In a Nov. 30 comment letter to the Financial Accounting Standards Board (FASB), the American Institute of CPAs’ Financial Reporting Executive Committee (FinREC) offered 14 views on the board’s proposed improvements to accounting for hedging activities.
The FASB issued proposed Accounting Standards Update (ASU), Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, on Sept. 8. The proposal is intended to better align risk management activities and financial reporting for hedging relationships through changes in the designation and measurement guidance for those relationships and the presentation of hedge results.
It would also expand hedge accounting for nonfinancial and financial risk components, and align the recognition and presentation of the effects of the hedging instrument and the hedged item in financial statements.
“The current hedging standard can be challenging for reporting entities to apply properly,” the letter states. “Achieving hedge accounting for financial and nonfinancial risks under the current guidance has also proven to be very challenging.”
In 2010, after FASB issued a previous hedge accounting proposal, FinREC sent a comment letter to the board indicating support of three provisions in that proposal:
- Continue to allow hedge designation by type of risk.
- Allow hedges to be reasonably effective rather than highly effective.
- Allow qualitative assessments to evaluate effectiveness rather than only quantitative assessments.
In its most recent letter to the FASB, FinREC wrote that “we are pleased that the current proposed ASU also includes provisions to address many of these concerns.”
“Overall, we believe the proposal will improve and simplify the hedge accounting model, will better reflect the economics of risk management activities, and will ease hedge documentation requirements,” the letter states.
Here’s a sampling of four of the committee’s responses to questions posed by the FASB. The complete questions and answers are in the Appendix of the letter.
1. The committee agrees with the board’s decision to allow an entity to designate the variability in cash flows attributable to changes in a contractually specified component as the hedged risk in a cash flow hedge of a forecasted purchase or sale of a nonfinancial asset, as this will align the accounting with management’s reason for entering into the hedging relationship.
2. The committee believes the board should retain the current concept of benchmark interest rates for fair value hedges of fixed-rate financial instruments and for cash flow hedges of forecasted issuances or purchases of fixed-rate financial instruments.
FinREC also supports the addition of the Securities Industry and Financial Markets Association’s Municipal Swap Rate as an acceptable benchmark rate.
“We also believe there should be a process for the FASB to expedite considering additional benchmark rates that are expected to become widely used or become widely used, or removing rates that would no longer be appropriate,” the letter states.
3. The FASB decided it would allow an entity to use either the full contractual coupon cash flows or the cash flows associated with the benchmark rate determined at hedge inception in calculating the change in the fair value of the hedged item attributable to interest rate risk, except when the current market yield of the financial instrument is below the benchmark rate at hedge inception. In that instance, the total contractual coupon cash flows would have to be used.
FinREC agrees, because these changes will allow entities the flexibility to conform hedges to be more consistent with risk management activities. However, the committee questions the FASB’s decision to prohibit entities from using the benchmark rate component of the contractual coupon cash flows to calculate the change in the hedged item’s fair value attributable to changes in the benchmark interest rate when the current market yield of the hedged item is less than the benchmark interest rate at the inception of the hedge, commonly referred to as the “sub-LIBOR issue.”
4. As an organization composed of many entities that prepare individual financial statements using varying accounting policies, FinREC is not able to comment with respect to any single policy as to what constitutes a pattern of determining that hedged forecasted transactions are not probable of occurring.