3.3 Nonfinancial Assets and Liabilities
As discussed in Section 2.3.2, in a fair value
hedge that involves nonfinancial assets or liabilities (including nonfinancial firm
commitments with no financial components), an entity can only designate a derivative
instrument to hedge the overall changes in fair value. Component hedging is not
available for fair value hedges of nonfinancial items. However, an entity is
permitted to hedge certain risks in cash flow hedges of the forecasted purchases and
sales of nonfinancial assets, so such hedges are much more common than fair value
hedges of existing nonfinancial assets or liabilities.
In many cases, the hedging derivative is not perfectly effective at offsetting the
total changes in fair value related to the hedged item in a fair value hedge of a
nonfinancial asset or liability. If an entity designates such a hedge, it must
remeasure the hedged item for changes in its overall fair value during the period.
Any mismatch between the derivative and the hedged item is recognized in
current-period earnings.
3.3.1 Basis Adjustments
ASC 815-25
35-8 The adjustment of the
carrying amount of a hedged asset or liability required
by paragraph 815-25-35-1(b) shall be accounted for in
the same manner as other components of the carrying
amount of that asset or liability. For example, an
adjustment of the carrying amount of a hedged asset held
for sale (such as inventory) would remain part of the
carrying amount of that asset until the asset is sold,
at which point the entire carrying amount of the hedged
asset would be recognized as the cost of the item sold
in determining earnings.
The hedged item in a qualifying fair value hedge is remeasured for changes in its
fair value that are attributable to the risk being hedged, which for
nonfinancial items can only be the overall changes in fair value. As is the case
for fair value hedges of financial assets (see discussion in Section 3.2.5), an entity treats adjustments to
the carrying amount of the hedged item in a fair value hedge involving a
nonfinancial item in the same manner as any other basis adjustment to the asset
or liability. However, unlike the treatment of interest-bearing assets and
liabilities, the basis adjustment to a nonfinancial item is not amortized at any
time. The entity recognizes the impact of hedge accounting in the income
statement when the nonfinancial item is sold, derecognized, or impaired (see
Section 3.3.1.1).
In a qualifying fair value hedging relationship, the change in the hedged item’s
fair value should be determined by using changes in the spot price, not the
forward price, of the item. For highly effective hedging relationships, ASC 815
requires the hedged item to be adjusted for changes in fair value that are
attributable to the hedged risk. As discussed previously, in a fair value hedge
of a nonfinancial asset, the only risk that may be designated is the overall
changes in fair value. Fair value is defined in the ASC master glossary as follows:
The price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date.
Fair value is the price of a current transaction, which is the spot price, not
the forward price.
3.3.1.1 Interaction With Impairment Guidance
ASC 815-25
35-10
An asset or liability that has been designated as
being hedged and accounted for pursuant to this
Section remains subject to the applicable
requirements in generally accepted accounting
principles (GAAP) for assessing impairment or credit
losses for that type of asset or for recognizing an
increased obligation for that type of liability.
Those impairment or credit loss requirements shall
be applied after hedge accounting has been applied
for the period and the carrying amount of the hedged
asset or liability has been adjusted pursuant to
paragraph 815-25-35-1(b). Because the hedging
instrument is recognized separately as an asset or
liability, its fair value or expected cash flows
shall not be considered in applying those impairment
or credit loss requirements to the hedged asset or
liability.
Pending Content (Transition Guidance: ASC
815-20-65-6)
35-10 [See Section 9.7.]
As noted in Section 3.3.1, basis
adjustments to a hedged item in a qualifying fair value hedging relationship
are accounted for in the same manner as other components of the item’s
carrying amount. Accordingly, when evaluating the hedged item for
impairment, an entity should use the carrying amount of the hedged item
after the hedge accounting adjustments as the starting point. ASC 815 does
not change the relevant impairment model for the hedged item.
3.3.2 Illustrative Examples
Example 3-10
Fair Value Hedge of Inventory With Futures Contract
(Excluded Forward Points)
On January 1, 20X1, FarmHouse Inc. enters into a
cash-settled futures contract to sell one million
bushels of corn at $2.16 per bushel on March 31, 20X1.
It designates the futures contract as a hedge of the
overall fair value of one million bushels of its corn
inventory, which is $2.10 per bushel as of January 1,
20X1.
FarmHouse elects to exclude the initial value of the
forward points (i.e., the excluded component) from the
assessment of effectiveness. According to ASC
815-20-25-83A, “the initial value of the [excluded
component] shall be recognized in earnings using a
systematic and rational method over the life of the
hedging instrument [with] [a]ny difference between the
change in fair value of the excluded component and
amounts recognized in earnings under that systematic and
rational method . . . recognized in other comprehensive
income.” Alternatively, FarmHouse could make an
accounting policy election under ASC 815-20-25-83B in
which it records the changes in the excluded component’s
fair value currently in earnings over the life of the
instrument (i.e., the fair value method). For
illustrative purposes, journal entries for both methods
of accounting for the excluded component are included
below.
The initial value of the forward points is $60,000, or
1,000,000 × ($2.16 – $2.10). For simplicity, assume that
no location basis differential exists for the spot rates
on the hedged item and hedging instrument.
The following table outlines the spot prices and March
31, 20X1, futures prices of corn as of January 1,
January 31, February 28, and March 31, 20X1, as well as
the cumulative losses on the futures contract as of
these respective dates.
Excluded Component — Systematic and Rational
Method
Using the default systematic and rational method,
FarmHouse records the following journal entries as of
January 1, January 31, February 28, and March 31:
Excluded Component — Recognized in Current
Earnings
Under the method in which changes in the excluded
component’s fair value are recognized in earnings, the
journal entries as of January 1, January 31, February
28, and March 31 are as follows:
Example 3-11
Fair Value Hedge of
Inventory — Discontinued Because of
Ineffectiveness
On January 1, 20X1, Maize Company
entered into a cash-settled futures contract to sell
$100 million worth of corn on December 31, 20X1. The
futures contract was designated as a hedge of the
overall fair value of its corn inventory. Maize’s policy
indicates that no components of the change in the
derivative’s fair value will be excluded from the
assessment of hedge effectiveness, which will be
performed quarterly by using regression analysis for
both the prospective and retrospective analyses.
The table below outlines the fair values
of the corn inventory and the futures contracts as well
as the results of the regression analyses on January 1,
March 31, June 30, September 30, and December 31.
Maize records the following journal
entries as of January 1, March 31, June 30, September
30, and December 31:
January 1,
20X1
No entry is required because the futures
contract was entered into at-market.
March 31,
20X1
Hedge accounting may be applied because
both the prospective assessment performed at the
beginning of the period and the retrospective assessment
performed at the end of the period support an assertion
that the hedging relationship is highly effective.
June 30,
20X1
Hedge accounting cannot be applied
because the retrospective assessment performed at the
end of the period does not support an assertion that the
hedging relationship is highly effective. Accordingly,
the inventory is not remeasured for changes in its fair
value.
September 30,
20X1
Hedge accounting cannot be applied
because the prospective assessment performed at the
beginning of the period did not support an assertion
that the hedging relationship is highly effective.
Accordingly, the inventory is not remeasured for changes
in its fair value.
December 31,
20X1
Hedge accounting may be applied because
both the prospective assessment performed at the
beginning of the period and the retrospective assessment
performed at the end of the period support an assertion
that the hedging relationship is highly effective.
Example 3-12
Fair Value Hedge of
Firm Commitment to Purchase Inventory
On January 1, 20X0, Reprise enters into
a firm commitment to buy 10,000 units of titanium at the
current forward price of $310 per unit on June 30, 20X0.
The titanium will be used in the production of goods
that Reprise will ultimately sell. The contract meets
the requirements for the normal purchases and normal
sales scope exception and is not accounted for as a
derivative (see Section 2.3.2 of
Deloitte’s Roadmap Derivatives).
On January 1, 20X0, Reprise also enters
into a net-settled forward contract to sell 10,000 units
of titanium at the current forward price of $310 per
unit on June 30, 20X0. It designates the forward
contract as a hedge of the changes in the fair value of
the firm commitment. Reprise measures hedge
effectiveness on the basis of the changes in the June
30, 20X0, forward price of titanium. Note that (1) any
gain or loss on the hedging instrument and (2) the gains
or losses on changes in the hedged item’s fair value
that are attributable to the risk being hedged are
recognized in earnings in the same income statement line
item as the earnings effect of the hedged item. In this
case, the titanium being purchased under the firm
commitment will be used in the production of goods and,
therefore, the gains and losses on both the derivative
and the hedged item (the firm commitment) will be
recognized in cost of goods sold.
The table below outlines the spot prices
and forward prices of titanium, as well as the fair
values of the firm commitment and forward contract, as
of March 31 and June 30:
Reprise records the following journal
entries as of January 1, March 31, and June 30:
January 1,
20X0
No entry is required because the futures
contract was entered into at-market.
March 31,
20X0
June 30, 20X0