5.2 Foreign Currency Fair Value Hedges

Hedging Relationship Type	Possible Types of Foreign-Currency-Denominated Hedged Items (See ASC 815-20-25-28)	Permitted Hedging Instruments
Foreign currency fair value hedge	Recognized asset or liability (including AFS securities)	Derivative
Foreign currency fair value hedge	Unrecognized firm commitment	Derivative or nonderivative

As indicated in the ASC master glossary and discussed in Chapter 3, a fair value hedge is “[a] hedge of the exposure to changes in the fair value of a recognized asset or liability, or of an unrecognized firm commitment, that are attributable to a particular risk.” The changes in that fair value must have the potential to affect reported earnings. When an entity elects to hedge a foreign-currency-denominated asset or liability for changes in fair value that are attributable to changes in foreign currency exchange rates, additional guidance is needed because the hedged item in many cases is already subject to remeasurement under ASC 830-20.

5.2.1 Hedged Items in a Foreign Currency Fair Value Hedge

A hedged item would only have exposure to changes in fair value that are attributable to changes in foreign currency exchange rates if it is an existing foreign-currency-denominated asset or liability or an unrecognized firm commitment to purchase or sell an asset with a price that is a fixed amount of a foreign currency.

ASC 815-20

25-37 This paragraph identifies possible hedged items in fair value hedges of foreign exchange risk. If every applicable criterion is met, all of the following are eligible for designation as a hedged item in a fair value hedge of foreign exchange risk:

Recognized asset or liability. A derivative instrument can be designated as hedging the changes in the fair value of a recognized asset or liability (or a specific portion thereof) for which a foreign currency transaction gain or loss is recognized in earnings under the provisions of paragraph 830-20-35-1. All recognized foreign-currency-denominated assets or liabilities for which a foreign currency transaction gain or loss is recorded in earnings shall qualify for the accounting specified in Subtopic 815-25 if all the fair value hedge criteria in this Section (including the conditions in paragraph 815-20-25-30(a) through (b)) are met.
Available-for-sale debt security. A derivative instrument can be designated as hedging the changes in the fair value of an available-for-sale debt security (or a specific portion thereof) attributable to changes in foreign currency exchange rates. The designated hedging relationship qualifies for the accounting specified in Subtopic 815-25 if all the fair value hedge criteria in this Section (including the conditions in paragraph 815-20-25-30(a) through (b)) are met.
Subparagraph superseded by Accounting Standards Update No. 2016-01.
Unrecognized firm commitment. Paragraph 815-20-25-58 states that a derivative instrument or a nonderivative financial instrument that may give rise to a foreign currency transaction gain or loss under Topic 830 can be designated as hedging changes in the fair value of an unrecognized firm commitment, or a specific portion thereof, attributable to foreign currency exchange rates.

In a manner consistent with ASC 815-20-25-37, if the relevant hedge accounting requirements are met, foreign currency exposures associated with (1) a recognized asset or liability, (2) an AFS security (subject to some restrictions), and (3) an unrecognized firm commitment may qualify as the hedged item in a fair value hedge of foreign currency risk.

5.2.1.1 Recognized Foreign-Currency-Denominated Asset or Liability

A foreign currency exposure on a recognized asset or liability may qualify as the hedged item in a fair value hedging relationship provided that the asset or liability is subject to the measurement provisions of ASC 830-20-35-1. The application of the foreign currency measurement requirements of ASC 830-20 is not viewed as measurement of the exposure at fair value, with changes in fair value recognized in earnings, because the remeasurement of the foreign-currency-denominated asset or liability is only based on changes in the foreign currency spot exchange rate, as noted in ASC 815-20-25-29. In that way, foreign currency exposures associated with recognized assets and liabilities are not precluded from qualifying as the hedged item. However, an asset or liability that is carried at fair value, with changes in fair value recognized in earnings (e.g., an equity security subject to ASC 321), would not qualify as the hedged item even if it is a foreign-currency-denominated asset or liability that is subject to ASC 830-20.

Also, as noted in Section 2.3.2.2, a recognized asset or liability must be denominated in a foreign currency for it to have exposure to changes in foreign currency exchange rates. Therefore, recognized nonfinancial assets do not qualify to be the hedged item in a foreign currency fair value hedge.

5.2.1.1.1 Recognized Foreign-Currency-Denominated Asset or Liability — Fair Value Hedge or Cash Flow Hedge?

Under ASC 815-20-25-28, an entity may enter into the following types of foreign currency hedges for a recognized asset or liability: (1) a fair value hedge of the recognized asset or liability, or a specific portion thereof (including an AFS debt security), and (2) a cash flow hedge of the forecasted functional currency cash flows associated with the recognized asset or liability. For such hedges, ASC 815-20-25-71(b) and (c) state that a nonderivative financial instrument cannot be designated as the hedging instrument.

Foreign-currency-denominated assets and liabilities have exposure to changes in both fair value and functional-currency cash flows when foreign currency exchange rates change. Consequently, entities have the choice of applying either fair value hedges (see ASC 815-20-25-37(a)) or cash flow hedges (see ASC 815-20-25-38(b)) to offset the foreign currency risk of recognized foreign-currency-denominated assets and liabilities. In some cases, if the entity wants to hedge more than one risk, the type of hedging relationship applied will be determined by the nonforeign currency risk. For example, if an entity wants to hedge fixed-rate foreign-currency denominated debt for both interest rate risk and foreign currency risk, it would designate a fair value hedging relationship because changes in interest rates affect the debt’s fair value.

In addition, the type of hedge that an entity can designate depends on whether the hedge is intended to eliminate all the variability in the hedged item’s functional currency cash flows, which would be a requirement for any cash flow hedge of the entity’s exposure to foreign currency risk under ASC 815-20-25-39(d) (see Section 5.3.3.1.1). Accordingly, risk management strategies in which the foreign currency exposure of a recognized asset or liability is swapped into a variable-rate exposure in an entity’s functional currency will not qualify for cash flow hedging because the hedged items’ functional currency cash flows would still be subject to variability.

The table below provides examples of the type of hedge that would be appropriate for an entity to designate to implement the listed risk management strategies. In each scenario, the foreign currency exposure is swapped into the entity’s functional currency, which is assumed to be USD. Depending on the nature of the strategy, the entity could designate an instrument such as a currency swap, forward contract, or combined interest rate and currency swap (CIRCUS) as the hedging derivative.

Issued by Entity With USD Functional Currency	Risk Management Strategy	Type of Hedge Under ASC 815
Fixed-rate foreign-currency-denominated debt	Swap into fixed-rate USD debt	Fair value or cash flow hedge of foreign currency risk
Fixed-rate foreign-currency-denominated debt	Swap into variable-rate USD debt	Fair value hedge of foreign currency and interest rate risk
Floating-rate foreign-currency-denominated debt	Swap into fixed-rate USD debt	Cash flow hedge of foreign currency and interest rate risk
Floating-rate foreign-currency-denominated debt	Swap into floating-rate USD debt	Fair value hedge of foreign currency risk

An entity that enters into a cross-currency interest rate swap to hedge foreign-currency-denominated debt for changes in its fair value attributable to foreign currency risk may exclude the cross-currency basis spread in the swap from the hedge effectiveness assessment in accordance with ASC 815-20-25-82(e). In doing so, the recognition of the accrual of the periodic interest settlements on the swap in earnings is considered a systematic and rational method of recognizing the initial value of the excluded component.

In addition, we believe that if all the following conditions are met, an entity may apply the critical-terms-match method (see Section 2.5.2.2) to a hedge of foreign-currency-denominated debt for changes in its fair value attributable to changes in the foreign currency spot exchange rate:

The debt is fixed-rate foreign-currency-denominated debt.
The hedging instrument is a fixed-for-fixed cross-currency interest rate swap.
The notional amount of the foreign currency leg of the swap matches the principal amount of the debt that is designated as the hedged item throughout the term of the hedging relationship.
The two currencies underlying the exchange rate of the swaps match the functional currency of the entity and the currency in which the debt is denominated.
Either of the following:
- The cross-currency basis spread is excluded from the assessment of hedge effectiveness.
- The interest payments on the foreign currency leg of the swap match the designated portion of the hedged interest payments (both timing and amount).
The swap has standard terms (see Section 5.4.2.1.1.1) and its fair value at hedge inception is zero.

See Example 5-7 for a detailed example of an entity using a fixed-for-fixed cross-currency interest rate swap to hedge fixed-rate foreign-currency-denominated debt.

5.2.1.1.2 AFS Securities

Foreign currency exposures on AFS debt securities may be identified as a hedged item in a fair value hedging relationship. While an AFS debt security is measured at fair value, changes in fair value (including those changes resulting from changes in foreign currency exchange rates) are recognized in OCI, not in earnings. Accordingly, an AFS debt security is not prohibited from being a hedged item.

An entity may choose to simply hedge the foreign currency risk related to the principal amount of an AFS debt security by entering into a forward contract.

Example 5-3

Weekapaug Regional Bank, an entity with a USD functional currency, acquires a EUR-denominated AFS debt security with a principal amount of EUR 10 million that matures in two years. It enters into a forward contract to sell EUR 10 million in exchange for USD 12.5 million in two years. Weekapaug could elect to designate the forward contract as a fair value hedge of the AFS debt security for changes in its fair value attributable to changes in the EUR/USD exchange rate.

An entity may also use a compound derivative, such as a CIRCUS, to hedge the foreign currency and interest exposures on a fixed-rate AFS debt security that is denominated in a foreign currency. ASC 320-10-35-36 requires an entity to record the entire change in the fair value of a foreign-currency-denominated AFS security in OCI (unless there is an impairment loss, which is recognized in earnings) rather than record the foreign currency component of that change in fair value through earnings, as would be required under ASC 830.

Example 5-4

Weekapaug Regional Bank, an entity with USD functional currency, has a five-year fixed-rate 100 million EUR-denominated debt security and classifies the investment as an AFS security. Weekapaug wants to enter into a derivative to “convert” the security to the equivalent of a USD-denominated variable-interest-rate investment. To do so, it enters into a CIRCUS in which (1) at maturity, it exchanges EUR 100 million for a fixed number of USD and (2) each quarter, it pays a fixed rate of interest in EUR and receives a variable rate of interest in USD. This strategy eliminates the risk of changes in the security’s fair value that are attributable to foreign currency and interest rate exposures (see Section 5.2.1.1.1). The CIRCUS should be accounted for as a fair value hedge of the AFS debt security as long as it is highly effective and all other conditions of ASC 815-20-25-37 are satisfied.

Section 5.2.1.1.1 notes that an entity may designate a recognized foreign-currency-denominated asset, including an AFS debt security, as the hedged item in a fair value or cash flow hedging relationship. The type of relationship that an entity applies is likely to be determined by the terms of the AFS debt security (e.g., fixed- or floating-rate) and the type of derivative used (e.g., a forward contract or CIRCUS). See Section 5.2.3.2.1 for further discussion of the accounting for foreign currency fair value hedges of AFS debt securities.

5.2.1.2 Firm Commitments

Firm commitments generally qualify as a hedged item in a fair value hedging relationship. However, foreign currency exposures on firm commitments may affect both the firm commitment’s fair value (in a fair value hedge) as well as the forecasted cash flows related to the firm commitment (in a cash flow hedge).

Even though firm commitments are required to have a fixed price, a cash flow exposure may arise because that price is not required to be denominated in the entity’s functional currency. As a result, foreign currency exposures on firm commitments may be eligible as a hedged item in either a fair value or a cash flow hedging relationship, depending on the manner in which it is designated.

The following firm commitments are precluded from qualifying as the hedged item in a foreign-currency-related fair value hedge:

Intercompany commitments — Such commitments would not meet the definition of a firm commitment because they are not with a third party (see Section 3.1.1). However, an entity may hedge forecasted transactions related to certain intercompany commitments that have foreign currency exposure in a cash flow hedging relationship (see Section 5.3.1.1.1).
Firm commitments to enter into a business combination — ASC 815-20-25-43(c)(5) specifically prohibits such commitments from qualifying as the hedged item in a fair value hedge.

5.2.2 Hedging Instruments in a Foreign Currency Fair Value Hedge

Generally, only derivative instruments are permissible hedging instruments in a fair value hedging relationship. However, as noted in Section 2.4.2, certain nonderivative instruments may qualify as the hedging instruments in a fair value hedge of the foreign currency risk of an unrecognized firm commitment. For a nonderivative to qualify, it must be subject to the measurement criteria of ASC 830-20, as required by ASC 815-20-25-58. Therefore, a nonderivative instrument that is measured at fair value, with changes in fair value recognized in earnings, would not qualify.

5.2.3 Accounting for Foreign Currency Fair Value Hedges

ASC 815-25

Changes Involving Foreign Exchange Risk

35-15 Gains and losses on a qualifying foreign currency fair value hedge shall be accounted for as specified in Section 815-25-40 and paragraphs 815-25-35-1 through 35-10.

35-16 If a nonderivative instrument qualifies as a hedging instrument under paragraph 815-20-25-58, the gain or loss on the nonderivative hedging instrument attributable to foreign currency risk shall be the foreign currency transaction gain or loss as determined under Subtopic 830-20. The foreign currency transaction gain or loss on a hedging instrument shall be determined, consistent with paragraph 830-20-35-1, as the increase or decrease in functional currency cash flows attributable to the change in spot exchange rates between the functional currency and the currency in which the hedging instrument is denominated. That foreign currency transaction gain or loss shall be recognized currently in earnings along with the change in the carrying amount of the hedged firm commitment.

35-17 Paragraph not used.

35-18 Remeasurement of hedged foreign-currency-denominated assets and liabilities is based on the guidance in Subtopic 830-20, which requires remeasurement based on spot exchange rates, regardless of whether a fair value hedging relationship exists.

As noted in Chapter 3, in a typical qualifying fair value hedging relationship, an entity would record the change in the hedging instrument’s fair value in current-period earnings, except for amounts that are excluded from the hedge effectiveness assessment (see Section 3.4). It would also adjust the carrying amount of the hedged item for the change in its fair value attributable to the risk being hedged. The adjustment to the carrying amount for the change in the hedged item’s fair value would also be recognized in current-period earnings. For qualifying fair value hedges, all amounts recognized in earnings related to both the hedging instrument and the hedged item are presented in the same income statement line item and should be related to the risk being hedged (see Section 5.2.3.3 for further discussion of income statement classification).

The accounting for a qualifying foreign currency fair value hedge requires some slight modifications to the typical fair value hedging model because of a couple of factors:

The hedging instrument is not always a derivative instrument that is remeasured at fair value in accordance with ASC 815. Nonderivative instruments may be used to hedge unrecognized firm commitments for foreign currency risk.
The hedged item may already be subject to the measurement requirements of ASC 830-20 (i.e., foreign-currency-denominated assets and liabilities).

The measurement of the hedging instrument and the hedged item are discussed separately in the next sections.

5.2.3.1 Accounting for the Hedging Instrument in a Foreign Currency Fair Value Hedge

The subsequent measurement and timing of the recognition of a hedging instrument are not affected or altered upon its designation in a hedging relationship. Instead, the hedging instrument will continue to be measured in a consistent manner as if no hedge designation had been made, with the resulting gains and losses recognized through earnings, as follows:

Hedging Instrument	Subsequent Measurement	Basis for Valuing the Instrument
Derivative	Fair value in accordance with ASC 815, with changes in fair value recognized in earnings	Fair value (forward rate) — The fair value measurement principle focuses on changes in the market rates (e.g., often the forward exchange rates when the instrument matures at future dates) between the functional currency and the currency of the derivative.
Nonderivative	In accordance with ASC 830-20, with changes in measurement recognized in earnings	Spot rate — The measurement principle in accordance with ASC 830-20 focuses on changes in the spot exchange rates between the functional currency and the currency of the hedging instrument, which is not affected by hedge accounting, as noted in ASC 815-25-35-16.

In a manner consistent with the above discussion, a key feature that distinguishes a derivative from a nonderivative hedging instrument is the basis of subsequent measurement. Accordingly, an entity should consider the manner in which a hedging instrument is measured when determining its hedging strategy and how to designate the hedging relationship. For example, when using a nonderivative instrument as the hedging instrument in a foreign currency fair value hedging relationship, an entity cannot exclude any components of the nonderivative instrument from the assessment of effectiveness. In addition, an entity would be likely to choose to assess hedge effectiveness on the basis of changes in the hedged item’s fair value that are attributable to changes in the spot exchange rate because the hedging instrument is remeasured on the basis of changes in the spot exchange rate. All amounts recognized in earnings related to the change in the measurement of the hedging instrument and the hedged item are presented in the same income statement line item and should be related to the risk being hedged.

5.2.3.2 Accounting for the Hedged Item in a Foreign Currency Fair Value Hedge

As discussed in Chapter 3, in a qualifying fair value hedging relationship, the hedged item is remeasured for changes in its fair value that are attributable to the hedged risk. However, ASC 815-25-35-18 notes that if the hedged item is a foreign-currency-denominated asset or liability, hedge accounting does not override the requirement of ASC 830-20 to remeasure those assets and liabilities on the basis of foreign currency exchange spot rates “regardless of whether a fair value hedging relationship exists.” In other words, ASC 830-20 already provides guidance on how to translate foreign-currency-denominated assets and liabilities (i.e., remeasure on the basis of changes in the foreign currency spot exchange rate), so if a foreign-currency-denominated asset or liability is the hedged item in a foreign currency fair value hedge, no further adjustments to the carrying amount are needed for changes attributable to foreign currency risk as a result of hedge accounting. However, if a foreign-currency-denominated asset or liability is the hedged item in a qualifying fair value hedging relationship that is being hedged for changes in fair value attributable to risks other than foreign currency risk, the hedged item should be remeasured for changes in its fair value attributable to those other risks before being translated in accordance with ASC 830-20.

As with all qualifying fair value hedging relationships, the changes in the hedged item’s carrying amount that result from the application of hedge accounting are recorded currently in earnings and presented in the same income statement line item as the changes in the derivative’s fair value, which should be related to the risk being hedged. In some cases, if multiple risks are being hedged, this could result in the changes in the hedged item being recognized in multiple income statement line items.

Example 5-5

Remeasuring Foreign-Currency-Denominated Debt Hedged for Interest Rate Risk and Foreign Currency Risk

SimpleBand has a functional and reporting currency in USD. On January 1, it obtains a EUR 1 million fixed-rate debt facility and wants to hedge the risks arising from its foreign-currency-denominated fixed-rate debt facility in a fair value hedge. SimpleBand designates as the hedged risks the changes in fair value that are attributable both to (1) changes in the foreign currency exchange rate and (2) changes in the benchmark interest rate. Assume that the hedge qualifies for hedge accounting and the hedging relationship is highly effective.

Accordingly, when subsequently measuring the hedged item, SimpleBand would apply the following steps to determine the gains or losses to be recorded for each risk being hedged:

Step 1a — Determine the gain or loss attributable to the interest rate risk. The change in fair value attributable to changes in the benchmark interest rate of the foreign-currency-denominated debt facility is calculated in the facility’s contractual currency (the foreign currency).
Step 1b — The journal entry recorded for the gain or loss associated with the change in fair value attributable to changes in the benchmark interest rate is translated into SimpleBand’s functional currency by using the beginning-of-period foreign currency exchange spot rate.
Step 2 — Determine the transaction gain or loss associated with the ASC 830 remeasurement (the foreign currency exposure).

The above sequence of steps ensures that the hedged item’s fair value is first identified on the basis of its contractual currency (foreign currency fair value). Subsequently, the measurement principles of ASC 830-20 would be applied to isolate the effects of the changes in foreign currency spot exchange rates.

Assume the following USD/EUR exchange rates and fair values for SimpleBand’s foreign-currency-denominated fixed-rate debt facility at the beginning and end of the year:

SimpleBand records the following journal entries for the hedged item in the fair value hedging strategy:

December 31

Thus, SimpleBand recognizes the following:

By contrast, if no hedge accounting had been applied or if the hedged risk had been designated as being only related to changes in fair value attributable to changes in foreign currency exchange rates, the debt facility would have been carried at $1.1 million instead of at $1.045 million, reflecting a change of 0.10 in the spot rates on only the initial principal amount (EUR 1 million). The resulting gain of $100,000 differs from the gain of $95,000 associated with changes in the foreign exchange spot rate because the carrying amount of the debt was adjusted for changes in fair value attributable to changes in the benchmark interest rate before it was translated under ASC 830-20.

Therefore, while it is noted that the subsequent measurement principles of ASC 830-20 apply irrespective of whether the hedged item is designated in a hedging relationship, the recognized gains and losses associated with a change in the spot rate are affected by whether other risks are being hedged in addition to the foreign currency exposure since this will affect the balance on which the remeasurement principles of ASC 830-20 are applied.

5.2.3.2.1 AFS Debt Securities

As discussed in Section 3.2.6, if the hedged item in a qualifying fair value hedge is already measured at fair value, with changes in fair value reported in OCI, no additional remeasurement of the hedged item is required. However, once the item is designated in a qualifying hedge, the portion of the change in fair value that is attributable to changes in the designated risk is recognized in earnings instead of OCI. The change in the fair value of a foreign-currency-denominated AFS debt security, excluding the amount recorded in the allowance for credit losses under ASC 326-30, is reported in OCI in accordance with ASC 320-10-35-36. If an entity is hedging an AFS debt security for changes in its fair value attributable to changes in foreign currency exchange rates, the transaction gain or loss that otherwise would have been reported in OCI should be recognized in earnings for a qualifying hedging relationship. As noted in Section 5.2.2, an entity may only use a derivative instrument as the hedging instrument in a hedge of an AFS debt security.

5.2.3.2.2 Unrecognized Firm Commitments

As discussed in Section 5.2.2, an entity may use either a derivative instrument or a foreign-currency-denominated asset or liability as the hedging instrument in a foreign currency fair value hedge of an unrecognized firm commitment. Because firm commitments are not foreign-currency-denominated assets or liabilities that are subject to ASC 830-20, the guidance in ASC 815-20-35-18 that limits the remeasurement of the hedged item to being based only on changes in spot exchange rates is not applicable. Therefore, an entity may choose to determine the change in a firm commitment’s fair value attributable to changes in foreign currency exchange rates on the basis of either forward rates or spot rates, which will in turn affect how the entity (1) performs its hedge effectiveness assessments and (2) remeasures the firm commitment in periods in which the relationship qualifies for hedge accounting.

If an entity is using a nonderivative as the hedging instrument, it would be likely to hedge the firm commitment for changes in fair value that are attributable to changes in foreign currency exchange spot rates since that would be consistent with how the hedging instrument is remeasured under ASC 830-20. Such a hedge would produce the highest level of effectiveness and reduce potential income statement volatility because both the hedging instrument and the hedged item would be remeasured by using spot rates.

By contrast, if an entity is using a derivative as the hedging instrument, the remeasurement of the derivative will be based on forward rates. However, a savvy hedger would choose between the following two options, each of which could lead to a perfectly effective hedge if the critical terms of the derivative match the critical terms of the firm commitment:

Hedge the firm commitment for changes in fair value attributable to changes in the foreign currency forward exchange rate. Under this option, the entity would remeasure the firm commitment for changes in fair value attributable to changes in the forward rates, which would be consistent with how the derivative is remeasured. The basis adjustments to the firm commitment would offset the remeasurement of the derivative and be incorporated into the basis of the item being purchased or sold under the firm commitment.
Hedge the firm commitment for changes in fair value attributable to changes in the foreign currency spot exchange rate and exclude components of the derivative from the effectiveness assessment. Under this option, the entity would remeasure the firm commitment for changes in fair value that are attributable to changes in the spot rate. The initial fair value of the excluded component would be recognized in earnings over the life of the hedging relationship (either by using a systematic and rational method or as the fair value of the excluded component changes), while the change in the derivative’s fair value attributable to changes in spot rates would be recognized in earnings each period. In this case, the basis adjustments to the firm commitment that only reflect changes in the spot rate would be incorporated into the basis of the item being purchased or sold under the firm commitment.

See Example 5-6 for an illustration of a foreign currency fair value hedge of a firm commitment under both scenarios.

5.2.3.3 Income Statement Classification

As discussed in Section 3.1, all amounts recognized in earnings related to both the hedging instrument and the hedged item in a qualifying fair value hedging relationship are presented in the same income statement line item and should be related to the risk being hedged. This requirement can be more complicated for foreign currency fair value hedging relationships because the hedged item may be hedged for multiple risks (e.g., foreign currency risk and interest rate risk) and also because some entities use an after-tax hedging strategy (see Section 5.1.3).

ASC 815-20

Income Statement Presentation of Hedging Instruments

Scenario C

55-79AB Entity C designates a fair value hedge of interest rate risk and foreign currency risk in which the hedged item is a foreign-currency-denominated fixed-rate available-for-sale debt security. The derivative designated as the hedging instrument is a pay-fixed-rate (in foreign currency), receive-floating-rate (in functional currency) cross-currency interest rate swap. In this scenario, Entity C’s objective is to convert the interest cash flows of the fixed-rate security to floating-rate and also to convert the cash flows of the security (both interest cash flows and the principal cash flow) from a foreign currency to Entity C’s functional currency.

55-79AC The cross-currency interest rate swap is a highly effective hedge of both the interest rate risk and foreign currency risk of the available-for-sale debt security. Therefore, the change in fair value of the cross-currency interest rate swap should be presented in the same income statement line item or items used to present the earnings effect of the hedged item. Before applying hedge accounting, Entity C recognizes the earnings effect of the hedged item (that is, interest accruals on the available-for-sale debt security) in an interest income line item in the income statement and recognizes all other changes in fair value in other comprehensive income in accordance with paragraph 320-10-35-1(b). Entity C should present changes in fair value of the hedging instrument (that is, the interest accruals and all other changes in fair value) in the same income statement line item used to present the earnings effect of the hedged item. However, if Entity C’s policy is to present the effect of foreign exchange rate changes on the fair value of the security that are recognized in earnings after applying hedge accounting in accordance with paragraph 815-25-35-6 in a different income statement line item (consistent with its presentation policies when reflecting other foreign exchange rate changes), then the related changes in fair value of the hedging instrument also should be presented in that income statement line item.

55-79AD This scenario illustrates that a single hedging instrument (a cross-currency interest rate swap) may be highly effective at offsetting changes in fair values or cash flows associated with the hedged item in which the earnings effect of the hedged item is presented in more than one income statement line item. If a hedging instrument is highly effective at offsetting changes in fair values or cash flows of the hedged item and the earnings effect of the hedged item is presented in more than one income statement line item, then the earnings effects of the hedging instrument also should be presented in those corresponding income statement line item(s).

If an entity is hedging multiple risks, the earnings effects of the hedging instrument and the adjustments of the hedged item will need to be allocated on the basis of how much each of the hedged risks affect the changes in the measurement of the hedging instrument and hedged item. As noted in ASC 815-20-55-79AB through 55-79AD, an entity that is hedging a foreign-currency-denominated fixed-rate debt security for changes in its fair value attributable to both foreign currency risk and interest rate risk would need to report (1) the changes in measurement attributable to changes in the benchmark interest rate in interest income and (2) the changes in measurement attributable to changes in the foreign currency exchange rates in a separate line item. For example, if an entity reports gains or losses resulting from changes in the foreign exchange rates of its investments as investment gains or losses, the related changes in the measurement of the hedging instrument and hedged item attributable to changes in foreign currency risk should also be reported as investment gains or losses.

Similarly, if an entity is hedging foreign-currency-denominated fixed-rate debt for changes in its fair value that are attributable to both foreign currency risk and interest rate risk, the changes in the measurement of the hedging instrument and hedged item should be allocated to interest expense and transaction gains or losses.

In addition, as noted in ASC 815-25-35-7 and Section 5.1.3, if an entity is using an after-tax hedging strategy, “the portion of the gain or loss on the hedging instrument that exceeded the loss or gain on the hedged item shall be included as an offset to the related tax effects in the period in which those tax effects are recognized.”

5.2.4 Illustrative Examples

Example 5-6

Foreign Currency Fair Value Hedge of Firm Commitment

Golden Age is a premium gold watch manufacturer with a USD functional currency. On July 1, 20X1, Golden Age enters into a firm commitment to purchase 1,000 ounces of gold from a European gold supplier on December 30, 20X1, for EUR 1,151 per ounce. Golden Age separately enters into a forward contract to purchase EUR 1,151,000 for USD 1,407,213 on December 30, 20X1, as a hedge of the changes in the fair value of its firm commitment to purchase gold that are attributable to changes in the EUR/USD exchange rate. The table below shows (1) the EUR/USD exchange rates (spot and forward) and (2) the fair values of the forward contract as of July 1, September 30, and December 30, 20X1.

The examples below illustrate the difference between (1) designating the hedged risk as changes in the forward exchange rate (Method 1) and (2) designating the hedged risk as changes in the spot exchange rate, with the excluded component recognized in earnings, by using a systematic and rational amortization method (Method 2).

Method 1 — Forward Rate

Golden Age designates the forward contract as a hedge of the changes in the firm commitment’s fair value that are attributable to changes in the EUR/USD forward exchange rate. The journal entries are as follows:

July 1, 20X1

No entry is required. The forward contract was entered into at market (i.e., a fair value of zero), and the firm commitment was entered into for no consideration.

September 30, 20X1

December 30, 20X1

Method 2 — Spot Rate With Forward Points Excluded From Assessment

Golden Age designates the forward contract as a hedge of the changes in the firm commitment’s fair value that are attributable to changes in the EUR/USD spot exchange rate. It excludes the forward points in the forward contract from the hedge effectiveness assessment and will recognize the forward points’ initial fair value in earnings by using a systematic and rational amortization method.

The initial fair value of the excluded component is calculated below.

The forward contract has a term of six months. As a result of using the systematic and rational amortization method, Golden Age will recognize $3,223 of the initial fair value in earnings each quarter (as an expense).

The journal entries are as follows:

July 1, 20X1

No entry is required. The forward contract was entered into at market (i.e., a fair value of zero) and the firm commitment was entered into for no consideration.

September 30, 20X1

December 30, 20X1

Example 5-7

Fixed-for-Fixed Cross-Currency Interest Rate Swap Hedging Fixed-Rate Debt Denominated in Foreign Currency

Orcas Worldwide, an entity with a USD functional currency, wishes to hedge its exposure to changes in its SEK 50 million foreign-currency-denominated fixed-rate debt attributable to changes in the USD/SEK foreign currency exchange rate. The debt was issued on March 5, 20X6, with interest payable quarterly (on the last day of each calendar quarter) at a rate of 1.75 percent per year. Principal is payable at maturity (September 30, 20X7), and the debt is not prepayable. On March 5, 20X6, Orcas enters into a fixed-for-fixed cross-currency interest rate swap to hedge that risk. The terms of the cross-currency interest rate swap are as follows:

Pay leg — USD 55,025,000 notional at a rate of 3.4 percent per annum.
Receive leg — SEK 50 million notional at a rate of 1.75 percent per annum.
Quarterly periodic settlements beginning March 31, 20X6.
Initial exchange — Orcas pays SEK 50 million and receives USD 55,025,000.
Final exchange — Orcas pays USD 55,025,000 and receives SEK 50 million.
Maturity date — September 30, 20X7.

Orcas designates the cross-currency interest rate swap as a hedge of SEK 50 million of changes in the fair value of the fixed-rate foreign-currency-denominated debt attributable to changes in the USD/SEK foreign currency exchange rate and designates the cross-currency interest rate swap as hedging changes in the swap’s fair value attributable to changes in the USD/SEK spot exchange rate. Orcas assesses the effectiveness of the hedging relationship by comparing (1) the changes in the swap’s fair value (excluding the changes in fair value attributable to changes in the cross-currency basis spread) with (2) the changes in debt’s fair value that are attributable to changes in the spot USD/SEK exchange rate. Because the swap is an at-market swap with standard terms, there are no excluded components to recognize in earnings separately from the periodic settlements. Orcas may assume that the hedge is perfectly effective under ASC 815-20-25-84 and 25-85 because:

The two currencies underlying the exchange rate of the swap match the functional currency of Orcas (USD) and the currency in which the debt is denominated (SEK).
The notional amount of the foreign currency leg of the swap (SEK) matches the principal amount of the debt through the term of the hedge (maturity of the debt).
The maturity date of the swap matches the maturity date of the debt (i.e., the date the last hedged cash flow is due and payable).
The fair value of the swap at hedge inception is zero and the swap has standard terms.
The cross-currency basis spread is excluded from the assessment of hedge effectiveness.

For this example, assume that the critical terms of the debt and the cross-currency swap match for the duration of both instruments.

Below is a table of key assumptions.

Orcas would record the following journal entries for each reporting period to account for the hedge and the translation of its foreign-currency-denominated fixed-rate debt:

March 31, 20X6

Translation of the foreign-currency-denominated debt is not required because the spot rate has not changed.

June 30, 20X6

September 30, 20X6

December 31, 20X6

March 31, 20X7

June 30, 20X7

September 30, 20X7

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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.