity is not required to assess similar hedges in a similar manner when an entity assesses effectiveness on a qualitative basis. Qualitative assessments may be performed on a hedge-by-hedge basis. 3. An entity may return to qualitative assessments of hedge effectiveness after a change in facts and circumstances requires a quantitative assessment to be performed or after the entity performs a quantitative assessment to validate whether qualitative assessments of hedge effectiveness remain appropriate. The same principle and factors should be used Feb. 15,

2 to evaluate whether an entity could perform qualitative assessments both at hedge inception and after a quantitative test has been performed after hedge inception. 4. All entities may perform the initial quantitative assessment of hedge effectiveness before or at the required quarterly effectiveness testing period using data applicable as of hedge inception. The timing requirement of the preparation of all other hedge documentation does not change. 5. In addition to the relief in item #4 above, a private company that is not a financial institution and a not-for-profit entity (except for those that have issued, or are a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an overthe-counter market) must prepare a statement of intent to hedge concurrently with hedge inception, but all initial and subsequent hedge effectiveness assessments (on either a quantitative basis or a qualitative basis as permitted or required by Topic 815) are not required to be performed and documented until the next set of interim (if applicable) or annual financial statements is available to be issued. The statement of intent includes (a) the hedging instrument, (b) the hedged item or transaction, and (c) the nature of the risk being hedged. However, the method that will be used to assess effectiveness is not required in the statement of intent to hedge, that is, documentation of the method can be deferred consistent with the hedge effectiveness assessments. Feb. 15, 2017 Feb. 15, 2017 Recognition and Presentation of 6. For fair value and cash flow hedges, the entire change in the fair value of the hedging instrument (including amounts excluded from the assessment of effectiveness) must be Oct. 7,

3 Changes in the Fair Value of Hedging Instruments in Fair Value and Cash Flow Hedges presented in the same income statement line item in which the earnings effect of the hedged item is presented. 7. An entity may exclude the portion of the change in fair value of a currency swap attributable to a cross-currency basis spread. 8. For amounts excluded from the assessment of effectiveness in fair value and cash flow hedges, the base recognition model is an amortization approach, and entities also are allowed, as an accounting policy election, to apply a mark-to-market through earnings approach as they are under current GAAP. 9. When a hedging relationship is discontinued and an amortization approach is used, the changes in fair value of excluded components recorded in accumulated other comprehensive income will be released to earnings consistent with existing GAAP for each respective type of hedging relationship, specifically: a. For a cash flow hedge in which the hedged forecasted transaction is still probable of occurring, at the time that the hedged forecasted transaction affects earnings b. For a fair value hedge, consistent with how fair value hedge basis adjustments are recognized in earnings for the related hedged item. 10. The Board decided to require that if a hedged forecasted transaction is probable of not occurring, amounts reclassified from accumulated other comprehensive income to earnings be presented in the same income statement line item in which the hedged forecasted transaction would have been presented had it occurred. This decision was March 22, 2017 Oct. 7, 2015 Mar. 22, 2017 Mar. 22, 2017 July 13,

4 rescinded at the January 25, 2017 Board meeting. Therefore, current GAAP is retained and there is no prescribed presentation guidance for missed forecasts. Benchmark Interest Rates Fair Value Hedges of Interest Rate Risk 11. For hedges of variable-rate financial instruments, an entity may designate the contractually specified interest rate as the hedged risk in cash flow hedges of interest rate risk, thus eliminating the concept of benchmark interest rates for variable-rate financial instruments. 12. For hedges of fixed-rate financial instruments, the concept and definition of the term benchmark interest rate and list of eligible benchmark rates in the United States is retained. The Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate is added to the list of permissible benchmark rates. 13. The Board decided not to add the concept that a rate can be expected to become widely used to the current definition of the term benchmark interest rate. Therefore, the Board will not further amend the definition of a benchmark interest rate beyond the amendments already made in the proposed Update. 14. When calculating the change in fair value of the hedged item in a fair value hedge of interest rate risk, an entity has the choice to use either the cash flows associated with the benchmark interest rate determined at hedge inception or the full contractual coupon cash flows. Oct. 7, 2015 Mar 8,

5 15. For prepayable financial instruments, an entity may consider only how changes in the benchmark interest rate affect a decision to settle a debt instrument before its scheduled maturity in calculating the change in the fair value of the hedged item attributable to interest rate risk. 16. An entity may measure the hedged item in a partial-term fair value hedge of interest rate risk by assuming the hedged item has a term that reflects only the designated cash flows being hedged. 17. For a closed portfolio of prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments, an entity may designate as the hedged item a stated amount of the asset or assets that are not expected to be affected by prepayments, defaults, and other factors affecting the timing and amount of cash flows if the designation is made in conjunction with the partial-term hedging election in item #16 (the last of layer method ). As part of the initial hedge documentation, an analysis shall be completed and documented to support the entity s expectation that the hedged item (that is, the designated last of layer) is anticipated to be outstanding as of the hedged item s assumed maturity date in accordance with the entity s partial-term hedge election. An entity may assume that if prepayments, defaults and other factors affecting the timing and amount of cash flows occur, they are first applicable to the portion of the portfolio of prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments that is not part of the designated hedged layer. An entity shall perform and document at each effectiveness assessment date an analysis that supports the entity s expectation that the hedged item (that is, the designated last of layer) Mar 8,

6 is still anticipated to be outstanding as of the hedged item s assumed maturity date. That analysis shall incorporate the entity s current expectations of prepayments, defaults, and other events affecting the timing and amount of cash flows using a method consistent with the method used to perform the analysis at hedge inception. Net Investment Hedges Shortcut Method 18. For qualifying net investment hedges, an entity records the entire change in the fair value of the hedging instrument that is included in the assessment of hedge effectiveness in the cumulative translation adjustment section of other comprehensive income. In the period(s) the hedged item affects earnings, entities will reclassify changes in fair value of the hedging instrument from accumulated other comprehensive income to the same income statement line item in which the earnings effect of the hedged item is presented. 19. For amounts excluded from the assessment of effectiveness in net investment hedges, the base recognition model is an amortization approach, and entities also are allowed, as an accounting policy election, to apply a mark-to-market through earnings approach as they are under current GAAP. When a net investment hedge is discontinued, any amounts that have not yet been recognized in earnings shall remain in the cumulative translation adjustment section of accumulated other comprehensive income until the hedged net investment is sold or liquidated in accordance with paragraphs and 40-1A. 20. There is no presentation requirement for amounts excluded from the assessment of effectiveness in net investment hedges. October 7, 2015 October 7, An entity may apply a long-haul method if use of the shortcut method was not or no longer is appropriate (for the periods in which the hedging relationship is highly 6

7 effective). In order to apply that long-haul method, the entity must document at the inception of the hedging relationship which long-haul methodology would be used. 22. The Board decided to amend one criterion of the shortcut method related to the matching of the expiration date of the interest rate swap and the maturity date of the hedged item. That amendment allows partial-term fair value hedges of interest rate risk under the shortcut method. July 13, 2016 Critical Terms Match (CTM) Method 23. The Board decided to allow an entity to use the CTM method for a cash flow hedge of a group of forecasted transactions if the forecasted transactions occur and the derivative matures within the same 31-day period or fiscal month and the entity meets all other requirements for the CTM method. July 13, 2016 Disclosures 24. An entity must provide additional disclosures related to cumulative basis adjustments for fair value hedges and certain incremental disclosures related to the last of layer method. 25. Certain tabular disclosures required in Topic 815 are amended to focus on the effect of hedge accounting on income statement line items. Effective Date and Early Adoption 26. The Board decided that the effective date for public business entities is for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. 7

8 27. The Board also decided that the effective date for entities other than public business entities is for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, The Board decided to permit early adoption in any interim or annual period upon issuance of the final Update. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period (that is, the initial application date). Transition 29. Transition requirement: For cash flow hedges and net investment hedges existing (that is, the hedging instrument has not expired, been sold, terminated, or exercised or the entity has not removed the designation of the hedging relationship) as of the date of adoption, an entity should eliminate the separate measurement of ineffectiveness by means of a cumulative-effect adjustment to accumulated other comprehensive income with a corresponding adjustment to the opening balance of retained earnings as of the initial application date. 30. Transition elections: An entity may make any of the following transition elections. Private companies that are not financial institutions and not-for-profit entities (except for not-for-profit entities that have issued, or are a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market) must make the transition elections below before the next set of interim (if applicable) or annual financial statements is available to be issued. All other entities must make the elections below before the first effectiveness testing date after adoption: March 23, 2016 March 23,

9 a. For a fair value hedge of interest rate risk existing as of the date of adoption, an entity may modify the measurement methodology for a hedged item in accordance with item #14 or #15 without dedesignation of the hedging relationship. The cumulative basis adjustment carried forward should be adjusted to an amount that reflects what the cumulative basis adjustment would have been at the date of adoption had the modified measurement methodology been used in all past periods in which the hedging relationship was outstanding. When making this election, the benchmark rate component of the contractual coupon cash flows should be determined as of the hedging relationship s original inception date. The cumulative effect of applying this election should be recognized as an adjustment to the basis adjustment of the hedged item recognized on the balance sheet with a corresponding adjustment to the opening balance of retained earnings as of the initial application date. b. For the fair value hedges of interest rate risk for which an entity modifies the measurement methodology for the hedged item to the benchmark rate component of the contractual coupon cash flows in accordance with item #30(a), an entity may elect to dedesignate a portion of the hedged item and reclassify the basis adjustment associated with the portion of the hedged item dedesignated to the opening balance of retained earnings as of the initial application date. c. For fair value hedges existing as of the date of adoption in which foreign exchange risk is the hedged risk or one of the hedged risks and a currency swap is the hedging instrument, an entity may, without dedesignation, modify its hedge documentation to exclude the cross-currency basis spread component of the currency swap from the 9

10 assessment of hedge effectiveness and recognize the excluded component through an amortization approach. The cumulative effect of applying this election should be recognized as an adjustment to accumulated other comprehensive income with a corresponding adjustment to the opening balance of retained earnings as of the initial application date. d. For hedges existing as of the date of adoption that exclude a portion of the hedging instrument from the assessment of effectiveness, an entity may modify the recognition model for the excluded component from a mark-to-market approach to an amortization approach without dedesignation of the hedging relationship. The cumulative effect of applying this election should be recognized as an adjustment to accumulated other comprehensive income with a corresponding adjustment to the opening balance of retained earnings as of the initial application date. e. An entity may modify documentation without dedesignating an existing hedging relationship to specify the following: i. For hedging relationships that currently use a quantitative method to assess effectiveness, that subsequent prospective and retrospective effectiveness assessments will be performed qualitatively. ii. For hedging relationships that currently use the shortcut method to assess effectiveness, the quantitative method that will be used to perform assessments of effectiveness if the entity determines at a later date that use of the shortcut method was not or no longer is appropriate. 10

11 f. For cash flow hedges existing as of the date of adoption in which the hedged risk is designated as the variability in total cash flows that meet the requirements to designate as the hedged risk the variability in cash flows attributable to changes in a contractually specified component or a contractually specified interest rate: iii. Modify the hedging relationship, without dedesignation, to specify the hedged risk is the variability in the contractually specified component or contractually specified interest rate. iv. Create the terms of the instrument used to estimate changes in value of the hedged risk (either under the hypothetical derivative method or another acceptable method in Subtopic ) in the assessment of effectiveness on the basis of market data as of the inception of the hedging relationship. v. Consider any ineffectiveness previously recognized on the hedging relationship as part of the transition adjustment in accordance with item #29. g. An entity may reclassify a debt security from held-to-maturity to available-for sale if the debt security is eligible to be hedged under the last of layer method. Any unrealized gain or loss at the date of the transfer should be recorded in accumulated other comprehensive income in accordance with paragraph (c). 31. For fair value hedges existing as of the date of adoption in which the hedged item is a tax-exempt financial instrument, the hedged risk may be modified to interest rate risk related to the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate. The modification should be considered a dedesignation and immediate March 23,

12 redesignation of the hedging relationship. In this situation, the cumulative basis adjustment of the hedged item from the dedesignated hedging relationship should be amortized to earnings on a level-yield basis over a period of time based on the applicable requirements in other Topics. 32. An entity is not required to apply the guidance in paragraph when comparing hedging relationships executed before and after the date of adoption for any of the following: a. Hedging relationships executed before the adoption date assessed under the shortcut method for which hedge documentation was not amended as permitted by item #30(e)(ii), and hedging relationships executed after the adoption date assessed under the shortcut method in accordance with item #21. b. Hedging relationships executed before the adoption date for which the hedged risk was not amended to a contractually specified component or a contractually specified interest rate as permitted by item # 30(f) and hedging relationships executed after the adoption date for which the hedged risk is the variability in cash flows attributable to changes in a contractually specified component or a contractually specified interest rate. c. Hedging relationships executed before the adoption date for which the recognition of excluded components was not amended to an amortization approach as permitted by item #30(d), and hedging relationships executed after the adoption date for which an amortization approach is elected. March 23,

13 33. On a prospective basis only (in all interim periods and fiscal years ending after the date of adoption), an entity should: a. Present the entire change in the fair value of the hedging instrument in the same income statement line item as the earnings effect of the hedged item when the hedged item affects earnings (with the exception of amounts excluded from the assessment of hedge effectiveness in a net investment hedge). b. Provide the amended disclosures required by the Update. 34. An entity should provide the following disclosures within Topic 250 on accounting changes and error corrections: a. The nature of and reason for the change in accounting principle b. The cumulative effect of the change on the opening balance of each affected component of equity or net assets in the statement of financial position as of the date of adoption c. The disclosures in (1) through (2) above in each interim and annual financial statement period in the fiscal year of adoption. March 23, 2016 Board Decisions Related to Other 35. The Board decided not to deliberate the issue raised in DIG H17, Hedging Functional- Currency-Equivalent Proceeds to Be Received from a Forecasted Foreign-Currency- Denominated Debt Issuance. January 25,

14 Feedback Received 36. The Board decided that in a cash flow hedge of a hedged forecasted transaction if the hedged risk component changes from the risk originally designated (for example, from LIBOR to Prime) and the hedged forecasted transaction remains probable of occurring, an entity does not need to dedesignate the hedging relationship if the derivative remains highly effective at offsetting the cash flows associated with the hedged item. A change in the hedged risk also does not affect an entity s conclusion of whether the forecasted transaction remains probable of occurring. This decision applies to hedges of both financial instruments and nonfinancial items. January 25,

New Developments Summary

November 7, 2017 NDS 2017-08 New Developments Summary Targeted improvements to hedge accounting ASU 2017-12 simplifies accounting for hedging activities Summary The FASB recently issued ASU 2017-12, Targeted