FASB issues expanded hedge accounting standard

By Jeff Drew

A new Accounting Standards Update (ASU) aims to better align hedge accounting with an organization's risk management strategies.

The ASU, issued Monday by FASB, expands the current single-layer hedging model to allow multiple-layer hedges of a single closed portfolio of prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments under the method. Due to the expansion, FASB has renamed the last-of-layer methods as the portfolio-layer method.

The ASU addresses issues raised after FASB released a new hedging standard in 2017 that increased transparency around how the results of hedging activities are presented — in both financial statements and their footnotes — for investors and analysts when hedge accounting is applied.

One of the major provisions of that standard was the addition of the last-of-layer hedging method. For a closed portfolio of fixed-rate prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments, such as mortgages or mortgage-backed securities, the last-of-layer method allows an entity to hedge its exposure to fair value changes due to changes in interest rates for a portion of the portfolio that is not expected to be affected by prepayments, defaults, and other events affecting the timing and amount of cash flows.

After that standard was issued, stakeholders told FASB that while the ability to elect hedge accounting for a single layer is useful, hedge accounting could better reflect risk management activities if expanded to allow multiple layers of a single closed portfolio to be hedged under the method.

The ASU also does the following: 

  • Expands the scope of the portfolio-layer method to include nonprepayable assets;
  • Specifies eligible hedging instruments in a single-layer hedge;
  • Provides additional guidance on the accounting for and disclosure of hedge basis adjustments under the portfolio-layer method; and
  • Specifies how hedge basis adjustments should be considered when determining credit losses for the assets included in the closed portfolio.

"The expanded hedge accounting method better reflects the effects of risk management activities in the financial statements and ultimately provides investors and other allocators of capital with more transparent, decision-useful information around an entity's use of derivatives," FASB Chair Richard R. Jones said in a news release.

The ASU applies to all entities that choose to apply the hedge accounting portfolio-layer method. For public business entities, the ASU is effective for fiscal years beginning after Dec. 15, 2022, and interim periods within those fiscal years. For all other entities, the ASU is effective for fiscal years beginning after Dec. 15, 2023, and interim periods within those fiscal years. Early adoption is permitted.

— To comment on this article or to suggest an idea for another article, contact Jeff Drew at Jeff.Drew@aicpa-cima.com.

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