4.1 Overview
As indicated in ASC 815-30-20 (and discussed briefly in Section 1.3.2), a cash flow hedge is a “hedge of the
exposure to variability in the cash flows of a recognized asset or liability, or of
a forecasted transaction, that is attributable to a particular risk.” The
variability in that risk must have the potential to affect reported earnings.
ASC 815-30
35-3 When the relationship
between the hedged item and hedging instrument is highly
effective at achieving offsetting changes in cash flows
attributable to the hedged risk, an entity shall record in
other comprehensive income the entire change in the fair
value of the designated hedging instrument that is included
in the assessment of hedge effectiveness. More specifically,
a qualifying cash flow hedge shall be accounted for as
follows:
-
An entity’s defined risk management strategy for a particular hedging relationship may exclude a specific component of the gain or loss, or related cash flows, on the hedging derivative from the assessment of hedge effectiveness (as discussed in paragraphs 815-20-25-81 through 25-83B). That excluded component of the gain or loss shall be recognized in earnings either through an amortization approach in accordance with paragraph 815-20-25-83A or through a mark-to-market approach in accordance with paragraph 815-20-25-83B. Under either approach, the amount recognized in earnings for an excluded component shall be presented in the same income statement line item as the earnings effect of the hedged item in accordance with paragraph 815-20-45-1A. For example, if the effectiveness of a hedging relationship with an option is assessed based on changes in the option’s intrinsic value, the changes in the option’s time value would be excluded from the assessment of hedge effectiveness and either may be recognized in earnings through an amortization approach in accordance with paragraph 815-20-25-83A or currently in earnings in accordance with paragraph 815-20-25-83B.
- Amounts in accumulated other
comprehensive income related to the derivative
designated as a hedging instrument included in the
assessment of hedge effectiveness are reclassified
to earnings in the same period or periods during
which the hedged forecasted transaction affects
earnings in accordance with paragraphs 815-30-35-38
through 35-41 and presented in the same income
statement line item as the earnings effect of the
hedged item in accordance with paragraph
815-20-45-1A. The balance in accumulated other
comprehensive income associated with the hedged
transaction shall be the cumulative gain or loss on
the derivative instrument from inception of the
hedge less all of the following:1. Subparagraph superseded by Accounting Standards Update No. 2017-12.1a. The derivative instrument’s gains or losses previously reclassified from accumulated other comprehensive income into earnings pursuant to paragraphs 815-30-35-38 through 35-41.1b. The cumulative amount amortized to earnings related to excluded components accounted for through an amortization approach in accordance with paragraph 815-20-25-83A.1c. The cumulative change in fair value of an excluded component for which changes in fair value are recorded currently in earnings in accordance with paragraph 815-20-25-83B.2. Subparagraph superseded by Accounting Standards Update No. 2017-12.If hedge accounting has not been applied to a cash flow hedging relationship in a previous effectiveness assessment period because the entity’s retrospective evaluation indicated that the relationship had not been highly effective in achieving offsetting changes in cash flows in that period, the cumulative gain or loss on the derivative referenced in (b) would exclude the gains or losses occurring during that period. That situation may arise if the entity had previously determined, for example, under a regression analysis or other appropriate statistical analysis approach used for prospective assessments of hedge effectiveness, that there was an expectation in which the hedging relationship would be highly effective in future periods. Consequently, the hedging relationship continued even though hedge accounting was not permitted for a specific previous effectiveness assessment period. . . .
An entity with a cash flow hedge that meets all the hedging criteria in ASC 815 would
record in OCI the changes in fair value attributable to components of the hedging
instrument that are included in the assessment of hedge effectiveness. Unlike the
accounting for a fair value hedge, the carrying value of the hedged item is not
adjusted in the accounting for a cash flow hedge. Instead, the changes in fair value
that are recorded in OCI are (1) reclassified from AOCI to earnings when the hedged
item affects earnings and (2) presented in earnings in the same line item as the
earnings effect of the hedged item. When the hedged transaction occurs, the amounts
in AOCI that accumulated from the hedging relationship cannot be recorded as a basis
adjustment to the hedged item.
If the hedged item is a forecasted transaction and it becomes
probable that the transaction will not occur within two months of the originally
specified time period, amounts that were recorded in AOCI should generally be
immediately reclassified (see Section 4.1.5
for further discussion of discontinued cash flow hedges).
The table below includes common examples of cash flow hedging strategies.
Hedged Item
|
Derivative
|
---|---|
Variable-rate debt
|
A receive-variable, pay-fixed interest rate swap or purchased
interest rate cap
|
Variable-rate loans
|
A receive-fixed, pay-variable interest rate swap or purchased
interest rate floor
|
Forecasted issuance of debt
|
Forward-starting interest rate swap, option, or forward on
U.S. Treasuries
|
Forecasted commodity purchases
|
Fixed-price forward or option to purchase commodity
|
Forecasted commodity sales
|
Fixed-price forward or option to sell commodity
|
Foreign-currency-denominated variable-rate debt
|
Pay-fixed, receive-variable cross-currency interest rate
swap
|
Forecasted foreign-currency-denominated purchases
|
Forward or option to purchase foreign currency
|
Forecasted foreign-currency-denominated sales
|
Forward or option to sell foreign currency
|
This chapter discusses the accounting for cash flow hedges from start to finish,
including how to reclassify amounts out of AOCI throughout the hedging relationship
and beyond. We first explain some of the general concepts behind cash flow hedging
relationships. The discussion is then broken down into the two major categories of
cash flow hedging relationships: hedges involving financial instruments and hedges
involving nonfinancial assets. Foreign currency hedges (both fair value and cash
flow hedges) are discussed separately in Chapter
5.
4.1.1 Forecasted Transactions
ASC Master Glossary
Forecasted Transaction
A transaction that is expected to occur for which there
is no firm commitment. Because no transaction or event
has yet occurred and the transaction or event when it
occurs will be at the prevailing market price, a
forecasted transaction does not give an entity any
present rights to future benefits or a present
obligation for future sacrifices.
ASC 815-20
25-15 A forecasted
transaction is eligible for designation as a hedged
transaction in a cash flow hedge if all of the following
additional criteria are met:
-
The forecasted transaction is specifically identified as either of the following:
-
A single transaction
-
A group of individual transactions that share the same risk exposure for which they are designated as being hedged. A forecasted purchase and a forecasted sale shall not both be included in the same group of individual transactions that constitute the hedged transaction.
-
-
The occurrence of the forecasted transaction is probable.
-
The forecasted transaction meets both of the following conditions:
-
It is a transaction with a party external to the reporting entity (except as permitted by paragraphs 815-20-25-30 and 815-20-25-38 through 25-40).
-
It presents an exposure to variations in cash flows for the hedged risk that could affect reported earnings. . . .
-
As discussed in Section 2.2.2, ASC 815
allows an entity to hedge the risk of changes in cash flows related to
forecasted transactions. To qualify as the hedged item in a cash flow hedging
relationship, a forecasted transaction must meet the following criteria:
-
It is either a “single transaction” or “a group of individual transactions that share the same risk exposure for which they are designated as being hedged” (see Section 2.2.2.2.2).
-
It is probable that the transaction will occur (see Section 4.1.1.1).
-
The transaction is with a party that is external to the reporting entity, except as permitted for certain foreign currency hedges discussed in Section 5.3.1.1.1 (see Section 4.1.1.2).
-
It presents an exposure to variations in cash flows for the hedged risk that could affect reported earnings (see Section 4.1.1.3).
ASC 815-20-25-14 also clarifies that “[f]or purposes of [applying the cash flow
hedge accounting rules], the individual cash flows related to a recognized asset
or liability and the cash flows related to a forecasted transaction are both
referred to as a forecasted transaction.”
4.1.1.1 Probable That the Transaction Will Occur
ASC 815-20
Probability of a Forecasted Transaction
55-24 An assessment of the
likelihood that a forecasted transaction will take
place (see paragraph 815-20-25-15(b)) should not be
based solely on management’s intent because intent
is not verifiable. The transaction’s probability
should be supported by observable facts and the
attendant circumstances. Consideration should be
given to the following circumstances in assessing
the likelihood that a transaction will occur.
-
The frequency of similar past transactions
-
The financial and operational ability of the entity to carry out the transaction
-
Substantial commitments of resources to a particular activity (for example, a manufacturing facility that can be used in the short run only to process a particular type of commodity)
-
The extent of loss or disruption of operations that could result if the transaction does not occur
-
The likelihood that transactions with substantially different characteristics might be used to achieve the same business purpose (for example, an entity that intends to raise cash may have several ways of doing so, ranging from a short-term bank loan to a common stock offering).
55-25 Both the length of time
until a forecasted transaction is projected to occur
and the quantity of the forecasted transaction are
considerations in determining probability. Other
factors being equal, the more distant a forecasted
transaction is or the greater the physical quantity
or future value of a forecasted transaction, the
less likely it is that the transaction would be
considered probable and the stronger the evidence
that would be required to support an assertion that
it is probable.
As discussed above, for an entity to designate a forecasted transaction as
the hedged item in a cash flow hedging relationship, it must be probable
that the transaction will occur, but there does not necessarily have to be a
firm commitment (see Section 4.1.1.3.1 for further
discussion of hedging firm commitments). The term “probable” requires a
significantly greater likelihood of occurrence than the phrase “more likely
than not.” The assertion that it is probable that a transaction will occur
should be supported by observable facts and circumstances.
Note that for hedge accounting to be applied, (1) it must be probable at the
inception of the hedge that the forecasted transaction will occur and (2) it
must continue to be probable during the life of the hedge that the
transaction will occur. If it is no longer probable that the forecasted
transaction will occur, the entity should discontinue hedge accounting at
the time it becomes no longer probable (see Section
4.1.5 for further discussion of discontinuing cash flow
hedging).
The following are some of the factors that an entity should consider in
determining whether a forecasted transaction is probable under ASC 815:
-
Frequency of similar past transactions and the quantity involved — ASC 815-20-55-24(a) requires an entity to consider the “frequency of similar past transactions,” and ASC 815-20-55-25 states, in part, that “the greater the physical quantity or future value of a forecasted transaction, the less likely it is that the transaction would be considered probable.” We believe that it makes sense to consider these criteria in combination. If the frequency and quantity of a forecasted transaction is consistent with history, in the absence of changes in current and future conditions, it may not be difficult to assert that the forecasted transaction is probable. For example, if an entity has consistently purchased 100 tons of aluminum on a monthly basis for its production of tweezers over the last three years, it would be reasonable for the entity to assert that forecasted monthly purchases of 100 tons of aluminum for the next six months would be probable as long as there are no significant changes in expected production. However, if the entity wants to hedge the forecasted purchase of 300 tons of aluminum in three months, it would be difficult for the entity to assert that the purchase is probable unless it has decided to change its purchase frequency from monthly to quarterly and has the ability to obtain and store the increased quantity.Note that an entity cannot rely solely on past transactions to support an assertion that a forecasted transaction is probable. It should also consider changes in internal factors (e.g., operating budgets or plans, decisions to increase or decrease certain activities) and external factors (e.g., changes in economic conditions or in customer demand).
-
Financial and operational ability to carry out transactions or the creditworthiness of a counterparty — ASC 815-20-55-24(b) requires an entity to consider its financial and operational ability to carry out transactions. This is especially relevant for significant nonrecurring transactions. If the transaction involves the payment of significant consideration, the entity should evaluate whether the party that would make the payment has the funds available or has access to them. In addition, if the forecasted transaction involves the delivery of assets, the entity should evaluate whether (1) the seller can deliver the quantity of assets underlying the forecasted transaction and (2) the buyer is capable of accepting the quantity of assets underlying the forecasted transaction. If the transaction involves nonfinancial assets, the entity should consider not just whether the seller is expected to have access to the assets to be delivered but also whether there are any constraints involved in transporting them to the delivery location. In addition, the entity should consider any constraints for the buyer to either store the assets at the delivery location or transport the assets to their ultimate destination.If the forecasted transaction involves a specific counterparty (e.g., a specific buyer or seller), the entity should consider the creditworthiness of that counterparty when evaluating its ability to perform under the transaction. The entity should also consider whether the forecasted transaction could be fulfilled by other counterparties.
-
Substantial commitments of resources to a particular activity — As noted in ASC 815-20-55-24(c), “[s]ubstantial commitments of resources to a particular activity” may be an indicator of whether it is probable that a forecasted transaction will occur. For example, if an entity has committed to a substantial financing transaction to fund a nonrecurring forecasted purchase of assets, that commitment would be a significant indicator that the forecasted transaction is probable. Conversely, if an entity has limited funding and has committed substantial resources to an activity that would conflict with the forecasted transaction, that would be a significant indicator that the forecasted transaction is not probable.
-
Extent of loss or disruption of operations if transaction does not occur and likelihood of using a different transaction — In accordance with ASC 815-20-55-24(d), an entity should consider the “extent of loss or disruption” that could result from the nonoccurrence of a forecasted transaction. If an entity needs to complete a forecasted transaction to fulfill commitments to customers or to maintain production, that would be an indicator that the transaction is probable. However, ASC 815-20-55-24(e) also notes that an entity should consider whether a transaction “with substantially different characteristics might be used to achieve the same business purpose.” For example, an entity may be firmly committed to a significant expenditure but may be considering whether to fund that expenditure with debt or an equity raise. If the entity wants to hedge changes in interest rates related to a forecasted debt issuance, it should consider the potential for the transaction to be funded by issuing equity instead of incurring debt when assessing whether the forecasted debt issuance is probable.
-
Length of time before the transaction is projected to occur — ASC 815-20-55-25 notes that an entity should consider “the length of time until a forecasted transaction is projected to occur.” This is an important consideration, and the paragraph states that “[o]ther factors being equal, the more distant a forecasted transaction is . . . , the less likely it is that the transaction would be considered probable and the stronger the evidence that would be required to support an assertion that it is probable.”
-
Pattern of previous similar forecasted transactions that did not occur — ASC 815-30-40-5 addresses the accounting for amounts in AOCI related to a previously qualifying cash flow hedging relationship when it becomes probable that a designated forecasted transaction will not occur (see Section 4.1.5.2). That paragraph also states that “[a] pattern of determining that hedged forecasted transactions are probable of not occurring would call into question both an entity’s ability to accurately predict forecasted transactions and the propriety of using hedge accounting in the future for similar forecasted transactions.”
4.1.1.1.1 Unique Considerations for Business Combinations
While an entity cannot hedge an expected business combination or a firm
commitment to enter into such a combination (see Section 2.2.1.3), it is not prohibited
from designating a transaction that is contingent on a business
combination (e.g., interest payments related to the acquirer’s
forecasted issuance of debt to fund the business combination) as the
hedged item in a qualifying cash flow hedging relationship. However, the
hedging relationship would need to meet the criteria to qualify for cash
flow hedge accounting, and it may be difficult to assert that the
consummation of a business combination is probable. An entity should
consider the many uncertainties involved in entering into a business
combination, including the need to obtain shareholder and regulatory
approvals.
Some entities enter into deal-contingent derivatives to hedge
transactions that are contingent on a proposed business acquisition. One
example is a “deal contingent swap,” which is a forward-starting
interest rate swap that is designed to hedge the forecasted issuance of
debt for changes in cash flows that are attributable to changes in the
designated benchmark rate (i.e., the index rate for the variable-rate
leg of the swap). However, if the acquisition is not consummated by a
specified date, the swap is terminated for no consideration.
While these deal-contingent swaps are very effective economic hedges,
they do not fare particularly well under the cash flow hedging model in
ASC 815. Under that guidance, an entity does not consider the
probability of the forecasted transaction when measuring the changes in
the cash flows of a forecasted transaction for the assessment of hedge
effectiveness. In other words, for a cash flow hedge of a forecasted
issuance of debt to fund a potential acquisition that is deemed
probable, the only factor that affects the changes in the estimated cash
flows attributable to changes in the designated benchmark interest rate
(e.g., LIBOR) is the changes in that designated benchmark interest rate.
However, the fair value of the hedging instrument (i.e., the
deal-contingent swap) is affected by both changes in the interest rate
specified in the hedging instrument (e.g., LIBOR) and changes in the
probability that the deal will be consummated by the date specified in
the swap.
The changes in the probability of the deal being consummated can result
in a source of ineffectiveness that is significant enough to cause the
hedging relationship to not be highly effective and, therefore, be
disqualified from hedge accounting. Even if the hedging relationship
does qualify for hedge accounting, it would not qualify for any of the
“perfectly effective” qualitative hedge assessment methods because of
the optionality in the swap that is not matched in the assessment of the
hedged forecasted transaction. For example, if an entity chose to apply
the hypothetical-derivative method discussed in Section 2.5.2.1.2.4 to a hedging
relationship that involves a deal-contingent swap, it would compare the
changes in the fair value of the swap with the fair value of a
forward-starting swap without the deal-contingent termination
option.
In addition, entities are required to assess whether the forecasted debt
issuance is probable throughout the hedging relationship. If it is no
longer probable that the forecasted debt issuance is going to occur,
hedge accounting must be discontinued (see further discussion of
discontinued cash flow hedges in Section
4.1.5).
4.1.1.1.2 LIBOR — Reference Rate Reform
ASC 848-50
25-2 An entity shall
continue to assess whether the underlying hedged
forecasted transaction (for example, the future
interest receipts of a financial asset or future
interest payments of a financial liability or the
forecasted issuance or purchase of a debt
instrument) remains probable in accordance with
paragraph 815-20-25-15(b). If the designated
hedged interest rate risk in a cash flow hedge of
a forecasted transaction is a reference rate that
meets the scope of paragraph 848-10-15-3, an
entity may assert that the hedged forecasted
transaction (for example, the future interest
receipts of a financial asset or future interest
payments of a financial liability or the
forecasted issuance or purchase of a debt
instrument) remains probable in accordance with
paragraph 815-20-25-15(b) regardless of the
modification or expected modification of terms in
accordance with paragraphs 848-20-15-2 through
15-3.
As the global markets actively plan the transition from
the use of LIBOR and other interbank offering rates to alternative
reference rates, questions are arising about the impact of reference
rate reform on an entity’s ability to assert that a forecasted
transaction is still probable if it involves payments based on reference
rates such as LIBOR that are expected to be discontinued. The FASB
issued ASU 2020-04 and
ASU 2021-01 to
address the impact of reference rate reform activities on several areas
of financial reporting, including this issue. ASU 2020-04 establishes a
new Codification topic, ASC 848, and ASU 2021-01 expands the scope of
ASC 848 (see Chapter
8 for an overview of ASC 848). Under ASC 848-50-25-2, as
long as the underlying transactions (i.e., the payments) are still
probable, an entity may assume that those payments will still be based
on the current reference rate.
4.1.1.2 Transaction With External Party
In accordance with ASC 815-20-25-15(c)(1), a forecasted transaction can only
be designated as the hedged item in a qualifying cash flow hedging
relationship if the transaction is with an external party (except for
certain foreign currency hedges discussed in Section
5.3.1.1.1). In the Background Information and Basis for Conclusions of Statement 133, the FASB reasoned that only transactions with
a party that is external to the reporting entity would affect earnings. In
other words, since intercompany transactions are typically eliminated in the
preparation of consolidated financial statements, they do not expose the
entity to changes in cash flows that could affect earnings. This is
consistent with the prohibition in ASC 815-20-25-43(b)(4) discussed in
Section 2.2.1.5.2.
4.1.1.3 Exposure to Variations in Cash Flows That Could Affect Earnings
To be designated as the hedged item in a cash flow hedging relationship, a
forecasted transaction also must have exposure to variations in cash flows
that could affect earnings. Common examples of such transactions are
interest payments on variable-rate debt, interest payments related to a
forecasted issuance of debt, and the forecasted purchase or sale of assets
that are not subject to fixed-price contracts. The exposure to variations in
cash flows must have the potential to affect earnings, so this precludes
forecasted transactions in an entity’s own stock (e.g., future issuances of
shares or treasury stock transactions). See Section
2.2.1.4 for a discussion of the prohibition on hedging
transactions that involve an entity’s own equity.
4.1.1.3.1 Forecasted Transaction Versus Firm Commitment
The price of a forecasted transaction is exposed to changes in market
factors. If market prices change before the date on which the
transaction is firmly committed, earnings may be affected. However, once
an agreement is reached that meets the definition of a firm commitment,
the entity is no longer exposed to changes in cash flows for the
underlying transaction (except for transactions denominated in a foreign
currency in which there is still exposure to changes in foreign currency
exchange rates). In fact, the ASC master glossary defines a forecasted
transaction as “[a] transaction . . . for which there is no firm
commitment.” Accordingly, a transaction that occurs under a firm
commitment cannot be a designated forecasted transaction in a qualifying
cash flow hedge unless it is either (1) a hedge of foreign currency risk
or (2) an “all-in-one” hedge (discussed in Section
4.1.1.3.2). The table below summarizes the types of
hedging strategies available for transactions subject to fixed-price
firm commitments.
Type of Firm Commitment
|
Price Fixed in:
| |
---|---|---|
Functional Currency
|
Foreign Currency
| |
ASC 815 derivative
|
All-in-one hedge (see Section
4.1.1.3.2)
|
All-in-one hedge (see Section
4.1.1.3.2)
|
Nonderivative
|
Fair value hedge (see Section
3.1.1)
|
Foreign currency cash flow hedge (see
Section 5.3)
|
4.1.1.3.2 All-in-One Hedges
ASC 815-20
25-21 Paragraph
815-10-15-4 states that, if a contract meets the
definition of both a derivative instrument and a
firm commitment under the Derivatives and Hedging
Topic (as illustrated in Example 8 [see paragraph
815-20-55-111]), then an entity shall account for
the contract as a derivative instrument unless one
of the exceptions in this Topic applies. In that
circumstance, either of the following may be
true:
-
The forecasted transaction and the derivative instrument used to hedge it are with the same counterparty.
-
The derivative instrument is the same contract under which the entity executes the forecasted transaction.
25-22 Assuming other cash
flow hedge criteria are met, a derivative
instrument that will involve gross settlement may
be designated as the hedging instrument in a cash
flow hedge of the variability of the consideration
to be paid or received in a forecasted transaction
that will occur upon gross settlement of the
derivative instrument itself (an all-in-one
hedge). This guidance applies to fixed-price
contracts to acquire or sell a nonfinancial or
financial asset that are accounted for as
derivative instruments under this Topic provided
the criteria for a cash flow hedge are met.
As noted in Section 4.1.1.3.1, the definition of a
forecasted transaction excludes transactions for which there is a firm
commitment. If a firm commitment must be accounted for as a derivative
instrument within the scope of ASC 815, it must be recognized at fair
value as of each reporting date. If the derivative cannot be used as a
hedging instrument in a qualifying hedging relationship, changes in the
derivative’s fair value would be recognized in earnings. DIG Issue G2
arose because of concerns that the prohibition on identifying the
transactions underlying the firm commitment as a hedged forecasted
transaction would cause unintended consequences, even though a firm
commitment acts as a perfect hedge against potential changes in cash
flows related to the purchase or sale of the item underlying the firm
commitment.
DIG Issue G2 (codified in ASC 815-20-25-21 and 25-22 and ASC
815-20-55-111 through 55-116) established the notion of an all-in-one
hedge by specifying that “a derivative instrument that will involve
gross settlement may be designated as the hedging instrument in a cash
flow hedge of the variability of the consideration to be paid or
received in a forecasted transaction that will occur upon gross
settlement of the derivative instrument itself (an all-in-one hedge).”
ASC 815-20-55-114 resolves the potential conflict regarding a firm
commitment’s ineligibility to be designated as a forecasted transaction
as follows:
The forecasted purchase or sale at a fixed price is
eligible for cash flow hedge accounting because the total
consideration paid or received is variable. The total consideration
paid or received for accounting purposes is the sum of the fixed
amount of cash paid or received and the fair value of the fixed
price purchase or sale contract, which is recognized as an asset or
liability, and which can vary over time.
In other words, while the terms of a firm commitment specify a fixed
price to be paid for the asset, if the firm commitment is accounted for
as a derivative and recognized as an asset or liability, the
consideration paid by the buyer of the asset is a combination of (1) the
contractual price and (2) either the delivery of an asset or the
extinguishment of a liability represented by the derivative. In that
sense, the forecasted transaction that results from such a firm
commitment is exposed to changes in consideration that have the
potential to affect earnings because the total consideration varies on
the basis of changes in the derivative’s fair value from the inception
of the firm commitment through its settlement. See Example
4-31 for a detailed example of an all-in-one hedge.
4.1.1.3.2.1 Options Do Not Qualify for All-in-One Hedging
The term “all-in-one hedge” applies only to hedging relationships
involving a firm commitment that is accounted for as a derivative.
An option or warrant does not meet the definition of a firm
commitment under ASC 815.
An entity is not precluded from designating the purchase of an asset
underlying an option as a forecasted transaction in a cash flow
hedging relationship that is not an all-in-one hedge simply because
the option does not meet the definition of a firm commitment.
However, to qualify for cash flow hedge accounting for an option
designated as the hedging instrument in a hedge of the forecasted
acquisition of an asset, the entity should be able to establish at
the inception of the relationship that the acquisition of the asset
is probable regardless of how it is acquired. In other words, the
entity must be able to assert that even if the option expires
out-of-the-money, it will still be probable that the entity will
acquire the asset (e.g., it will instead acquire the asset in the
marketplace).
ASC 815-20-55-27 through 55-32 provide guidance on
an example of the forecasted acquisition of a marketable debt
security. ASC 815-20-55-31 and 55-32 state:
55-31 Therefore, to qualify for cash flow hedge
accounting in this circumstance, the entity shall be able to
establish that it is probable that it will acquire the
marketable debt security by any of the following means:
-
Exercising the option designated as the hedging instrument if it is in the money
-
Purchasing the security in the marketplace at its prevailing market price if the option is out of the money.
55-32 If the entity expects to acquire the
marketable debt security only by exercising the option and
only if the option were in the money, a cash flow hedging
relationship typically would not be designated because
acquisition of the security is contingent and thus would not
be considered probable.
In documenting the hedging relationship, the entity should specify
the date of the forecasted acquisition or the period in which it
will occur. The assertion that the forecasted acquisition is
probable should be assessed in each reporting period (see
Section 4.1.1.1).
A traditional loan commitment that is accounted for as a derivative
cannot be designated as a hedging instrument in an all-in-one cash
flow hedge because such a commitment is not a firm commitment as
defined in ASC 815. A loan commitment does not require the borrower
to exercise the loan commitment and initiate the borrowing.
In addition, an entity may not designate a loan commitment that is a
derivative under ASC 815 as a hedged item in other hedge accounting
strategies because ASC 815 does not permit derivatives to be
designated as hedged items. However, loan commitments that are
derivatives may be economically hedged with another derivative
(e.g., a forward loan sales contract that is a derivative) if both
derivatives are marked to fair value through earnings.
4.1.2 Specificity of Designation
As discussed in Section 2.6.1, to qualify for hedge accounting for a cash flow hedging relationship, an entity must document all relevant details about the hedged forecasted transaction in its hedge designation documentation. In paragraph 458 of the Background Information and Basis for Conclusions of Statement 133, the FASB discusses its rationale for
requiring specific identification of the forecasted transaction at the outset of
a hedge. It notes that such “information is necessary to (a) assess the
likelihood that the transaction will occur, (b) determine if the cumulative cash
flows of the designated derivative are expected to be highly effective at
offsetting the change in expected cash flow of the forecasted transaction
attributable to the risk being hedged, and (c) assess the hedge’s effectiveness
on an ongoing basis.” In addition, since changes in the fair value of a
derivative that is designated as a hedging instrument in a qualifying cash flow
hedge are recorded in OCI, the timing of when amounts are reclassified out of
AOCI is linked to when the forecasted transaction affects earnings.
ASC 815-20-25-3(d)(1)(vi) states:
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).
As noted in Section 2.6.1, the hedge designation
documentation for the hedge of a forecasted transaction should include the
following details:
-
The specific nature of the asset or liability involved (if any).
-
The current price of the 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.
4.1.2.1 Identification of the Hedged Item
The hedge designation documentation must describe the hedged forecasted
transaction with enough specificity to (1) ensure that an entity can
properly perform the hedge effectiveness assessments and (2) make it clear
when the transaction has occurred and when it would affect earnings. The
level of specificity provided in the designation documentation is critical
in the entity’s determination of whether it is probable that the forecasted
transaction will occur (or if it is probable that the transaction will not
occur and amounts will need to be reclassified out of AOCI; see
Section 4.1.5 for the accounting for discontinued
cash flow hedges).
When the terms of a forecasted transaction are subject to variability, there
is a natural tension between describing the transaction (1) broadly enough
to allow for such variability and (2) narrowly enough that the hedging
instrument is still highly effective at offsetting the changes in cash flows
that are attributable to the hedged risk.
Example 4-1
Reprise purchases aluminum on the spot market at
several locations and with differing grades. It is
not able to find one derivative that is highly
effective at hedging all its aluminum purchases. If
Reprise enters into a derivative that is only highly
effective at hedging purchases of a specific grade
at a specific location, it should specify both the
grade and location in its documentation for the
forecasted purchases. However, the risk of providing
that level of specificity (i.e., grade- and
location-specific purchases) is that if Reprise
shifts its production to different locations or uses
different grades of aluminum than it had originally
expected, it may no longer be probable that the
specified forecasted transactions will occur.
As discussed in Section 2.2.2.2, when hedging a group of
forecasted transactions in a single hedging relationship, entities should be
mindful that the designated forecasted transactions must have the same
exposure to the hedged risk. In other words, to qualify to be the hedged
item in a cash flow hedging relationship, all of the transactions in a group
of forecasted transactions must be similar.
4.1.2.2 Date or Range of Dates
ASC 815-20
25-16 Example 4 (see
paragraph 815-20-55-88) illustrates that how the
hedged forecasted transaction is designated and
documented in a cash flow hedge is critically
important in determining whether it is probable that
the hedged forecasted transaction will occur. The
following guidance expands on the timing and
probability criteria in paragraphs 815-20-25-3 and
815-20-25-15(b): . . .
c. Uncertainty of timing within a range. For
forecasted transactions whose timing involves some
uncertainty within a range, that range could be
documented as the originally specified time period
if the hedged forecasted transaction is described
with sufficient specificity so that when a
transaction occurs, it is clear whether that
transaction is or is not the hedged transaction.
As long as it remains probable that a forecasted
transaction will occur by the end of the
originally specified time period, cash flow hedge
accounting for that hedging relationship would
continue. See paragraph 815-30-40-4 for related
guidance and Example 5 (see paragraph
815-20-55-100), which illustrates the application
of this paragraph.
d. Importance of timing in both documentation
and hedge effectiveness. Although documenting only
the period within which the forecasted transaction
will occur is sufficient to comply with the
requirements of paragraph 815-20-25-3, compliance
with Section 815-20-35 and paragraph
815-20-25-75(b) requires that the best estimate of
the forecasted transaction’s timing be both
documented and used in assessing hedge
effectiveness. As explained in paragraphs
815-20-25-84 and 815-20-25-120 through 25-121, the
time value of money is likely to be important in
the assessment of cash flow hedge effectiveness,
especially if the entity plans to use a rollover
or tailing strategy to hedge its forecasted
transaction. The use of time value of money
requires information about the timing of cash
flows. . . .
ASC 815-20-25-3(d)(1) requires an entity to document “[t]he date on or period
within which the [hedged] forecasted transaction is expected to occur.” ASC
815-20-25-16(c) expands on this concept by noting that “[f]or forecasted
transactions whose timing involves some uncertainty within a range, that
range could be documented as the originally specified time period if the
hedged forecasted transaction is described with sufficient specificity so
that when a transaction occurs, it is clear whether that transaction is or
is not the hedged transaction.” An example provided in ASC 815-20-55-100
through 55-104 discusses an entity undertaking a construction project that
has a term of five years. The entity wants to hedge a forecasted
foreign-currency-denominated payment to a subcontractor that it expects to
make at the end of year 2. ASC 815-20-55-102 states, in part:
The general
contractor could document . . . that the hedged forecasted transaction
is the foreign-currency-denominated payment to the foreign subcontractor
to be paid within the five-year contract period of the overall project
(which is the originally specified time period referred to in paragraphs
815-30-40-4 through 40-5). In accordance with paragraph 815-20-25-16(c),
as long as it remains probable that the forecasted transaction will
occur by the end of the originally projected five-year period of the
overall project, cash flow hedge accounting for that hedging
relationship would continue. Consequently, if the subcontractor’s
payment is delayed by more than two months, but less than three years
and two months, then the forecasted transaction would still be
considered probable of occurrence within the originally specified time
period.
As noted in ASC 815-20-25-16(d), even though an entity may specify a range of
time in which it expects a forecasted transaction to occur, “compliance with
Section 815-20-35 and paragraph 815-20-25-75(b) requires that the best
estimate of the forecasted transaction’s timing be both documented and used
in assessing hedge effectiveness.” For example, if an entity is using the
hypothetical-derivative method to assess the effectiveness of a hedge, the
settlement date for the hypothetical derivative should match the best
estimate of the forecasted transaction date.
An entity must reevaluate its best estimate of the forecasted transaction’s
timing on each hedge effectiveness assessment date and use its current best
estimate of the most likely date in each assessment. See Section
4.1.4 for further discussion of how changes in the forecasted
transaction affect hedge accounting.
Connecting the Dots
Given that hedge accounting must be discontinued
when it is no longer probable that a forecasted transaction will
occur by the originally specified date or time period (see further
discussion in Section
4.1.5.1.2.3), an entity should consider documenting
the expected timing of a forecasted transaction whose timing is
uncertain by using a range that allows for unexpected delays. ASC
815-20-25-16(d) requires an entity to use its best estimate of the
date the transaction will occur (as opposed to considering all
potential dates for the designated period) in its hedge
effectiveness assessment. This requirement would appear to conflict
with the guidance in ASC 815-20-25-79(a), which states, in part,
that “[t]he quantitative prospective assessment may not be limited
only to the likely or expected changes in fair value (if a fair
value hedge) or in fair value or cash flows (if a cash flow hedge)
of the derivative instrument or the hedged items.” We believe that
the estimated timing of the forecasted transaction is the only
element of the transaction for which an entity may use its best
estimate rather than considering all reasonably possible changes, as
described in ASC 815-20-25-79(a) (except for hedges of interest
payments on “choose-your-rate” debt, as discussed in Section 4.2.1.1.2).
Changing Lanes
The FASB staff has proposed refining the model for
considering changes in the forecasted transaction and the designated
risk. In November 2019, it issued a proposed ASU that would
permit an entity that is assessing hedge effectiveness to use its
best estimate for all aspects of the forecasted transaction
regardless of how broadly or narrowly the forecasted transaction is
described in the hedge designation documentation. The staff is
currently working to respond to comments received from stakeholders
related to the 2019 proposed ASU and hopes to resolve the issues
during 2024.
4.1.2.3 Designated Transaction Versus Designated Risk
When an entity is hedging a forecasted transaction in a cash flow hedging
relationship, its hedge designation documentation must describe both the
forecasted transaction and the designated risk component of that
transaction. As discussed in Sections 4.1.2.1 and
4.1.2.2, the specificity of the forecasted
transaction is important for determining (1) whether it is probable that the
forecasted transaction will occur, (2) when the transaction has occurred,
and (3) when it affects earnings, as well as for the hedge effectiveness
assessment. On the other hand, the entity’s identification of a specific
risk as the hedged risk is only relevant in its calculation of the changes
in the hedged item’s cash flows that are attributable to the identified risk
for the hedge effectiveness assessment (see Section 2.3
for a discussion of the risks that may be identified as the hedged risk).
Changes in either the description of the forecasted transaction or the
designated hedged risk can only be accomplished through a dedesignation and
redesignation of the hedging relationship.
The table below includes examples that illustrate the differences between the
specified forecasted transaction and the designated hedged risk.
Forecasted Transaction
|
Designated Risk
|
---|---|
Quarterly interest payments on existing $10 million
variable-rate debt with Weekapaug Regional Bank
|
Contractually specified interest rate (e.g.,
three-month LIBOR)
|
Forecasted issuance of $100 million of five-year
fixed-rate debt that will occur within the next six
months
|
Benchmark interest rate (e.g., five-year LIBOR swap
rate)
|
Forecasted first ton of aluminum purchased under
supply contract with Supplier ABC at Factory XYZ
under supply contract for each of the next 12
months
|
Contractually specified component of purchase price
(e.g., the Midwest Transaction Price of
aluminum)
|
4.1.3 Terminal Value Method
Under the terminal value method of assessing the effectiveness of a cash flow
hedging relationship, an entity can compare an option’s ultimate settlement
amount to the change in the cash flows of the hedged transaction that are
attributable to the hedged risk (see Section 2.5.2.1.2.2).
While the terminal value method can eliminate the impact of the changes in an
option’s time value from the hedge effectiveness assessment, it does not exclude
any components of the option’s fair value from the assessment. Because the
option’s ultimate settlement amount is used in the calculation, an entity will
only compare changes in the option’s intrinsic value to changes in the hedged
transaction’s cash flows that are attributable to the hedged risk; however, all
of the changes in the option’s fair value are recognized in OCI in a qualifying
cash flow hedging relationship for which the terminal value method is used.
Amounts in AOCI are reclassified into earnings when the forecasted transaction
affects earnings.
An entity may use the terminal value method for a hedging relationship in which
the hedging instrument is a purchased option made up of a series of options that
are each hedging an individual hedged transaction in a series of hedged
transactions. In such cases, the entity should evaluate each option separately
when (1) assessing hedge effectiveness and (2) allocating the time value of the
combined option to the individual forecasted transactions for determining when
to record amounts in OCI and when to reclassify related amounts out of AOCI.
Example 4-2
Reprise hedges the next eight quarterly interest payments
on variable-rate debt with an interest rate cap that
covers those eight quarterly periods. It views the
interest rate cap as a series of eight interest rate
options (“caplets”) that are each hedging an individual
interest payment in a series of hedged interest payments
with different repricing dates. Therefore, it should
allocate the cap’s fair value at inception to each of
the eight individual caplets on the basis of its
relative fair value (“the caplet method”). In this case,
the initial fair value allocated to each caplet (as well
as any related intrinsic value that is recorded in AOCI)
will be (1) reclassified into earnings when the
respective hedged interest payment affects earnings and
(2) presented in the same income statement line item
(interest expense) as the earnings effect of the hedged
forecasted transactions. See Example
4-21 for a more detailed example.
The hedge effectiveness assessment results under the terminal value method may be
similar to the results of an assessment in which an option’s time value is
excluded, but the recognition of the option’s time value is different under the
two approaches. As noted above, under the terminal value method, all changes in
the fair value of an option in a qualifying hedging relationship are recognized
in OCI (including all the initial time value) and reclassified from AOCI into
income when the forecasted transaction affects earnings. However, in assessments
in which the option’s time value is excluded, the entity recognizes the initial
time value in earnings over the life of the hedging relationship but only
reclassifies the changes in the option’s intrinsic value out of AOCI when the
forecasted transaction affects earnings. See Section 4.1.6
for a more detailed discussion of approaches that exclude components of changes
in the derivatives’ fair value from the hedge effectiveness assessment.
The table below illustrates some of the differences between approaches that
exclude an option’s time value and the terminal value method.
Terminal Value Method
|
Time Value Excluded From Assessment
|
---|---|
Changes in time value recorded in OCI —
Reclassified into earnings when the forecasted
transaction affects earnings
|
Changes in time value recorded in OCI —
Reclassified into earnings over the life of the hedging
relationship unless the entity elects to recognize
changes in fair value currently in earnings
|
If series of options — The caplet method must be
applied to allocate initial time value to individual
forecasted transactions
|
If series of options — No requirement to apply the
caplet method
|
Hedge effectiveness assessment —
If the critical-terms-match method cannot be applied,
compare to hypothetical option (see Section
2.5.2.2.3)
|
Hedge effectiveness assessment — Time value is
ignored
|
4.1.4 Impact of Changes in Forecasted Transaction
As noted in Section 4.1.2, the identification of the hedged
forecasted transaction in the designation documentation is critical to the
assessment of (1) whether the hedging relationship is highly effective and (2)
the probability that the designated forecasted transaction will occur. An entity
must perform these assessments throughout the life of the hedging
relationship.
If the terms of the hedged forecasted transaction change, the entity needs to
consider how the changes affect its ability to continue applying hedge
accounting to the hedging relationship.
4.1.4.1 Change in Timing
If the expected timing of a hedged forecasted transaction changes during the
life of a hedging relationship, the entity must first assess whether it is
still probable that the forecasted transaction will occur within the period
established in the hedge designation documentation and then determine
whether hedge accounting can be continued:
-
If it is still probable that the forecasted transaction will occur within the timing specified in the hedge designation documentation, the entity is not necessarily required to discontinue hedge accounting. However, it must assess the effectiveness of the hedging relationship on the basis of the revised terms of the forecasted transaction to determine whether the hedging relationship is still highly effective.
-
If it is no longer probable that the forecasted transaction will occur within the timing specified in the hedge designation documentation, the entity should discontinue hedge accounting for the hedging relationship (see Section 4.1.5.1.2.3).
-
If the entity is hedging a group of forecasted transactions in a single hedging relationship and it is no longer probable that a portion of those forecasted transactions will occur within the timing specified in the hedge designation documentation, it should discontinue at least a portion of the hedging relationship (see Section 4.1.5.1.3.1).
Note that if the forecasted transaction is expected to occur
shortly after the timing specified in hedge designation documentation, the
entity is still required to discontinue hedge accounting. ASC 815-30-40-4
states, in part, that “[t]he net derivative instrument gain or loss related
to a discontinued cash flow hedge shall continue to be reported in
accumulated other comprehensive income unless it is probable that the
forecasted transaction will not occur by the end of the originally specified
time period (as documented at the inception of the hedging relationship)
or within an additional two-month period of time thereafter”
(emphasis added). While the guidance in ASC 815-30-40-4 might be interpreted
to mean that a delay of a forecasted transaction for up to two months will
not disqualify the hedging relationship from hedge accounting, it is
actually related to the treatment of amounts in AOCI for a hedging
relationship that is already discontinued (see further discussion in
Section
4.1.5.2). ASC 815-20-25-16 addresses some of the
considerations regarding the assessment of whether the occurrence of the
hedged forecasted transaction is probable. Specifically, ASC 815-20-25-16(c)
states, in part, that “[a]s long as it remains probable that a forecasted
transaction will occur by the end of the originally specified time period,
cash flow hedge accounting for that hedging relationship would continue.”
There is no such grace period in the evaluation of whether an entity can
continue applying hedge accounting to a hedging relationship in which it is
no longer probable that the forecasted transaction will occur within the
time period originally specified in the hedge designation documentation.
4.1.4.2 Change in Terms Other Than Timing
When there is a change in the expected terms of a forecasted transaction that
is unrelated to its timing, the process for evaluating such a change is
similar to the process for evaluating timing changes discussed in
Section 4.1.4.1, but the application of the steps
is more complicated.
An entity first needs to consider whether the revised forecasted transaction
still matches the description of the forecasted transaction specified in the
hedge designation documentation. The distinction between the specified
forecasted transaction and the designated hedged risk is important in this
analysis.
Example 4-3
TreyCo has $100 million of variable-rate debt
outstanding, with an interest rate that resets every
three months to a rate equal to the current
three-month LIBOR plus 5 percent. After two years,
TreyCo refinances the debt and replaces it with
variable-rate debt that resets every three months to
a rate equal to the current prime rate plus 2
percent. It is still probable that TreyCo will have
interest payments on $100 million of variable-rate
debt for the remaining term of the hedging
relationship.
The table below illustrates four different ways that
TreyCo could define the forecasted transaction in
its original hedge designation documentation and how
the differences in those designations would affect
whether the originally specified forecasted
transactions would still be probable at the time
TreyCo determines that it will replace the
LIBOR-based debt with prime-based debt.
Forecasted Transaction
|
Designated Risk
|
Transaction Still Probable?
|
---|---|---|
Interest payments on the specific debt issuance
of $100 million
|
Contractually specified interest rate
|
No.
|
Interest payments on the specific debt issuance
of $100 million and any replacement debt for the
specified term
|
Contractually specified interest rate
|
Yes.
|
Interest payments on first $100 million of
three-month LIBOR-based debt
|
Contractually specified interest rate
|
No. However, if the debt was replaced with
three-month LIBOR debt, the forecasted interest
payments might still be probable, depending on
whether it was probable that there would be
three-month LIBOR debt outstanding over the
remaining life of the hedge.
|
Interest payments on first $100 million of
variable-rate borrowings
|
Contractually specified interest rate
|
Yes.
|
If the revised forecasted transaction no longer matches the description of
the forecasted transaction in the designation documentation, an entity
should discontinue hedge accounting since it is no longer probable that the
forecasted transaction will occur. In addition, amounts in AOCI should be
reclassified into earnings because it is then probable that the forecasted
transaction will not occur (see Section 4.1.5.2).
If the revised forecasted transaction still matches the
description of the forecasted transaction in the designation documentation,
an entity should assess the effectiveness of the hedging relationship on the
basis of the revised transaction’s terms to determine whether the
relationship is still highly effective in accordance with ASC 815-30-55-98A.
If it is not highly effective, it should be discontinued, but amounts in
AOCI should remain in AOCI until the forecasted transaction affects earnings
(see Section
4.1.5.1.2.1).
4.1.5 Discontinuing a Cash Flow Hedge
There are several reasons why any entity may need to discontinue hedge accounting
for a cash flow hedging relationship. In many cases, discontinuation is required
because of a change in circumstances (e.g., it is no longer probable that the
hedged forecasted transaction will occur). In other cases, hedge accounting is
discontinued at the option of the entity. The next section discusses the reasons
why hedge accounting may be discontinued for a cash flow hedging relationship,
and Section 4.1.5.2 explains how to account for the related
amounts in AOCI after a discontinuation (including amounts associated with
components that were excluded from the hedge effectiveness assessment).
4.1.5.1 Reasons for Discontinuing a Cash Flow Hedge
ASC 815-30
40-1 An entity shall
discontinue prospectively the accounting specified
in paragraphs 815-30-35-3 and 815-30-35-38 through
35-41 for an existing hedge if any one of the
following occurs:
-
Any criterion in Section 815-30-25 is no longer met.
-
The derivative instrument expires or is sold, terminated, or exercised.
-
The entity removes the designation of the cash flow hedge.
4.1.5.1.1 Derivative No Longer Held or Is Modified
In a manner similar to the treatment of fair value hedges, discussed in
Section 3.5.1.1, ASC 815-30-40-1(b) requires
entities to discontinue cash flow hedge accounting for a hedging
relationship if the hedging derivative “expires or is sold, terminated,
or exercised.” In such a case, hedge accounting should be applied
through the date of the expiration, sale, termination, or exercise as
long as the relationship met the criteria to qualify for hedge
accounting up until that date. After that date, the derivative is not
remeasured on the balance sheet, so there would be no more changes in
fair value to potentially record in OCI. See Section
4.1.5.2 for a discussion of the accounting for amounts in
AOCI related to a discontinued hedging relationship.
If any of the critical terms of a derivative that is designated in a cash
flow hedging relationship are modified, the hedging relationship should
be dedesignated and discontinued. The novation of the derivative from
one counterparty to another counterparty is not, in and of itself, a
change in a critical term of the hedging relationship. See
Sections 3.5.1.1.1 and
3.5.1.1.2 for a more thorough discussion of
derivative modifications and novations, which is also applicable to all
types of hedging relationships.
4.1.5.1.2 Relationship No Longer Qualifies for Hedge Accounting
4.1.5.1.2.1 Hedging Relationship Not Highly Effective
As noted in ASC 815-30-40-1(a), hedge accounting should be
discontinued for a cash flow hedging relationship if any of the
qualifying criteria for a cash flow hedge are no longer met.
Accordingly, an entity should discontinue hedge accounting if the
results of a hedge effectiveness assessment indicate that the
relationship is no longer highly effective. As discussed in
Section 2.5.1, we do not believe that a
hedging relationship needs to be dedesignated upon a failed hedge
effectiveness assessment because the discontinuation of hedge
accounting ensures that it is not applied during the period in which
the relationship does not qualify for such accounting. ASC
815-30-35-3(b) discusses the accounting for amounts in AOCI that are
related to a cash flow hedging relationship. After describing the
composition of the balance in AOCI for a qualifying cash flow
hedging relationship, ASC 815-30-35-3(b) states, in part:
If
hedge accounting has not been applied to a cash flow hedging
relationship in a previous effectiveness assessment period
because the entity’s retrospective evaluation indicated that the
relationship had not been highly effective in achieving
offsetting changes in cash flows in that period, the cumulative
gain or loss on the derivative referenced in (b) would exclude
the gains or losses occurring during that period. That situation
may arise if the entity had previously determined, for example,
under a regression analysis or other appropriate statistical
analysis approach used for prospective assessments of hedge
effectiveness, that there was an expectation in which the
hedging relationship would be highly effective in future
periods. Consequently, the hedging relationship continued even
though hedge accounting was not permitted for a specific
previous effectiveness assessment period.
If a hedging relationship is not dedesignated, hedge accounting may
be applied in any subsequent period in which the entity can provide
(1) a prospective hedge effectiveness assessment that shows at the
beginning of the period that the hedging relationship is expected to
be highly effective and (2) a retrospective hedge effectiveness
assessment that shows that the hedging relationship was highly
effective during the period. However, as noted in Section
2.5.1, if there are repeated failed hedge
effectiveness assessments, an entity may want to consider whether a
different hedging strategy could qualify for hedge accounting.
As noted in the discussion of fair value hedges in Section
3.5.1.2.1, ASC 815-25-40-4 states that “if the event
or change in circumstances that caused the hedging relationship to
fail the effectiveness criterion can be identified, the entity shall
recognize in earnings the changes in the hedged item’s fair value
attributable to the risk being hedged that occurred before that
event or change in circumstances.” ASC 815-30 does not provide
similar guidance for cash flow hedging relationships; however, we
believe that the same concepts apply to cash flow hedges because the
requirement for a hedging relationship to be highly effective
applies to all hedging relationships. In other words, if an entity
can identify an event or change in circumstances that caused the
hedging relationship to fail the effectiveness criterion, it should
recognize the changes in the derivative’s fair value that occurred
before that event or change in circumstances in OCI.
4.1.5.1.2.2 Forecasted Transaction Not Probable
As discussed in Section 4.1.1.1, a forecasted
transaction can only be designated as the hedged item in a
qualifying cash flow hedging relationship if it is probable that the
transaction will occur. To maintain hedge accounting, the entity
must be able to assert that the forecasted transaction is probable
throughout the life of the hedging relationship. If it becomes no
longer probable that the designated forecasted transaction will
occur, (1) the transaction would no longer qualify to be the hedged
item in a cash flow hedging relationship and (2) hedge accounting
should be discontinued under ASC 815-30-40-1(a). Amounts in AOCI
related to the discontinued cash flow hedging relationship are not
necessarily reclassified into earnings at the time hedge accounting
is discontinued. See Section 4.1.5.2 for a
discussion of the accounting for a cash flow hedging relationship
after hedge accounting is discontinued.
When determining whether it is probable that a forecasted transaction
will occur, an entity should consider whether the parties to the
transaction have the ability to perform, as noted in
Section 4.1.1.1. ASC 815-20-25-16(a) states
that “[a]n entity using a cash flow hedge shall assess the
creditworthiness of the counterparty to the hedged forecasted
transaction in determining whether the forecasted transaction is
probable, particularly if the hedged transaction involves payments
pursuant to a contractual obligation of the counterparty.”
Similarly, the reporting entity also must consider how its own
creditworthiness (i.e., its ability to execute the forecasted
transaction) affects the hedging relationship. For example, if the
entity wants to apply hedge accounting to a cash flow hedging
relationship in which the forecasted transactions are interest
payments on its variable-rate debt, it needs to consider the
probability that the interest payments will be made.
As discussed in Section 2.5.2.1.2.6, changes in
the creditworthiness of the counterparties to the derivative
contract can also affect the ability to apply hedge accounting.
4.1.5.1.2.3 Forecasted Transaction Is Delayed
As noted in Section 4.1.4.1, ASC 815-20-25-16(c)
states, in part, that “[a]s long as it remains probable that a
forecasted transaction will occur by the end of the originally
specified time period, cash flow hedge accounting for that hedging
relationship would continue.” If it is no longer probable that the
forecasted transaction will occur within the time frame specified in
the designation documentation, hedge accounting should be
discontinued.
Alternatively, if a forecasted transaction will be delayed but is
still expected to occur within the time frame described in the hedge
designation documentation, the entity should perform the hedge
effectiveness assessment on the basis of the change in the
forecasted transaction’s timing. If the hedging relationship is no
longer highly effective, hedge accounting should be
discontinued.
See Section 4.1.5.2 for a discussion of the
accounting for a cash flow hedging relationship when hedge
accounting is discontinued.
4.1.5.1.2.4 Forecasted Transaction Changes
If a forecasted transaction changes and therefore no longer meets the
description in the hedge designation documentation, the hedging
relationship should be discontinued. In addition, even if the terms
of the transaction change and the transaction still meets the
description in the hedge designation documentation, the hedging
relationship should be discontinued if it is no longer highly
effective. See Section 4.1.4.2 for a more
thorough discussion of the changes in the terms of a forecasted
transaction and Section 4.1.5.2 for a
discussion of the accounting for a cash flow hedging relationship
when hedge accounting is discontinued.
4.1.5.1.3 Dedesignations
In a manner similar to the requirements for fair value hedges, discussed
in Section 3.5.1.3, ASC 815-30-40-1(c) requires
cash flow hedge accounting to be discontinued for a hedging relationship
if an entity “removes the designation of the cash flow hedge.” An entity
may discontinue a hedging relationship at any time even if (1) the
hedging instrument and the hedged item remain unchanged and are not
sold, terminated, expired, or executed or (2) it is still probable that
the hedged transaction will occur (in the case of a forecasted
transaction). When voluntarily discontinuing a hedging relationship, an
entity should formally document dedesignation of the relationship and
discontinue applying hedge accounting to the relationship on the date of
the documentation.
4.1.5.1.3.1 Proportional Dedesignations
As discussed in Section 3.5.1.3.1, an entity may
want or be required to dedesignate a proportion of a hedging
relationship. For example, if the entity is hedging a series of
forecasted transactions and it is no longer probable that a
proportion of those transactions will occur (see Section
4.1.5.1.2.2), the entity would be required to
dedesignate at least the proportion of the hedging relationship that
is related to those forecasted transactions that are no longer
probable. The ability to dedesignate a proportion of a hedging
relationship is equally available to all types of hedging
relationships, including cash flow hedges.
Any dedesignation should be accomplished through contemporaneous
documentation. A proportional dedesignation maintains the original
hedging relationship for the remaining proportion of the
relationship (i.e., the proportion that has not been dedesignated)
for the remainder of its term. If the hedging relationship met the
conditions to apply hedge accounting up to the date of the
proportional dedesignation, hedge accounting would be applied to the
entire hedging relationship up until that date.
After a dedesignation, the entity would only assess the remaining
proportion of the hedging relationship to determine whether it
qualified for hedge accounting. In other words, the entity would
compare (1) the proportion of the changes in the derivative’s fair
value that are related to the proportion that is still designated as
the hedging instrument and included in the assessment of hedge
effectiveness with (2) changes in the cash flows of the newly
designated proportion of the hedged item that are attributable to
changes in the designated risk.
The table below summarizes the treatment of changes in a derivative’s
fair value both before and after a proportional dedesignation of a
cash flow hedging relationship. It is assumed that the proportion of
the derivative that was dedesignated is not designated in a new
qualifying hedging relationship.
Before Date of
Dedesignation
|
After Date of
Dedesignation
| |||
---|---|---|---|---|
Hedge Is Highly
Effective
|
Hedge Is Not Highly
Effective
|
Hedge Is Highly
Effective
|
Hedge Is Not Highly
Effective
| |
Proportion of Derivative Still
Designated
|
Change in fair value recorded
in OCI1
|
Change in fair value recorded in earnings
|
Change in fair value recorded
in OCI2
|
Change in fair value recorded in earnings
|
Proportion of Derivative
Dedesignated
|
Change in fair value recorded in earnings
|
Amounts in AOCI (including amounts related to excluded components)
are reclassified into earnings when the hedged item affects earnings
regardless of whether hedge accounting is discontinued in part or in
full unless (1) it is probable that the forecasted transaction will
no longer occur or (2) there will be a significant delay in the
transaction (see the next section).
4.1.5.2 Accounting for a Discontinued Cash Flow Hedge
ASC 815-30
Discontinuing Hedge Accounting
40-2 In the circumstances
discussed in paragraph 815-30-40-1, the net gain or
loss shall remain in accumulated other comprehensive
income and be reclassified into earnings as
specified in paragraphs 815-30-35-38 through 35-41.
Example 16 (see paragraph 815-30-55-94) illustrates
the application of paragraph 815-30-35-3 if a
hedging relationship is terminated.
40-4 The net derivative
instrument gain or loss related to a discontinued
cash flow hedge shall continue to be reported in
accumulated other comprehensive income unless it is
probable that the forecasted transaction will not
occur by the end of the originally specified time
period (as documented at the inception of the
hedging relationship) or within an additional
two-month period of time thereafter, except as
indicated in the following sentence. In rare cases,
the existence of extenuating circumstances that are
related to the nature of the forecasted transaction
and are outside the control or influence of the
reporting entity may cause the forecasted
transaction to be probable of occurring on a date
that is beyond the additional two-month period of
time, in which case the net derivative instrument
gain or loss related to the discontinued cash flow
hedge shall continue to be reported in accumulated
other comprehensive income until it is reclassified
into earnings pursuant to paragraphs 815-30-35-38
through 35-41.
40-5 If it is probable that
the hedged forecasted transaction will not occur
either by the end of the originally specified time
period or within the additional two-month period of
time and the hedged forecasted transaction also does
not qualify for the exception described in the
preceding paragraph, that derivative instrument gain
or loss reported in accumulated other comprehensive
income shall be reclassified into earnings
immediately. A pattern of determining that hedged
forecasted transactions are probable of not
occurring would call into question both an entity’s
ability to accurately predict forecasted
transactions and the propriety of using hedge
accounting in the future for similar forecasted
transactions.
40-6A When applying the
guidance in paragraph 815-20-25-83A, if the hedged
forecasted transaction is probable of not occurring,
any amounts remaining in accumulated other
comprehensive income related to amounts excluded
from the assessment of effectiveness shall be
recorded in earnings in the current period. For all
other discontinued cash flow hedges, any amounts
associated with the excluded component remaining in
accumulated other comprehensive income shall be
recorded in earnings when the hedged forecasted
transaction affects earnings.
Upon the discontinuation of hedge accounting for a cash flow hedging
relationship, any amounts in AOCI related to that relationship, including
amounts associated with any components of the derivative that were excluded
from the hedge effectiveness assessment (see ASC 815-30-40-6A), are still
associated with the hedged transaction and should affect earnings at the
same time and in the same manner in which the hedged transaction affects
earnings.
The table below illustrates the method of reclassifying amounts from AOCI to
income for a few potential hedged forecasted transactions.
Hedged Transaction
|
Recognition of AOCI in Income
|
---|---|
Forecasted purchase of a machine in a foreign
currency
|
Adjustment of depreciation over the useful life of
machine
|
Forecasted sale of an AFS debt security
|
Adjustment of gain or loss on sale of the security
when sold
|
Forecasted debt issuance
|
Adjustment of interest expense over term of debt
|
Forecasted purchase of raw materials
|
Adjustment of the cost of sales when related
inventory is sold
|
For a more detailed discussion of the reclassification of amounts from AOCI,
see Section 4.2.5 for hedges of transactions involving
financial instruments and Section 4.3.5 for hedges of
transactions involving nonfinancial assets.
If an entity discontinues a hedging relationship involving a series of
forecasted transactions but it is still probable that the hedged
transactions will occur, the amounts in AOCI should be reclassified into
earnings as those forecasted transactions affect earnings (i.e., over the
remaining term of the hedging relationship). ASC 815 does not specify what
method an entity should use to determine the amount in AOCI related to each
of the remaining previously hedged transactions, but we believe that it is
acceptable to apply either (1) the caplet/swaplet method or (2) a systematic
and rational method of amortization of the amount in AOCI. Under the
caplet/swaplet method, an entity determines how much of the change in fair
value that was recognized in OCI is related to each individual component of
the derivative that was hedging each individual forecasted transaction.
Under the systematic and rational amortization method, the amount in AOCI is
allocated to the remaining transactions. For example, an entity may
determine the allocation by dividing the amount in AOCI by the number of
remaining transactions.
In some circumstances, all or some of the amounts in AOCI
related to a specific discontinued hedging relationship need to be
reclassified into earnings before the forecasted transaction affects
earnings. Specifically, if it becomes probable that the forecasted
transaction either will not occur at all or will not occur without
significant delay, the entity must immediately reclassify amounts into
earnings. ASC 815-30-40-5 generally requires amounts in AOCI to be
reclassified into earnings if it becomes probable that a designated
forecasted transaction will not occur within two months of the time period
specified in the original hedge designation documentation. However, ASC 815
is silent on the income statement classification of amounts that are
reclassified out of AOCI in accordance with ASC 815-30-40-5. The exposure
draft for ASU 2017-12 would
have required amounts to be reported in the same line item in which the
earnings effect of the forecasted transaction would have been reported, but
the Board decided to remove that requirement when it issued the final ASU.
Paragraph BC140 of ASU 2017-12 explains the basis for that decision:
In the feedback received from stakeholders, both
preparers and users emphasized that such presentation would not provide
decision-useful information because of the potentially distortive
effects on individual income statement line items. In a missed forecast,
only the earnings effect of the hedging instrument would have been
recorded in the line item intended to be hedged, but there would have
been no offsetting earnings effect from a hedged item. For example, in a
missed forecasted sales transaction, an entity would record the change
in the fair value of the hedging instrument in revenue, but there would
be no corresponding revenue from the sale. The Board concluded that
financial reporting would not be improved by requiring that the gain or
loss of the hedging instrument that had been deferred in accumulated
other comprehensive income be recorded in a line item in which there is
no offset from the hedged item. Therefore, the Board decided to retain
current GAAP by not providing specific presentation guidance for missed
forecasts.
In the absence of guidance, we believe that an entity should exercise
judgment in deciding where to report amounts that are reclassified out of
AOCI into earnings when it becomes probable that a forecasted transaction
will not occur within two months of the originally specified time frame. An
entity should disclose where such amounts are reported and consistently
apply any policy that it develops. Even though the FASB decided not to
require such amounts to be recognized in the same line item in which the
earnings effect of the forecasted transaction would have been reported, an
entity is not precluded from doing so.
ASC 815-30-40-4 states, in part, that “[i]n rare cases, the existence of
extenuating circumstances that are related to the nature of the forecasted
transaction and are outside the control or influence of the reporting entity
may cause the forecasted transaction to be probable of occurring on a date
that is beyond the additional two-month period of time, in which case the
net derivative instrument gain or loss related to the discontinued cash flow
hedge shall continue to be reported in accumulated other comprehensive
income until it is reclassified into earnings pursuant to paragraphs
815-30-35-38 through 35-41.” Because this exception is available only in
“rare” cases, an entity should document the extenuating circumstances and
explain why the transaction would meet this rare exception.
Connecting the Dots
At its April 8, 2020, meeting, the FASB staff stated
that the guidance in ASC 815-30-40-4 (i.e., on delays of a
forecasted transaction caused by extenuating circumstances that are
related to the nature of the forecasted transaction and that are
outside the control or influence of the entity) may be applied to
delays in the timing of forecasted transactions if those delays are
attributable to the COVID-19 pandemic. In a Q&A released on April 28, 2020, the FASB
staff reiterated and expanded on this view. According to the
Q&A, if an entity concludes that it is still probable that the
forecasted transactions associated with a discontinued hedge will
occur after the additional two-month period, it should retain in
AOCI those amounts associated with the discontinued hedge and
reclassify them into earnings in the same period(s) in which the
forecasted transaction affects earnings.
The FASB staff also cautioned that an entity would need to exercise
judgment and consider the specific facts and circumstances related
to the forecasted transaction in determining whether (1) the
forecasted transaction delays were caused by the effects of the
COVID-19 pandemic and (2) it is probable that the forecasted
transaction still will occur after the additional two-month period.
As noted in the Q&A, when assessing a forecasted transaction’s
probability of occurrence, an entity “should consider whether the
forecasted transaction remains probable over a time period that is
reasonable given the nature of the entity’s business, the nature of
the forecasted transaction, and the magnitude of the disruption to
the entity’s business related to the effects of the COVID-19
pandemic.” If an entity determines that it is no longer probable
that the forecasted transaction will occur within the “reasonable
time period beyond the additional two-month period,” it should
immediately reclassify all AOCI amounts related to the discontinued
hedge into earnings and provide appropriate disclosures in its
interim and annual financial statements.
The Q&A also clarifies that when an entity determines that
amounts deferred in AOCI should be reclassified into earnings
because of a missed forecast as a result of the COVID-19 pandemic,
the entity need not consider that missed forecast in its assessment
of whether it has exhibited a pattern of missed forecasts that would
call into question its ability to apply cash flow hedge accounting
to similar transactions in the future. An entity would need to
exercise judgment and consider its specific facts and circumstances
when making its determination that the missed forecast is related to
the effects of the COVID-19 pandemic.
The table below summarizes the treatment of the changes in the fair value of
a derivative designated in a cash flow hedging relationship on the basis of
the likelihood that the forecasted transaction will occur. It is assumed
that all the other criteria for hedge accounting are met.
Likelihood of Transaction Occurring
|
Treatment of Changes in Derivative’s Fair Value
|
Hedge Accounting Status
|
---|---|---|
Probable
|
Retain in AOCI; recognize subsequent changes in fair
value through OCI
|
Continues
|
Reasonably possible
|
Freeze amounts in AOCI; recognize subsequent changes
in fair value through earnings
|
Ceases
|
Probably not
|
Immediately reclassify amounts from AOCI into
earnings; recognize subsequent changes in fair value
through earnings
|
Ceases
|
Example 4-4
Hedge Discontinued but Forecasted Transaction
Still Probable
Assume that on February 3, 20X1, Maize Company
expects that it will purchase 100,000 bushels of
corn on May 20, 20X1. On February 3, 20X1, it enters
into 20 futures contracts, each for the purchase of
5,000 bushels of corn (100,000 in total) on May 20,
20X1. The price of the futures contracts is $2.6875
per bushel (a total price of $268,750 for 100,000
bushels). Maize immediately designates those
contracts as a hedge of the forecasted purchase of
100,000 bushels of corn. It measures effectiveness
by comparing the entire change in the futures
contracts’ fair value with changes in the cash flows
on the forecasted transaction.
On May 1, 20X1, Maize dedesignates the futures
contracts and closes them out by entering into
offsetting contracts on the same exchange. As of
that date, it has recognized gains of $26,250 on the
futures contracts in AOCI. Because Maize still plans
to purchase 100,000 bushels of corn on May 20, 20X1,
the gains that occurred before the dedesignation
will remain in AOCI until the finished product is
sold. If Maize had not closed out the futures
contracts when it dedesignated them, any subsequent
gains or losses on those contracts would have been
recognized in earnings, but amounts in AOCI would
have remained in AOCI until the finished product was
sold.
Example 4-5
Hedge
Discontinued and Forecasted Transaction Is
Delayed
Alaskan Crude enters into a cash
flow hedge of the forecasted sale of 100 barrels of
oil inventory on April 30. Gains and losses on the
hedging instrument are recognized in OCI and will be
reclassified from AOCI into earnings as sales occur.
After the initiation of the hedging relationship,
Alaskan Crude determines that it is no longer
probable that the 100 barrels will be sold on April
30 and the cash flow hedge is discontinued. However,
it believes that the forecasted sales will occur by
June 30. Alaskan Crude should continue to report the
gains and losses on the hedging instrument
associated with the discontinued cash flow hedge in
AOCI because it is not probable that the forecasted
sale will not occur within the additional two-month
period after the transaction date specified in the
original hedge documentation.
If Alaskan Crude instead concludes
that (1) it is probable that the sale will
not occur by June 30 (i.e., within two
months after the sale date forecasted in the
original hedge documentation) and (2) the
circumstances related to the sale did not constitute
one of the rare cases in which an additional
extension (as described above) is warranted, it will
immediately recognize in income the amounts in AOCI
that are associated with the discontinued cash flow
hedge.
4.1.5.2.1 Impact of Missed Forecasts on Future Forecasts
As previously discussed, ASC 815-30-40-5 states, in part, that “[a]
pattern of determining that hedged forecasted transactions are probable
of not occurring would call into question both an entity’s ability to
accurately predict forecasted transactions and the propriety of using
hedge accounting in the future for similar forecasted transactions.”
Connecting the Dots
At the 2000 AICPA Conference on Current SEC Developments, the SEC
staff said that it will challenge the credibility of
management’s previous and future assertions about forecasted
transactions if the entity displays a pattern of determining
that it is no longer probable that its hedged forecasted
transactions will occur: “One instance is not a pattern, but a
recurrence will quickly raise a red flag that could result in a
revision in the accounting for cash flow hedging
relationships.”
The SEC staff believes that this issue is a matter of judgment
based on individual facts and circumstances. However, there are
several questions that are useful for evaluating whether an
entity has a pattern of determining that forecasted transactions
are no longer probable. These include:
-
What were the business or operating circumstances that led the entity to its conclusion?
-
Has the entity experienced other instances with similar forecasted transactions?
-
If so, when did the other instance(s) occur and what were the business or operating circumstances?
-
Do the current circumstances differ, if at all, from the previous instance(s)?
-
Were the circumstances or events that led to the conclusion(s) within the entity’s control?
-
Is the entity expecting a similar forecasted transaction within the near future?
4.1.5.2.2 Hedged Forecasted Transaction Is Impaired
The cash flow hedging guidance in ASC 815-30-35-43 (as amended by ASU
2019-04) states, in part, that “[i]f, under existing requirements in
GAAP, an asset impairment loss or writeoff due to credit losses is
recognized on an asset or an additional obligation is recognized on a
liability to which a hedged forecasted transaction relates, any
offsetting or corresponding net gain related to that transaction in
accumulated other comprehensive income shall be reclassified immediately
into earnings.”
Paragraph 498 of Statement 133 explains that the FASB’s rationale for
establishing this requirement was to ensure that “a derivative gain or
loss recognized in accumulated other comprehensive income as a hedge of
a variable cash flow on a forecasted transaction is . . . reclassified
into earnings in the same period or periods as the offsetting loss or
gain on the hedged item.” Therefore, “a derivative gain that offsets
part or all of an impairment loss on a related asset or liability should
be reclassified into earnings in the period that an impairment loss is
recognized.”
Accordingly, for an impaired asset to be considered “related” to the cash
flow hedging relationship, there should be a clear and direct link
between (1) the hedged exposure(s) identified in the documentation for
the hedging relationship and (2) the impaired asset. Without a direct
link, there is no conceptual basis for offsetting AOCI amounts against
the impairment loss.
Example 4-6
Weekapaug Regional Bank decides to sell a
fixed-rate AFS debt security to fund the purchase
of new equipment that will be delivered in six
months, and it enters into a forward sale contract
to hedge the probable forecasted sale of the
security. At the inception of the hedge, the fair
value of the AFS debt security equals its
amortized cost. Three months later, because of an
increase in interest rates, the fair value of the
forward sale contract increases to $10 million,
with an offset recorded in OCI to reflect hedge
accounting, and the fair value of the AFS security
decreases by $10 million. Because Weekapaug
intends to sell the security, it must recognize an
impairment loss for the security in accordance
with ASC 326-30-35-10. In this scenario, there is
a clear and direct link between the hedged
forecasted sale and the impaired security;
therefore, the two are “related” and Weekapaug
should reclassify $10 million of the AOCI balance
associated with the hedged sale to income to
offset the $10 million impairment loss on the
security.
Example 4-7
Mercury Provisions is hedging the forecasted
sales of its products, and therefore it cannot
assert that amounts recorded in AOCI in connection
with the hedge are related to the impairment of
equipment used to manufacture those products. In
that scenario, the hedged items are the sales of
the products, which would be distinct from the
impairment of the equipment. Such an impairment
would not be directly related to the hedged cash
flows specified in the hedge documentation because
cash flows from the sales of products would not
yet have occurred. Therefore, offsetting the
amounts in AOCI that are attributable to the
hedged forecast sales against the impairment would
be inconsistent with the FASB’s objective of
recognizing the earnings effects of the hedging
instrument and the hedged items in the same
period(s). In addition, such accounting would not
achieve Mercury’s intended purpose of recognizing
a fixed price for the forecasted sale because
after the impairment was offset, there would be
fewer (or no) amounts left in AOCI to offset
against the spot price of the forecasted sales
when they actually occur.
Further, in such a case it would be difficult to
argue conceptually that the entire amount recorded
in AOCI that is attributable to specific hedged
sales should be offset against the impairment.
Under both steps of the impairment test in ASC
360-10-35-17 (i.e., assessment of recoverability
and measurement of impairment), Mercury would
consider all future cash flows of the equipment,
not just those cash flows identified as the hedged
sales. Because the impairment would be indirectly
related to all the future products created by the
equipment, it would seem inconsistent to offset
the entire amount of the impairment loss on the
equipment against the amounts in AOCI that were
only attributable to the specified hedged cash
flows. In addition, even if the hedged forecasted
sales span the entire period of expected
production from the equipment, it still would not
be appropriate for Mercury to remove from AOCI
amounts related to those sales to offset the
impairment of the equipment because the cash flows
of each are distinct and not related.
4.1.6 Excluded Components of a Derivative
As discussed in Section 2.5.2.1.2.1, an entity may exclude
components of a derivative’s fair value (and the resulting changes in the fair
value of the excluded components) from the assessment of hedge effectiveness. In
such a case, if the entity recognizes the excluded amounts in earnings by using
a systematic and rational method over the life of the hedging instrument, any
difference between the change in the fair value of those components and the
amount recognized in earnings should be recognized in OCI. An entity may also
elect to recognize the changes in the excluded components’ fair value in
earnings as they occur.
See Example 4-20 for a detailed illustration of a hedging
relationship that involves excluding an option’s time value from the assessment
of a hedging relationship.
Footnotes
1
If any component of the
derivative is excluded from the hedge
effectiveness assessment and the difference
between the changes in that component’s fair value
and the amount recognized in earnings under a
systematic and rational method are recorded in OCI
as permitted by ASC 815-20-25-83A, only the
proportion of the derivative that is still in a
hedging relationship qualifies for this treatment
after the date of the proportional
dedesignation.
2
See footnote 1.