FASB issued a new standard Monday that is designed to make hedge accounting easier for financial statement preparers and easier for financial statement users to understand.
According to FASB Chairman Russell Golden, Accounting Standards Update No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, was created to:
- Better align accounting rules with a company’s risk management activities.
- Better reflect the economic results of hedging in the financial statements.
- Simplify hedge accounting treatment.
The standard takes effect for public companies for fiscal years, and interim periods within those fiscal years, beginning after Dec. 15, 2018. For private companies, the standard takes effect for fiscal years beginning after Dec. 15, 2019, and interim periods beginning after Dec. 15, 2020. Early adoption is permitted.
In creating the standard, FASB sought to address concerns of both preparers who found hedge accounting rules burdensome and users who had difficulty understanding some of the presentations of hedge accounting information that exist under present GAAP.
Hedge accounting for both financial and commodity risks is expanded under the new standard. It was designed to create more transparency around presentation of economic results on the face of the financial statements and in the footnotes.
The standard takes a three-pronged approach to improving accounting rules, with a focus on:
- Measurement and hedging strategies.
- Presentation and disclosure.
- Easing the administrative burden that hedge accounting can create for preparers.
James Kroeker, FASB’s vice chairman, said during an interview that the standard puts nonfinancial hedging on an equal playing field with many of the financial hedging strategies that have been available. Current GAAP did not allow for component hedging of nonfinancial risk but permitted component hedging of interest rate risk, Kroeker said.
“It also opens up a number of … commonly employed strategies in the risk management space for hedges of, for example, prepayable loans on a portfolio basis,” Kroeker said. “The extent that companies were able to do that in the past was through very complicated accounting math versus more clearly allowing for that strategy or allowing for partial-term hedging of interest rate risks.”
According to an issue of FASB in Focus devoted to the standard, under refinements made to measurement of the hedged item, preparers will:
- 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.
- Consider only how changes in the benchmark interest rate affect a decision to settle a prepayable instrument before its scheduled maturity when calculating the fair value of the hedged item.
- Measure the fair value of the hedged item using the benchmark rate component of the contracted coupon cash flows determined at conception.
The board also hopes to simplify hedge accounting by eliminating the requirement to separately measure and report hedge ineffectiveness. Under current GAAP, Kroeker said, the separate reporting of ineffectiveness measures in hedges that were effective overall could confuse investors.
“I think [the new standard] really helps the investor,” Kroeker said. “In the past investors were confused by, ‘You told me you have this highly effective derivative. What is this ineffectiveness, and why am I seeing this noise?’ ”
The presentation and disclosure changes under the new standard include the amendment of a tabular disclosure of hedging activities to focus on the effect of hedge accounting on individual income statement line items.
In addition, changes in the value of the hedging instrument are required to be presented in the same income statement line as the earnings effect of the hedged item. And a new required disclosure will provide investors with more information about basis adjustments in fair value hedges.
The standard aims to eliminate administrative difficulties for preparers with simplifications related to assessments of hedge effectiveness, and it will more closely align GAAP with hedge accounting performed under IFRS, Kroeker said.
Private company preparers also will get additional relief with documentation requirements that are more closely aligned with the issuance of financial statements. At hedge inception, they still will have to identify the hedge and prepare a statement of intent to hedge. And they will have to state upfront that they are going to enter into a hedge. But they will get more time to prepare the documentation of effectiveness testing.
“The PCC [Private Company Council] was very supportive all along of the project and helpful to us in understanding the resources of private companies and their ability—or in some cases lack thereof—to provide contemporaneous documentation of all of the things that were required,” Kroeker said.
The new hedge accounting standard does not affect the GAAP exception that provides a simplified hedge accounting method for certain interest rate swaps that private companies other than financial institutions enter to convert variable-rate debt to fixed-rate debt. That exception remains available to private companies.
—Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is a JofA editorial director.