Alert: FASB Accounting Standards Update No. 2017-12 – Derivatives and Hedging

Category: US GAAP

Alert: FASB Accounting Standards Update No. 2017-12 – Derivatives and Hedging

On August 28, 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2017-12 Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The amendments in this ASU help to better align an entity’s risk management activities and related financial reporting. The ASU also makes targeted simplifications to the hedge accounting application guidance.

Risk Component Hedging

Changes were made to address the limitations in current Generally Accepted Accounting Principles in the United States (US GAAP) on how an entity can designate the hedged risk in certain cash flow and fair value hedging relationships, as follows:

  1. The requirement in current US GAAP that only the overall variability in cash flows or variability related to foreign currency risk can be designated as the hedged risk in a cash flow hedge of a non-financial asset has been removed. An entity is permitted under the ASU to designate changes in a contractually specified component of a forecasted purchase/sales contract as an individual hedged risk in a cash flow hedge of a forecasted purchase or sale of a non-financial asset.
  2. The requirement to designate only the overall variability in cash flows as the hedged risk in a cash flow hedge of a variable-rate instrument indexed to a non-benchmark interest rate has been removed. An entity is permitted under the ASU to designate the variability in cash flows attributable to the contractually specified interest rate as the hedged risk in a cash flow hedge of a variable-rate financial instrument.
  3. The Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate has been added as an eligible benchmark interest rate in the US for a fair value hedge of interest rate risk.

Accounting for the Hedged Item in Fair Value Hedges of Interest Rate Risk

Current US GAAP contains limitations on how an entity can designate the hedged item in a fair value hedge of interest rate risk. Limitations also exist on how an entity can measure changes in fair value of the hedged item attributable to interest rate risk in certain fair value hedging relationships. The ASU addresses these limitations by permitting an entity to:

  1. Measure the change in fair value of the hedged item based on the benchmark rate component of the contractual coupon cash flows determined at hedge inception versus the full contractual coupon cash flows currently required under US GAAP.
  2. 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.
  3. Consider only how changes in the benchmark interest rate affect a decision to settle a prepayable debt instrument before its scheduled maturity in calculating the change in the fair value of the hedged item attributable to interest rate risk.
  4. Designate an amount that is not expected to be affected by prepayments, defaults, and other events affecting the timing of cash flows (the “last-of-layer” method) for a closed portfolio of prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments.

Recognition and Presentation of the Effects of Hedging Instruments

The ASU brings clarity to the financial statement presentation of the economic results of an entity’s risk management activities by requiring an entity to combine the earnings effect of both the hedging instrument and hedged item in the same income statement line item. This allows financial statement users to better understand the results and costs of an entity’s hedging program by no longer separately measuring and presenting hedge ineffectiveness. The ASU achieves this by requiring an entity to present the total fair value change of a hedging instrument included in the assessment of hedge effectiveness in:

  1. The income statement line that is used to present the earnings effect of the hedged item for fair value hedges.
  2. Other comprehensive income or in the currency translation adjustment section of other comprehensive income for cash flow and net investment hedges, respectively.

Amounts Excluded from the Assessment of Hedge Effectiveness

An entity is permitted under the ASU to exclude the portion of the change in fair value of a currency swap that is attributable to a cross-currency basis spread from the assessment of hedge effectiveness. Option premiums and forward points continue to be excluded from the assessment of hedge effectiveness.

Under the ASU, the fair value changes in an excluded component are recognized using a systematic and rational method over the life of the hedging instrument. Alternatively, an entity may elect to recognize all fair value changes in an excluded component currently in earnings, consistent with current US GAAP. Such an election will need to be applied consistently to similar hedges.

Other Simplifications of Hedge Accounting Guidance

The ASU provides amendments to the hedge effectiveness testing requirements as follows:

  1. An entity may make an election, on a hedge-by-hedge basis, to perform subsequent assessments of hedge effectiveness qualitatively in instances in which quantitative testing is initially required.
  2. An entity is permitted to assume a hedging derivative matures at the same time as a group of forecasted transactions if both occur within a 31-day period or fiscal month.
  3. An entity is permitted to perform the initial prospective quantitative assessment of hedge effectiveness at any time between the hedge inception date and the first quarterly effectiveness testing date.
  4. Private companies that are not financial institutions or certain not-for-profit entities do not need to perform the initial quantitative effectiveness assessment and all quarterly hedge effectiveness assessments until the date on which the next interim, if applicable, or annual financial statements are available to be issued.
  5. If the shortcut method is no longer appropriate, an entity may apply a long-haul method for assessing hedge effectiveness if the hedge is highly effective and the entity documents at inception which long-haul methodology it will use.

Disclosures

The ASU modifies disclosures required in current US GAAP, including tabular disclosures related to (i) the effect on the income statement of fair value and cash flow hedges, and (ii) cumulative basis adjustments for fair value hedges. It also eliminates the requirement to disclose the ineffective portion of the change in fair value of hedging instruments.

Effective Date and Transition Requirements

The amendments are to be applied only to hedging relationships existing on the date of adoption. The ASU is effective as follows:

  • Public business entities – for fiscal years beginning after December 15, 2018, including interim periods therein.
  • All other entities – for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020.

Early adoption is permitted in any interim period after issuance of this ASU, with the initial application date being the beginning of the fiscal year in which the ASU is adopted.

A cumulative-effect adjustment arising from the elimination of the separate measurement of ineffectiveness for cash flow and net investment hedges existing at the date of adoption should be recorded in accumulated other comprehensive income. A corresponding adjustment to opening retained earnings as of the beginning of the fiscal year that an entity adopts this ASU is also required. The presentation and disclosure amendments are to be applied prospectively. Certain transition elections are available upon adoption of the amendments as described in paragraph 815-20-65-3.

To access the full script of ASU No. 2017-12, click here.

This communication contains a general overview of the topic and is current as of August 28, 2017. The application of the principles addressed will depend upon the particular facts and circumstances of each individual case. Accordingly, this publication is not a substitute for professional advice and we recommend that any decisions you take about the application or not of any of the information presented be made in consultation with a qualified professional, who can address any variance that may be required to reflect your circumstances. Please contact your local MNP representative for customized assistance with the application of this material. MNP LLP accepts no responsibility or liability for any loss related to any person's use of or reliance upon this material. © MNP LLP 2017. All rights reserved.

Contact us

Michelle Balmer

Michelle Balmer CPA, CA

Vice President, Assurance

Michelle Balmer, CPA, CA, is a Senior Assurance Services Partner with MNP. With 14 years of experience in public practice, Michelle helps a broad range of public and privately held companies in a variety of industries. She also works on special projects, including costing studies, benchmarking and best-practice studies, operational analyses, litigation support and due diligence.

As a key member of MNP's Assurance team, Michelle has played an instrumental role in assurance policy development, implementing accounting and assurance standards firm-wide and educating assurance practitioners regarding methodologies and new pronouncements. She also provides technical advice and consultation on accounting and assurance issues, as well as on rules of professional conduct issues, to all MNP practitioners.

Michelle was certified a Chartered Accountant (CA) after obtaining a Bachelor of Commerce degree from the University of Alberta. She has been actively involved with the Institute of Chartered Accountants of Alberta, including the Chartered Accountants School of Business, in an instructional and marketing capacity. An avid volunteer, she has assisted numerous groups such as the Easter Seals of Alberta, Paralympic Sports Association and Junior Achievement of Northern Alberta.