FASB issues final hedging guidance, can be adopted immediately

In brief Aug 28, 2017

Hedge accounting changes are here. Read our summary.

What happened?

On August 28, the FASB issued significant amendments1 to hedge accounting. The amendments can be adopted immediately in any interim or annual period (including the current period). The mandatory effective date for calendar year-end public companies is January 1, 2019. All others have an additional year to adopt.

At a glance

New amendments to hedge accounting will change how all types of companies account for and disclose hedges. The new guidance may be (but is not required to be) adopted immediately.

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1ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities

 

Why is this important?

The FASB’s new guidance will make more financial and nonfinancial hedging strategies eligible for hedge accounting. It also amends the presentation and disclosure requirements and changes how companies assess effectiveness. It is intended to more closely align hedge accounting with companies’ risk management strategies, simplify the application of hedge accounting, and increase transparency as to the scope and results of hedging programs.

Hedging strategies

More hedging strategies will be eligible for hedge accounting. These include hedges of a contractually-specified price component of a commodity purchase or sale, hedges of the benchmark rate component of the contractual coupon cash flows of fixed-rate assets or liabilities, hedges of the portion of a closed portfolio of prepayable assets not expected to prepay, and partial-term hedges of fixed-rate assets or liabilities (e.g., the first and second years of a five-year bond).

Timing of effectiveness assessments

Public business entities, public not-for-profit entities, and financial institutions will have until the end of the first quarter in which a hedge is designated to perform an initial assessment of a hedge’s effectiveness. All other companies will have until their financial statements are available to be issued.

Effectiveness assessments

After initial qualification, the new guidance permits a qualitative effectiveness assessment for certain hedges instead of a quantitative test, such as a regression analysis, if the company can reasonably support an expectation of high effectiveness throughout the term of the hedge. An initial quantitative test to establish that the hedge relationship is highly effective is still required.

 

Recognition of derivative gain or loss

For cash flow hedges, if the hedge is highly effective, all changes in the fair value of the derivative hedging instrument will be recorded in other comprehensive income. They will be reclassified to earnings when the hedged item impacts earnings.

On the other hand, for fair value hedges, because the change in fair value of the hedged item and the derivative hedging instrument will still be recorded in current earnings, if the hedge is not perfectly effective, there will be an income statement impact.

Presentation

The change in fair value of the derivative will be recorded in the same income statement line item as the earnings effect of the hedged item.

Excluded components

In addition to option premiums and forward points, the new guidance permits cross-currency basis spreads to be excluded from the assessment of hedge effectiveness. Companies may also make an accounting policy election (to be applied consistently to similar hedges) to recognize changes in fair value of excluded components either (1) in other comprehensive income, to be amortized into earnings over the life of the derivative, or (2) in earnings currently.

Disclosure

Additional disclosures include cumulative basis adjustments for fair value hedges and the effect of hedging on individual income statement line items.

What's next?

Companies that early adopt the guidance in calendar year 2017 will have to apply the new guidance as of the beginning of the year. The standard includes detailed transition provisions for most aspects of the new guidance, including certain transition provisions that provide relief if elected at the date of adoption.

Stay tuned for our In depth summarizing the changes in greater detail. Also, register here for our live webcast on September 27.

To have a deeper discussion, contact:

Chip Currie

Partner, National Professional Services Group

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Nick Milone

Partner, National Professional Services Group

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Maria Constantinou

Director, National Professional Services Group

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Got 3 minutes? Watch our video on the new hedging standard

New hedge accounting guidance released to align hedge accounting with companies' risk management strategies, simplify the application of hedge accounting, and increase transparency.

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David Schmid
IFRS & US Standard Setting Leader, National Professional Services Group
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