FASB’s proposed changes in the hedge accounting standards for 2017
In planning for 2017, it is important for companies to consider the implications of FASB’s proposed changes in the hedge accounting standards to determine if the proposed changes could impact their hedging activity in 2017. On September 8, 2016 FASB issued a Proposed Accounting Standards Update, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (the “Update”), intended to better align financial reporting with a company’s risk management objectives. In addition, the Update would simplify hedge accounting guidance, thus eliminating several burdensome hurdles companies struggle to overcome when considering the adoption of hedge accounting under ASC 815.
The exposure draft will become effective after FASB has reviewed the comments received from the public as well as those received during roundtable meetings that were held in late November and early December. Adoption is expected to be permitted one fiscal year prior to the published effective date.
Some key benefits of the hedge accounting changes proposed by the Update include the following:
- For variable-rate cash flow hedges, the concept of benchmark interest rates would be eliminated. Any specified index rate would be eligible as the hedged risk for cash flow hedges.
- For cash flow hedges of non-financial assets, the designated risk may be a contractually specified component or ingredient linked to an index or specified rate. This would eliminate the requirement that only variability in cash flows or in foreign currency can be designated as the hedged risk.
- For fair value hedges of interest rate risk:
- the hedged item in a partial-term fair value hedge could be measured assuming its term reflects only the designated hedged period.
- an institution would be able to designate the benchmark component – a portion – of the total coupon cash flows as the hedged risk
- The fair value of the hedging instrument would be recorded in the same income statement line item, in the same period(s), in which the hedged item affects earnings.
- For cash flow and net investment hedges, the concept of periodic ineffectiveness would be eliminated. That is, if the relationship qualifies as highly effective, all changes in fair value of the hedging instrument included in the assessment would be recorded within Other Comprehensive Income.
- Subsequent testing of hedge effectiveness could be performed on a qualitative basis after the hedging relationship initially qualifies on a quantitative basis. However, quantitative testing of the hedge relationship would be required on an ongoing basis if the economic environment significantly changes.
- An institution initially electing the shortcut method could document a “long-haul” method to be used if the shortcut method were to be subsequently disqualified after hedge inception.
- More enhanced disclosures would be required to highlight the effect of hedge accounting on individual income statement line items and to describe hedging goals.
We believe these proposed changes would both ease the burden of applying hedge accounting and encourage entities to pursue hedge accounting where in the past they either have not qualified or have viewed hedge accounting to be overly burdensome. With greater flexibility from the proposed changes more entities should gain the flexibility needed to take advantage of the benefits of hedge accounting.
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The complete proposed accounting standard update for Topic 815 can be found on the FASB’s website here.