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FASB Eyes Improvements to Hedge Accounting Rules

Sep 9th 2016
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The Financial Accounting Standards Board (FASB) on Sept. 8 proposed several improvements to the accounting guidance for hedging activities.

“Stakeholders shared concerns that current hedge accounting requirements do not faithfully portray the economic results of an institution’s risk management activities,” FASB Chairman Russell Golden said in a prepared statement. “The proposed Accounting Standards Update sets forth the board’s recommendations for improving this area of financial reporting, and for simplifying the application of hedge accounting guidance without compromising the quality of financial reporting information provided to investors.”

Stakeholders also indicated that the effect of hedge accounting on an entity’s reported results can be tough to understand and interpret. They want reported results to better help financial statement users understand risk exposures and how hedging tactics manage those exposures.

The proposal, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, would 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.

To achieve that, the proposal seeks to expand hedge accounting for nonfinancial and financial risk components. It also would align the recognition and presentation of the effects of the hedging instrument and the hedged item in financial statements.

Here’s a snapshot of the proposal:

Risk component hedging. Current US GAAP limits how an entity can designate the hedged risk in certain cash flow and fair value hedging relationships. To address that, the proposal would allow hedge accounting for risk components in hedging relationships involving nonfinancial risk and interest rate risk.

Refining the accounting for hedged items in fair value hedges of interest rate risk. GAAP limits how an entity measures changes in fair value of the hedged item attributable to interest rate risk in certain fair value hedging relationships. The proposal would change the guidance for measuring the change in fair value of the hedged item in fair value hedges of interest rate risk.

Recognition and presentation of the effects of hedging instruments. The proposed amendments would require an entity to report the entire effect of the hedging instrument in the same income statement line item as the earnings effect of the hedged item. GAAP currently requires special hedge accounting only for the portion of the hedge considered highly effective and requires an entity to separately reflect the amount by which the hedging instrument doesn’t offset the hedged item, referred to as the “ineffective amount.”

Disclosures. Disclosures required in current GAAP would be modified to include a tabular disclosure related to the effect on the income statement of fair value and cash flow hedges. The requirement to disclose the ineffective portion of the change in fair value of hedging instruments would be eliminated. Several new disclosures would be required, including those related to cumulative basis adjustments for fair value hedges and enhanced qualitative disclosures that describe quantitative hedging goals set to achieve hedge accounting objectives.

In addition, the exposure draft includes proposals that would simplify the application of hedge accounting by:

  • Providing more time for the completion of initial quantitative assessments of hedge effectiveness.
  • Allowing subsequent assessments of hedge effectiveness to be performed on a qualitative basis when an initial quantitative test is required.
  • Clarifying the application of the critical terms match method for a group of forecasted transactions.
  • Permitting an institution that elects the shortcut method to continue hedge accounting by using a “long-haul” method to assess hedge effectiveness if use of the shortcut method was not or no longer is appropriate after hedge inception.

“Overall, these proposed amendments would be an improvement because an entity’s financial statements would reflect more accurately and comprehensively the intent and outcome of its hedging strategies,” the proposal states.

Comments on the proposal are due by Nov. 22. The exposure draft contains instructions on how to submit comments to the FASB.

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