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:
1. A single transaction
2. 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:
1. 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).
2. 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., SOFR OIS) 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., SOFR OIS) 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.

Pending Content (Transition Guidance: ASC 848-10-65-1)

25-2 Paragraph superseded by Accounting Standards Update No. 2020-04.

As the global markets actively planned the transition from the use of LIBOR and other interbank offering rates to alternative reference rates, questions arose 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 being 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 established a new Codification topic, ASC 848, and ASU 2021-01 expanded 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:
Type of Firm Commitment	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 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. However, on the basis of comments received from stakeholders, the change in hedged risk guidance in the project was narrowed to only apply to hedges involving choose-your-rate debt instruments (see Section 4.2.1.1.2) in the FASB’s September 2024 proposed ASU.

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 term SOFR)
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 SOFR OIS 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 term SOFR 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 SOFR-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 term SOFR-based debt	Contractually specified interest rate	No. However, if the debt was replaced with three-month term SOFR debt, the forecasted interest payments might still be probable, depending on whether it was probable that there would be three-month term SOFR 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 OCI1	Change in fair value recorded in earnings	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

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.

See footnote 1.

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