New hedge accounting guidance released to align hedge accounting with companies' risk management strategies, simplify the application of hedge accounting, and increase transparency.
Hi, I’m Maria Constantinou, a Director in PwC’s National Office.
Today, the FASB issued final guidance that more closely aligns hedge accounting with companies' risk management programs, simplifies its application and increases transparency.
Before I get into the highlights of what's changing, there is one key thing to know upfront. The new standard can be adopted immediately, so in Q3 2017 if you want.
However, that would mean calendar-year companies would go back to January 1 2017 to reflect the new guidance.
Now, let's talk about what's changing. The FASB's new guidance will impact all areas of hedge accounting, but here are a few of the bigger changes.
First, more hedging strategies are now eligible for hedge accounting and some will be more effective. These include a cash flow hedge of a component of a non-financial item, such as the purchase or sale of a commodity, if the contract separately specifies the component. For example, this could be applied to a contract to purchase natural gas for delivery at a specific plant, when the contract specifies that the price is based on the price at a liquidhub.
Also, hedges of interest rate risk of fixed-rate assets and liabilities, such as debt, will likely be more effective.
Additionally, it will be easier to hedge portfolios of prepayable assets, for example, part of a residential loan portfolio, subject to certain criteria being met.
Second, to simplify things, the new standard permits a qualitative assessment for effectiveness for certain hedges on an ongoing basis. Although an initial quantitative assessment, such as a regression analysis, is still required upfront to establish that the hedge relationship is highly effective, this avoids doing recurring math in every period.
Third, there's a change to the recognition of cash flow hedges.
Under the new standard, if a cash flow hedge is highly effective, all changes in the fair value of the derivative hedging instrument are recorded in Other Comprehensive Income.
On the other hand, for fair value hedges, the changes in fair value of the hedged item and the hedging instrument are recorded in current earnings. If the hedge is not perfectly effective, there will be P&L volatility.
Last, but not least, there are changes to presentation. Before, there wasn’t any prescriptive guidance on presentation; now there is.
The change in fair value of the derivative is presented in the same income statement line item as the earnings effect of the hedged item.
So, that's a brief overview of the new standard. Although called “targeted improvements,” there are significant changes coming, some optional, some required. Consider the full impact of the new guidance when thinking about your adoption date.
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