UNDERSTANDING THE NEW HEDGING STANDARD

Transcription

1 UNDERSTANDING THE NEW HEDGING STANDARD February 13, 2018 BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms.

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3 With you today GAUTAM GOSWAMI National Assurance Partner (312) JULIE VALPEY National Assurance Partner (212)

4 LEARNING OBJECTIVES Describe how ASU issued to improve hedge accounting guidance, simplifies hedge accounting requirements and expands the eligible hedging strategies for financial and nonfinancial risks. Explain how to present and disclose the hedging results under ASU Identify ways to apply the simplified model presented in ASU , providing for partial relief on certain aspects of hedge documentation and recognition through earnings. 4

5 KEY ASPECTS OF ASC 815, DERIVATIVES AND HEDGING Report all derivatives as assets or liabilities on the balance sheet at fair value Record changes in fair value in earnings Special hedge accounting is permitted for derivatives designated and qualifying as hedges 5

6 NO HEDGE DESIGNATION: ACCOUNTING Mark the derivative to fair value. Record the change in fair value through the income statement. Change in the Fair Value of the Derivative 6

7 HEDGE ACCOUNTING OR 7

8 CASH FLOW HEDGE ACCOUNTING HEDGING INSTRUMENT The effective portion of the gain (or loss) on the hedging instrument is reported in OCI The ineffective portion of the gain (or loss) on the hedging instrument is recognized currently in earnings HEDGED ITEM No change to accounting for hedged item or forecasted transaction. 8

9 FAIR VALUE HEDGE ACCOUNTING Income Statement Change in fair value of the hedged item that is attributed to the hedged risk (XXX) XXX Change in F/V of the derivative If the hedging is not 100% effective, then the ineffectiveness will automatically influence the P&L 9

10 CONCEPT OF HEDGE INEFFECTIVENESS: ELIMINATED The hedging relationship still has to be highly effective in order to apply hedge accounting Ineffective portion of the hedging instrument is no longer required to be recognized currently in earnings or disclosed For cash flow and net investment hedges, all changes in the fair value of the hedging instrument (i.e., both the effective and ineffective portions) will be deferred in AOCI 10

11 OTHER CHANGES MADE BY ASU , DERIVATIVES AND HEDGING (TOPIC 815): TARGETED IMPROVEMENTS TO ACCOUNTING FOR HEDGING ACTIVITIES Documentation Relief and Effectiveness Requirements Simplification Expands Risks Eligible To be Hedged Simplifies Fair Value Hedges of Interest Rate Risk Establishes Presentation Requirements Incremental Disclosures Transition and Effective Date One Time Transition Elections 11

12 DOCUMENTATION REQUIREMENTS CURRENT GUIDANCE Entity s risk management objectives and strategies for undertaking the hedge, Nature of the hedged risk, Derivative hedging instrument, The hedged item or forecasted transaction, Method the entity will use to retrospectively and prospectively assess the hedging instrument s effectiveness, and Method the entity will use to measure hedge ineffectiveness [including those situations in which the change in fair value method, as described in ASC will be used]. 12

13 DOCUMENTATION REQUIREMENTS RELIEF GRANTED TO PUBLIC COMPANIES The timing of the initial prospective quantitative hedge effectiveness test is extended up to the first quarterly effectiveness assessment date 13

14 DOCUMENTATION REQUIREMENTS ADDITIONAL RELIEF GRANTED TO PRIVATE COMPANIES MAY BEFORE THE DATE ON WHICH THE NEXT FINANCIAL STATEMENTS ARE AVAILABLE TO BE ISSUED: Select the method of assessing hedge effectiveness Perform both the initial effectiveness test and all subsequent quarterly hedge effectiveness assessments REQUIRED TO DOCUMENT ONLY THE FOLLOWING CONTEMPORANEOUSLY AT HEDGE INCEPTION: Hedging instrument Hedged item or transaction Nature of the risk being hedged 14

15 EFFECTIVENESS ASSESSMENTS Applies the qualitative shortcut method for assessing hedge effectiveness Later determines this method to be inappropriate Allowed to change to a specified quantitative long-haul method (e.g., regression) Long-haul method to be documented at inception. 15

16 EFFECTIVENESS ASSESSMENTS Critical Terms Match Method - May assume that the hedging derivative s maturity date and the occurrence of the forecasted transactions (e.g., forecasted sales) match if they occur within the same 31-day period fiscal month 16

17 EFFECTIVENESS ASSESSMENTS An entity may elect to perform the subsequent quarterly hedge effectiveness assessments qualitatively Even if a quantitative test (e.g., regression) was required at hedge inception Certain conditions to be met 17

18 RISKS ELIGIBLE TO BE HEDGED FINANCIAL RISK COMPONENTS CASH FLOW HEDGES Concept of benchmark interest rates (e.g., LIBOR) eliminated Can hedge any contractually specified interest rate (e.g., Prime) FAIR VALUE HEDGES Concept of benchmark interest rates (e.g., LIBOR) retained Add Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate 18

19 RISKS ELIGIBLE TO BE HEDGED NONFINANCIAL RISK COMPONENTS Can hedge the variability in cash flows attributable to changes in any contractually specified component of a nonfinancial asset. For instance, may hedge just the rubber component of forecasted tire purchases instead of the entire purchase price. 19

20 CHANGED IN THE DESIGNATED HEDGED RISK If an entity designates a hedged risk that changes in the future, that change should not result in an automatic hedge dedesignation. The hedge could be continued if the hedging instrument provided highly effective offset in relation to the revised hedged risk. 20

21 EXCLUDED COMPONENTS Time Value of Options, Forward points (Spot-Forward differences), Cross Currency Basis Spreads Mark to market (similar to guidance prior to adoption of ASU ) Recognize in current earnings Amortization Initial amount amortized in systematic and rational manner (straight line approach) Subsequent changes recognized in OCI 21

22 SIMPLIFIES FAIR VALUE HEDGES OF INTEREST RATE RISK Measure the change in fair value of the hedged item considering only the hedged benchmark interest rate component, instead of the full contractual coupon (including credit spread). Measure the hedged item by assuming it has a term that reflects only the designated cash flows being hedged, e.g., the first 3 years of a 7 year note (Partial Term Hedge) Use a last-of-layer method in hedging closed portfolios of prepayable financial assets. Prepayment risk is not incorporated into the measurement of the hedged item 22

23 SIMPLIFIES FAIR VALUE HEDGES OF INTEREST RATE RISK Measure the change in fair value of the hedged item considering only the hedged benchmark interest rate component, instead of the full contractual coupon (including credit spread). Measure the hedged item by assuming it has a term that reflects only the designated cash flows being hedged, e.g., the first 3 years of a 7 year note (Partial Term Hedge) Use a last-of-layer method in hedging closed portfolios of prepayable financial assets. Prepayment risk is not incorporated into the measurement of the hedged item 23

24 SIMPLIFIES FAIR VALUE HEDGES OF INTEREST RATE RISK Measure the change in fair value of the hedged item considering only the hedged benchmark interest rate component, instead of the full contractual coupon (including credit spread). Measure the hedged item by assuming it has a term that reflects only the designated cash flows being hedged, e.g., the first 3 years of a 7 year note (Partial Term Hedge) Use a last-of-layer method in hedging closed portfolios of prepayable financial assets. Prepayment risk is not incorporated into the measurement of the hedged item 24

25 PRESENTATION Presentation of the earnings effect of the hedging instrument in the same income statement line item as the hedged item Cash Flow Hedge: Amounts deferred in AOCI for interest rate hedges will be reclassified to interest expense Fair Value Hedges: Fair value change of the hedging instrument is presented in the same income statement line that includes the hedged item s impact on earnings 25

26 DISCLOSURES Removes requirement to disclose amounts of hedge ineffectiveness Requires new tabular disclosures related to the carrying amounts and cumulative basis adjustments for fair value hedges For last-of-layer method: Details about hedges designated under the last-of layer method Closed portfolio s amortized cost basis Basis adjustment for last of layer Amends current tabular disclosures related to the effect on the income statement of fair value and cash flow hedges Total amounts reported for each income and expense line item that is affected by fair value or cash flow hedges The effects of hedging on those line items Disclosures are required for every annual and interim reporting period 26

27 EFFECTIVE DATES PUBLIC BUSINESS ENTITIES Effective for fiscal years beginning after December 15, 2018 Interim periods within those fiscal years Early application is permitted in any interim period after issuance of the amendments for existing hedging relationships on the date of adoption ALL OTHER ENTITIES Effective for fiscal years beginning after December 15, 2019 Interim periods beginning after December 15, 2020 Early application is permitted in any interim period after issuance of the amendments for existing hedging relationships on the date of adoption. 27

28 EARLY APPLICATION Early application is permitted In any interim period for existing hedging relationships on the date of adoption Effect of adoption reflected as of the beginning of the fiscal year of adoption (the initial application date) Existing hedging relationships as of the date of adoption Hedging instrument has not expired, been sold, terminated, or exercised and Have not been de-designated 28

29 TRANSITION Cash flow and net investment hedges: Elimination of the separate measurement Recording of ineffectiveness Should be applied through a cumulative-effect adjustment to AOCI with a corresponding entry to the opening balance of retained earnings Specific transition guidance provided for fair value hedges of interest rate risk and component hedging The amended presentation and disclosure guidance is required only prospectively In each annual and interim reporting period in the fiscal year of adoption, entities will also be required to provide certain disclosures required by ASC 250, Accounting Changes and Error Corrections 29

30 CERTAIN ONE-TIME BENEFICIAL TRANSITION ELECTIONS Amending hedge documentation to indicate that subsequent hedge effectiveness assessments will be performed qualitatively Documenting the alternative long-haul method that will be applied, if the shortcut method is determined to be inappropriate 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-oflayer method. 30

31 QUESTIONS? 31

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