Chapter 2 — Hedge Accounting Requirements

2.6 Hedge Designation Documentation

2.6.1 General Hedge Designation Requirements

ASC 815-20

Formal Designation and Documentation at Hedge Inception

25-3 Concurrent designation and documentation of a hedge is critical; without it, an entity could retroactively identify a hedged item, a hedged transaction, or a method of assessing effectiveness to achieve a desired accounting result. To qualify for hedge accounting, there shall be, at inception of the hedge, formal documentation of all of the following:

Subparagraph not used
Documentation requirement applicable to fair value hedges, cash flow hedges, and net investment hedges:
1. The hedging relationship
2. The entity’s risk management objective and strategy for undertaking the hedge, including identification of all of the following:
  1. The hedging instrument.
  2. The hedged item or transaction.
  3. The nature of the risk being hedged.
  4. The method that will be used to retrospectively and prospectively assess the hedging instrument’s effectiveness in offsetting the exposure to changes in the hedged item’s fair value (if a fair value hedge) or hedged transaction’s variability in cash flows (if a cash flow hedge) attributable to the hedged risk. There shall be a reasonable basis for how the entity plans to assess the hedging instrument’s effectiveness.
    
    01. An entity shall perform an initial prospective assessment of hedge effectiveness on a quantitative basis (using either a dollar-offset test or a statistical method such as regression analysis) unless one of the following applies:
    
    A. In a cash flow or fair value hedge, the entity applies the shortcut method in accordance with paragraphs 815-20-25-102 through 25-117
    
    B. In a cash flow or fair value hedge, the entity determines that the critical terms of the hedging instrument and the hedged item match in accordance with paragraphs 815-20-25-84 through 25-85.
    
    C. In a cash flow hedge, the hedging instrument is an option, and the conditions in paragraphs 815-20-25-126 and 815-20-25-129 through 25-129A are met.
    
    D. In a cash flow hedge, a private company that is not a financial institution as described in paragraph 942-320-50-1 applies the simplified hedge accounting approach in paragraphs 815-20-25-133 through 25-138.
    
    E. In a cash flow hedge, the entity assesses hedge effectiveness under the change in variable cash flows method in accordance with paragraphs 815-30-35-16 through 35-24, and all of the conditions in paragraph 815-30-35-22 are met.
    
    F. In a cash flow hedge, the entity assesses hedge effectiveness under the hypothetical derivative method in accordance with paragraphs 815-30-35-25 through 35-29, and all of the critical terms of the hypothetical derivative and hedging instrument are the same.
    
    G. In a net investment hedge, the entity assesses hedge effectiveness using a method based on changes in spot exchange rates, and the conditions in paragraph 815-35-35-5 (for derivative instruments) or 815-35-35-12 (for nonderivative instruments) are met.
    
    H. In a net investment hedge, the entity assesses hedge effectiveness using a method based on changes in forward exchange rates, and the conditions in paragraph 815-35-35-17A are met.
    
    02. The initial prospective quantitative hedge effectiveness assessment using information applicable as of the date of hedge inception is considered to be performed concurrently at hedge inception if it is completed by the earliest of the following:
    
    A. The first quarterly hedge effectiveness assessment date
    
    B. The date that financial statements that include the hedged transaction are available to be issued
    
    C. The date that any criterion in Section 815-20-25 no longer is met
    
    D. The date of expiration, sale, termination, or exercise of the hedging instrument
    
    E. The date of dedesignation of the hedging relationship
    
    F. For a cash flow hedge of a forecasted transaction (in accordance with paragraph 815-20-25-13(b)), the date that the forecasted transaction occurs.
    
    03. An entity also shall document at hedge inception whether it elects to perform subsequent retrospective and prospective hedge effectiveness assessments on a qualitative basis and how it intends to carry out that qualitative assessment. See paragraphs 815-20-35-2A through 35-2F for additional guidance on qualitative assessments of effectiveness. In addition, the entity shall document which quantitative method it will use if facts and circumstances of the hedging relationship change and the entity must quantitatively assess hedge effectiveness in accordance with paragraph 815-20-35-2D. An entity must document that it will perform the same quantitative assessment method for both initial and subsequent prospective hedge effectiveness assessments. The guidance in paragraphs 815-20-55-55 through 55-56 applies if the entity wants to change its quantitative method of assessing effectiveness after the initial quantitative effectiveness assessment.
    
    04. An entity that applies the shortcut method in paragraphs 815-20-25-102 through 25-117 may elect to document at hedge inception a quantitative method to assess hedge effectiveness and measure hedge results if the entity determines at some point during the term of the hedging relationship that the use of the shortcut method was not or no longer is appropriate. See paragraphs 815-20-25-117A through 25-117D.
  5. Subparagraph superseded by Accounting Standards Update No. 2017-12.
  6. If the entity is hedging foreign currency risk on an after-tax basis, that the assessment of effectiveness will be on an after-tax basis (rather than on a pretax basis).
Documentation requirement applicable to fair value hedges only:
1. For a fair value hedge of a firm commitment, a reasonable method for recognizing in earnings the asset or liability representing the gain or loss on the hedged firm commitment.
2. For one or more interest rate risk hedging relationships designated under the portfolio layer method, an analysis to support the entity’s expectation that the hedged layer or layers is anticipated to be outstanding for the designated hedge period (see paragraph 815-20-25-12A for additional guidance).
Documentation requirement applicable to cash flow hedges only:
1. For a cash flow hedge of a forecasted transaction, documentation shall include all relevant details, including all of the following:
  1. The date on or period within which the forecasted transaction is expected to occur.
  2. The specific nature of asset or liability involved (if any).
  3. Either of the following:
    
    01. The expected currency amount for hedges of foreign currency exchange risk; that is, specification of the exact amount of foreign currency being hedged
    
    02. The quantity of the forecasted transaction for hedges of other risks; that is, specification of the physical quantity (that is, the number of items or units of measure) encompassed by the hedged forecasted transaction.
  4. If a forecasted sale or purchase is being hedged for price risk, the hedged transaction shall not be specified in either of the following ways:
    
    01. Solely in terms of expected currency amounts
    
    02. As a percentage of sales or purchases during a period.
  5. The current price of a forecasted transaction shall be identified to satisfy the criterion in paragraph 815-20-25-75(b) for offsetting cash flows.
  6. The hedged forecasted transaction shall be described with sufficient specificity so that when a transaction occurs, it is clear whether that transaction is or is not the hedged transaction. Thus, a forecasted transaction could be identified as the sale of either the first 15,000 units of a specific product sold during a specified 3-month period or the first 5,000 units of a specific product sold in each of 3 specific months, but it could not be identified as the sale of the last 15,000 units of that product sold during a 3-month period (because the last 15,000 units cannot be identified when they occur, but only when the period has ended).
  7. If the hedged risk is the variability in cash flows attributable to changes in a contractually specified component in a forecasted purchase or sale of a nonfinancial asset, identification of the contractually specified component.
  8. If the hedged risk is the variability in cash flows attributable to changes in a contractually specified interest rate for forecasted interest receipts or payments on a variable-rate financial asset or liability, identification of the contractually specified interest rate.

Upon issuing Statement 133, the FASB noted in paragraph 385 of the Background Information and Basis for Conclusions that “concurrent designation and documentation of a hedge is critical; without it, an entity could retroactively identify a hedged item, a hedged transaction, or a method of measuring effectiveness to achieve a desired accounting result.” The documentation requirements are enumerated in ASC 815-20-25-3, and the way in which entities comply with those requirements is commonly referred to as the hedge designation documentation. Before the adoption of ASU 2017-12, all of the components of the hedge designation documentation had to be completed at the inception of the hedging relationship (except for hedging relationships that used the simplified hedge accounting approach). ASU 2017-12 provided some timing relief related to certain aspects of the hedge designation documentation, which we discuss in more detail below, but there is still a requirement for at least some level of hedge designation documentation at the inception of a hedge (unless an entity is applying the simplified hedge accounting approach).

As stated in ASC 815-20-25-3, the documentation for a hedging relationship must describe:

The hedging relationship
The entity’s risk management objective and strategy for undertaking the hedge, including identification of all of the following:
1. The hedging instrument.
2. The hedged item or transaction.
3. The nature of the risk being hedged.

The documentation also must describe the method an entity will use to retrospectively and prospectively assess the hedging instrument’s effectiveness in offsetting the exposure to changes in the hedged item’s fair value or cash flows that are attributable to the hedged risk. If an entity elects to perform subsequent retrospective and prospective hedge effectiveness assessments qualitatively, it should note its election in the hedge designation documentation and indicate (1) how it will perform such qualitative assessments and (2) the quantitative method it will use if facts and circumstances change so that qualitative assessments are no longer sufficient for evaluating hedge effectiveness (see Section 2.5.2.2.6). An entity that applies the shortcut method to the hedging relationship also may elect to document a quantitative (i.e., a long-haul) method that it will use to assess hedge effectiveness and measure hedge results if it determines at some point during the hedge that use of the shortcut method was not or is no longer appropriate (see Section 2.5.2.2.1.9).

An entity also must perform the initial prospective assessment of hedge effectiveness on a quantitative basis (see Section 2.5.2.1) at hedge inception unless the hedging relationship qualifies for an assumption of perfect hedge effectiveness (see Sections 2.5.2.2.1 through 2.5.2.2.5). However, because of the changes to ASC 815-20-25-3(b)(2)(iv)(02) made by ASU 2017-12, an entity would be deemed to have completed the initial prospective quantitative assessment concurrently with hedge inception if it uses the information applicable at hedge inception to complete the assessment by the earliest of:

“The first quarterly hedge effectiveness assessment date.”
“The date that financial statements that include the hedged transaction are available to be issued.”
“The date that any [required hedge accounting] criterion in Section 815-20-25 no longer is met.”
“The date of [the hedging instrument’s] expiration, sale, termination, or exercise.”
“The date of dedesignation of the hedging relationship.”
“For a cash flow hedge of a forecasted transaction . . . , the date that the forecasted transaction occurs.”

Certain hedge designation documentation requirements are specific to either fair value hedges or cash flow hedges. Under those requirements, an entity must document the following for each type of hedge:

Fair value hedges:
- Hedge of a firm commitment — A reasonable method that the entity will use to recognize in earnings the asset or liability that represents the gain or loss on the hedged firm commitment.
- Portfolio layer method hedge — An analysis that, according to ASC 815-20-25-3(c)(2)), supports “the entity’s expectation that the hedged layer or layers is anticipated to be outstanding for the designated hedge period” (see Section 3.2.1.4).
Cash flow hedges:
- Hedge of a forecasted transaction:
  - The quantity of the forecasted item(s). The expected currency amount for hedges of foreign currency risk or the quantity (i.e., the number of items or units of measure) of the forecasted transaction for hedges of other risks.
  - The date on or period within which the forecasted transaction is expected to occur.
  - The specific nature of the asset or liability involved (if any).
  - The current price of the forecasted transaction.
  - Depending on the nature of the forecasted transaction, there may be other specific documentation requirements (e.g., an assertion that an entity will always pick a specific rate under “choose-your-rate” debt; see Section 4.2.1.1.2).
- If the hedged risk is the variability in the cash flows attributable to the changes in a contractually specified component in a forecasted purchase or sale of a nonfinancial asset, the entity must identify and document the hedged component.
- If the hedged risk is the variability in the cash flows attributable to changes in a contractually specified interest rate for forecasted interest receipts or payments on a variable-rate financial asset or liability, the entity must identify and document the hedged rate.

Note that even if a company has a specific risk management policy that identifies permissible and required hedging activities, it is still required to provide individual documentation of each hedge. A general policy would not be specific enough to meet the formal documentation requirements related to the individual hedging relationships. ASC 815 expressly requires an entity, at the inception of each hedge, to formally document the hedging relationship and the entity’s risk management objectives and strategy for undertaking the hedge. Such documentation should include everything outlined above and provide the basis for assessing effectiveness and determining when a hedging relationship is terminated. An entity is not permitted to apply hedge accounting without providing specific documentation of each hedging relationship.

2.6.2 Certain Private Companies — Additional Timing Relief

ASC 815-20

Assuming Perfect Hedge Effectiveness in a Cash Flow Hedge of a Variable-Rate Borrowing With a Receive-Variable, Pay-Fixed Interest Rate Swap Recorded Under the Simplified Hedge Accounting Approach

25-136 In applying the simplified hedge accounting approach, the documentation required by paragraph 815-20-25-3 to qualify for hedge accounting must be completed by the date on which the first annual financial statements are available to be issued after hedge inception rather than concurrently at hedge inception.

Timing of Hedge Documentation for Certain Private Companies if Simplified Hedge Accounting Approach Is Not Applied

Concurrent Hedge Documentation

25-139 Concurrent with hedge inception, a private company that is not a financial institution as described in paragraph 942-320-50-1 shall document the following:

The hedging relationship in accordance with paragraph 815-20-25-3(b)(1)
The hedging instrument in accordance with paragraph 815-20-25-3(b)(2)(i)
The hedged item in accordance with paragraph 815-20-25-3(b)(2)(ii), including (if applicable) firm commitments or the analysis supporting a portfolio layer method designation in paragraph 815-20-25-3(c), or forecasted transactions in paragraph 815-20-25-3(d)
The nature of the risk being hedged in accordance with paragraph 815-20-25-3(b)(2)(iii).

25-140 A private company that is not a financial institution is not required to perform or document the following items concurrent with hedge inception but rather is required to perform or document them within the time periods discussed in paragraph 815-20-25-142:

The method of assessing hedge effectiveness at inception and on an ongoing basis in accordance with paragraph 815-20-25-3(b)(2)(iv) and (vi)
Initial hedge effectiveness assessments in accordance with paragraph 815-20-25-3(b)(2)(iv)(01) through (04).

25-141 Example 1A beginning in paragraph 815-20-55-80A illustrates hedge documentation when the critical terms of the hedging instrument and hedged forecasted transaction match. Although that Example illustrates the documentation of the method of assessing hedge effectiveness, private companies that are not financial institutions may complete hedge documentation requirements in accordance with paragraphs 815-20-25-139 through 25-140.

Hedge Effectiveness Assessments

25-142 For a private company that is not a financial institution, the performance and documentation of the items listed in paragraph 815-20-25-140, as well as required subsequent quarterly hedge effectiveness assessments, may be completed before the date on which the next interim (if applicable) or annual financial statements are available to be issued. Even though the completion of the initial and ongoing assessments of effectiveness may be deferred to the date on which financial statements are available to be issued the assessments shall be completed using information applicable as of hedge inception and each subsequent quarterly assessment date when completing this documentation on a deferred basis. Therefore, the assessment should be performed to determine whether the hedge was highly effective at achieving offsetting changes in fair values or cash flows at inception and in each subsequent quarterly assessment period up to the reporting date.

Private companies that are not financial institutions may apply the simplified hedge accounting approach to certain hedging relationships (see Section 4.2.1.1.5 for more details). Under ASC 815-20-25-136, the documentation required for a hedging relationship that qualifies for the simplified hedge accounting approach “must be completed by the date on which the first annual financial statements are available to be issued after hedge inception rather than concurrently at hedge inception.”

ASU 2017-12 gave private companies that are not financial institutions additional relief related to the timing of documentation for hedging relationships that do not qualify for the simplified hedge accounting approach. For example, under ASC 815-20-25-139, such entities need only document the following at hedge inception:

“The hedging relationship.”
“The hedging instrument.”
“The hedged item . . . , including (if applicable) firm commitments or the analysis supporting a portfolio layer method designation . . . , or forecasted transactions.”
“The nature of the risk being hedged.”

As stated in ASC 815-20-25-140, such entities do not need to (1) document the “method of assessing hedge effectiveness at inception and on an ongoing basis” or (2) perform the initial prospective quantitative hedge effectiveness assessment until the date on which the next interim (if applicable) or annual financial statements are available to be issued. The performance of the subsequent hedge effectiveness assessments may also be deferred until the time of the initial hedge effectiveness assessment.

Example 2-36

Page and Leo is a private piano manufacturing company. It prepares financial statements annually only and has a December 31 year-end. On July 15, 20X0, Page and Leo enters into an interest rate swap to hedge interest payments on its debt and prepares documentation of the hedging relationship, the swap, the debt that gives rise to the interest payments, and the fact that it is hedging for interest rate risk. Page and Leo will perform hedge effectiveness assessments at the end of each quarter. By the time the December 31, 20X0, financial statements are available to be issued (assume that date is May 15, 20X1), Page and Leo will have to use data relevant to the following dates to complete hedge effectiveness assessments:

July 15, 20X0 (initial prospective quantitative assessment).
September 30, 20X0.
December 31, 20X0.
March 31, 20X1.

There is no timing relief for subsequent assessments over the remaining life of the hedging relationship. Therefore, future assessments, starting with the June 30, 20X1, assessment, must be performed on a timely basis.

In addition to deferring documentation of the four items listed in ASC 815-20-25-139 (see above), an entity may defer its preparation of all other hedge documentation required by ASC 815-20-25-3 until the date on which the financial statements are available to be issued.

2.6.3 Certain Not-for-Profit Entities — Additional Timing Relief

ASC 815-20

Hedge Accounting Provisions Applicable to Certain Not-for-Profit Entities

25-143 Not-for-profit entities (except for not-for-profit entities that have issued, or are a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market) may apply the guidance on the timing of hedge documentation and hedge effectiveness assessments in paragraphs 815-20-25-139 through 25-142. Specifically, those entities shall document the items listed in paragraph 815-20-25-139 concurrent with hedge inception, but they may perform and document the items listed in paragraph 815-20-25-140 and perform the required subsequent quarterly hedge effectiveness assessments in accordance with paragraph 815-20-25-142 within the time periods discussed in paragraph 815-20-25-142.

Not-for-profit entities may also use the timing relief for hedging relationships unless such entities have issued, or are conduit bond obligors for, securities that are traded, listed, or quoted on an exchange or an OTC market.

Confidential and Proprietary — for Use Solely by Authorized Personnel

This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.