7.2 Summary of Significant Changes to Accounting and Reporting

ASU 2017-12 made a number of changes to the hedge accounting model in ASC 815. Many of these changes are discussed in earlier chapters. Key changes that altered the accounting for and reporting of qualifying hedging relationships are summarized below.

7.2.1 Elimination of the Concept of Separately Recognizing Periodic Hedge Ineffectiveness

ASU 2017-12 eliminated the concept of separately recognizing periodic hedge ineffectiveness for cash flow and net investment hedges (however, under the mechanics of fair value hedging, economic ineffectiveness is still reflected in current earnings for those hedges). The Board believed that requiring an entity to record the impact of both the effective and ineffective components of a hedging relationship in the same financial reporting period and in the same income statement line item makes that entity’s risk management activities and their effect on the financial statements more transparent to financial statement users. See Section 6.3 for a more thorough discussion of the presentation of hedge accounting results in the income statement.

7.2.2 Recognition and Presentation — Components Excluded From the Hedge Effectiveness Assessment

ASU 2017-12 continues to allow an entity to exclude the time value of options, or portions thereof, and forward points from the assessment of hedge effectiveness. It also permits an entity to exclude the change in the fair value of cross-currency basis spreads in currency swaps from the effectiveness assessment.

As noted in Section 2.5.2.1.2.1, for excluded components in fair value, cash flow, and net investment hedges, the base recognition model under ASU 2017-12 is an amortization approach. Although an entity will no longer be required to record changes in the fair value of the excluded component currently in earnings, it may elect to do so under the ASU. However, such an election will need to be applied consistently to similar hedges.

ASU 2017-12 also requires that when the excluded components are recognized in earnings, those amounts are recognized in the same income statement line item as the change in fair value of the hedging instrument that is included in the hedge effectiveness assessment, except for net investment hedging (see Section 6.3.1.2).

7.2.3 Amendments to Benchmark Interest Rates and the Definition of Interest Rate Risk

Previously, U.S. GAAP defined “interest rate risk” for both fair value and cash flow hedges as the “risk of changes in a hedged item’s fair value or cash flows attributable to changes in the designated benchmark interest rate.” ASU 2017-12 redefined “interest rate risk” as follows:

For recognized variable-rate financial instruments and forecasted issuances or purchases of variable-rate financial instruments, interest rate risk is the risk of changes in the hedged item’s cash flows attributable to changes in the contractually specified interest rate in the agreement.

For recognized fixed-rate financial instruments, interest rate risk is the risk of changes in the hedged item’s fair value attributable to changes in the designated benchmark interest rate. For forecasted issuances or purchases of fixed-rate financial instruments, interest rate risk is the risk of changes in the hedged item’s cash flows attributable to changes in the designated benchmark interest rate.

Thus, ASU 2017-12 eliminated the benchmark interest rate concept for variable-rate financial instruments but retained it for fixed-rate financial instruments.

As indicated in the revised definition of interest rate risk, in cash flow hedges of interest rate risk associated with forecasted issuances or purchases of debt, the nature of the hedged risk will depend on the characteristics of the forecasted transaction. An entity that expects to issue or purchase fixed-rate debt would hedge the variability in cash flows associated with changes in the benchmark interest rate; for a forecasted issuance or purchase of variable-rate debt, the entity would hedge the variability in cash flows associated with changes in the contractually specified rate. If the entity is unsure about the nature of its forecasted transaction, it would designate as the hedged risk the variability in cash flows attributable to a change in a rate that would qualify both as a benchmark interest rate (if the forecasted transaction ultimately was fixed rate) and as a contractually specified rate (if the forecasted transaction ultimately was variable rate).

As discussed in Section 2.3.1.1, ASU 2017-12 also added the SIFMA Municipal Swap Rate to those benchmark interest rates already permitted under preadoption guidance to make it easier for entities to hedge interest rate risk for fixed-rate tax-exempt financial instruments.

7.2.4 Fair Value Hedges of Interest Rate Risk

ASU 2017-12 simplified fair value hedges of interest rate risk by adding the following:

The ability to determine the change in the hedged item’s fair value that is attributable to changes in the benchmark interest rate by using only the benchmark interest rate component of coupon cash flows (see Section 3.2.1).
The ability to consider only how changes in the benchmark interest rate affect the decision to settle the hedged item before its scheduled maturity when calculating the change in the hedged item’s fair value that is attributable to interest rate risk (see Section 3.2.1.2).
Partial-term hedging, which is the ability to measure the change in the hedged item’s fair value that is attributable to changes in the benchmark interest rate by “using an assumed term that begins when the first hedged cash flow begins to accrue and ends when the last hedged cash flow is due and payable.” Because the hedged item’s assumed maturity will be the date on which the last hedged cash flow is due and payable, a principal payment will be assumed to occur at the end of the specified partial term (see Section 3.2.1.1).
A “last-of-layer method” that enables an entity to apply fair value hedging to closed portfolios of prepayable assets without having to consider prepayment risk or credit risk when measuring those assets. An entity can also apply the method to one or more beneficial interests (e.g., an MBS) secured by a portfolio of prepayable financial instruments (see Section 3.2.1.4).

7.2.5 Contractually Specified Components of Nonfinancial Assets

As discussed in Section 2.3.2.1, ASU 2017-12 added the ability for entities to hedge the risk of changes to a contractually specified component of the price of a forecasted purchase or sale of a nonfinancial asset. The ASU defines a contractually specified component as “[a]n index or price explicitly referenced in an agreement to purchase or sell a nonfinancial asset other than an index or price calculated or measured solely by reference to an entity’s own operations.”

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