Hedging gets a boost from simplified accounting guidance

By Ken Tysiac

One of FASB’s goals for its new hedge accounting guidance was to remove some of the barriers that the old accounting rules presented for hedging.

“The interest is palpable, particularly from the treasury/risk management side,” said Rob Royall, CPA, leader of the Derivatives and Financial Instruments team in EY’s Financial Accounting Advisory Services practice. “They see strategies or instruments that were difficult before that suddenly have a lifeline to them.”

Issued last August, Accounting Standards Update No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, was created to:

  • Align accounting rules with risk management activities.
  • More accurately reflect the economic results of hedging in the financial statements.
  • Simplify hedge accounting treatment.

Royall said the reception of financial statement preparers has been enthusiastic, adding that EY has worked with a number of companies that have early adopted the standard.

“It’s unusual to be happy and excited about a new accounting standard,” Royall said. “We don’t hear that all the time.”

The standard creates opportunities for companies to use hedging strategies that were so cumbersome to account for that it wasn’t practical to use them, said Jon Howard, CPA, a senior consultation partner in the Financial Instruments Group of Accounting Services in Deloitte & Touche LLP’s national office.

“It also just makes even current strategies and the accounting and the ongoing operational aspects of it a little bit easier, too, burden-wise,” Howard said. “There’s less volatility in the financials and less having to track what we would call ineffectiveness.”

Nonetheless, Royall cautions that it’s important for companies to consider hedging opportunities thoughtfully and deliberately before using them. That means going through normal controls and processes and consulting treasury committees or risk management committees before jumping in too quickly.

He said some of the early adopters merely are taking advantage of simpler accounting for hedges they already had planned to employ. Another early adopter didn’t have any live hedges, so the adoption of the standard basically consisted of an accounting policy disclosure.

Implementation isn’t quite that easy for everyone, though.

“This is a meaningful standard,” Royall said. “These are not little nips and tucks to make it prettier. These are substantial. … Derivatives didn’t suddenly become easy. They just became easier than they used to be.”

Resource constraints also are a concern for companies, which already have been wrestling for the past few years to implement FASB’s new revenue recognition and lease accounting standards.

“Sometimes your intention is, ‘I really want to do this right away,’ but whether they can pull all that off is something that we’ll have to see,” Howard said. “I certainly can’t take precedence on early adopting [the hedge accounting standard] over adopting revenue recognition. So it’s really a case of, where are the resources at the entities, and can they really do this?”

In many cases, companies are asking questions of their accounting consultants after their banks describe new opportunities related to hedging, Howard said. He said today’s conditions make it favorable for entities that have subsidiaries in Europe, Great Britain, or Japan to engage in foreign currency hedging.

“We’ve seen a big groundswell of entities that are interested in doing these transactions and also wanting to apply the easier standard where they don’t have the volatility in the income statement, and it’s a nice, smooth amount that’s hitting earnings,” Howard said.

Hedges that Howard and Royall said are becoming more attractive include:

  • Hedges of net investments in foreign operations. This hedge of foreign currency risks rose in popularity in 2015 when the dollar strengthened dramatically, Royall said.
  • Hedges that convert fixed-rate loans to floating-rate loans. Banks have been among the early adopters of the standard because it made accounting for this type of hedge dramatically easier, Royall said.
  • Hedges of commodity price risk that hedge only the core component of the commodity price risk rather than the entire price risk.

The standard also provides a convenient transition accommodation because it allows existing hedges to be modified or refined for accounting purposes without having to be de-designated. It also provides for companies to reclassify held-to-maturity securities that are prepayable.

“Depending on how many hedges you have in place, you want to make sure you take the full inventory so that you don’t miss this one-time opportunity to make these amendments and do the reclassifications, if you want to, out of held-to-maturity,” Howard said. “There are a lot of things you can do only when you adopt.”

He said a lot of calendar-year reporting organizations are taking inventory of their hedges and planning to make all their elections so they can early adopt for the first quarter by March 31. If the standard is adopted during an interim period, organizations are required to push any changes to prior quarterly accounting back to the beginning of the fiscal year of adoption.

At the same time, Royall said companies are making sure they don’t recklessly enter into new territory without performing their due diligence.

“It’s been a really interesting time and also an exciting time to see accounting not stopping business like it had started to at some companies,” Royall said. “And I think that’s why FASB acted.”

Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is a JofA editorial director.

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