The Financial Accounting Standards Board (FASB) has issued a final standards update intended to improve and simplify hedge accounting rules.
The new standard expands hedge accounting for financial and commodity risks, according to the FASB. It allows more transparency for the presentation of economic results in the body of financial statements and in footnotes.
The update takes effect for fiscal years (and interim periods within those fiscal years) beginning after Dec. 15 for public companies, and for fiscal years beginning after Dec. 15, 2019 (and interim periods for fiscal years beginning after Dec. 15, 2020) for private companies. Early adoption is permitted in any interim period or fiscal years before the effective date of the standard.
“Companies and investors alike have expressed overwhelming support for this long-awaited standard,” said FASB Chairman Russell Golden in a statement. “Thanks to their input, the final [update] better aligns the accounting rules with a company’s risk management activities, better reflects the economic results of hedging in the financial statements, and simplifies hedge accounting treatment.”
The update, No. 2071-12, Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities, was released in answer to stakeholders’ concerns that the hedge accounting requirements in current generally accepted accounting standards (GAAP) don’t always permit an entity to properly recognize the economic results of its hedging strategies in its financial statements.
Stakeholders insisted that improvements to the hedge accounting model are needed to make financial reporting more closely reflect an entity’s risk management activities. They also noted that the effect of hedge accounting on reported results often is tough to understand and interpret. Stakeholders stressed that reported results should help financial statement users better understand an entity’s exposures to risk and how hedging strategies manage those exposures.
Here’s what the FASB says the amendments accomplish:
A closer alignment of the results of cash flow and fair value hedge accounting with risk management activities in changes to the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results.
Specific limits in current GAAP are addressed by expanding hedge accounting for nonfinancial and financial risk components.
The measurement of hedge results are refined to better reflect an entity’s hedging strategies.
An entity will be able to better report the economic results of hedging activities for certain fair value and cash flow hedges.
Mismatched earnings will be avoided by allowing more precision when measuring changes in the fair value of the hedged item for certain fair value hedges.
By aligning the timing of recognition of hedge results with the earnings effect of the hedged item for cash flow and net investment hedges, and by including the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is presented, the results of an entity’s hedging program and the cost of executing that program will be more visible to users of financial statements.
The tabular disclosure related to effects on the income statement of fair value and cash flow hedges and the disclosure of cumulative basis adjustments for fair value hedges provide users with a more complete picture of the effect of hedge accounting on an entity’s income statement and balance sheet.
The amendments should ease the operational burden of applying hedge accounting by allowing more time to prepare hedge documents and by allowing assessments of effectiveness to be done on a qualitative basis after hedge inception.
The FASB will host a one-hour webinar about the update Sept. 25, from 1 p.m. to 2 p.m. ET. The webinar is free for those who preregister.
Presenters include FASB Vice Chairman James Kroeker, FASB member R. Harold Schroeder, and members of the FASB project team. Viewers will be eligible for up to 1.2 continuing professional education credits. Registration and other information is available on the FASB website.
Terry Sheridan is an award-winning journalist who has covered real estate, mortgage finance, health care, insurance, personal finance, and accounting and taxation issues for newspapers, magazines, and websites. A Chicago native and former South Florida resident, she now lives in New England.