7.4 Transition Provisions

Entities adopt the provisions of ASU 2017-12 by applying a modified retrospective approach to existing hedging relationships2 as of the adoption date. Under this approach, entities with cash flow or net investment hedges make (1) a cumulative-effect adjustment to AOCI so that the adjusted amount represents the cumulative change in the hedging instruments’ fair value since hedge inception (less any amounts that should have been recognized in earnings under the new accounting model) and (2) a corresponding adjustment to opening retained earnings as of the most recent period presented on the date of adoption.

7.4.1 Transition Elections

ASU 2017-12 provides the following transition elections, which may be applied individually or in any combination:

Transition elections for all hedges that exist on the date of adoption:
- An entity may modify the recognition model for excluded components from a mark-to-market approach to the amortization approach without having to dedesignate the hedging relationship by making (1) a cumulative-effect adjustment to AOCI and (2) a corresponding adjustment to opening retained earnings as of the initial application date.
- An entity may modify hedge documentation without dedesignating those hedges to specify the following:
  - That subsequent prospective and retrospective hedge effectiveness assessments will be performed qualitatively.
  - For hedging relationships for which the entity uses the shortcut method, the quantitative method that the entity will use to perform assessments of effectiveness if it determines at a later date that use of the shortcut method was not or no longer is appropriate.
Transition elections for fair value hedges that exist on the date of adoption:
- For fair value hedges of interest rate risk, an entity may elect to apply the revised measurement methods related to (1) using the benchmark rate component of contractual coupon cash flows to measure changes in the hedged item’s fair value that are attributable to changes in the benchmark interest rate or (2) considering only changes in benchmark interest rates in calculating prepayable financial instruments’ change in fair value that is attributable to interest rate risk. When making this election, which does not require dedesignation of the hedging relationship, an entity should:
  - Adjust the amount of any existing cumulative basis adjustment to what it would have been as of the adoption date had the entity applied the revised measurement method throughout the life of the hedging relationship and make a corresponding adjustment to the opening balance of retained earnings as of the initial application date.
  - Determine the benchmark rate component of the contractual coupon cash flows as of the hedging relationship’s original inception date.
- An entity that elects to revise its measurement method to use the benchmark rate component of the contractual coupon cash flows also may elect to rebalance the hedging relationship by increasing or decreasing the designated notional amount of the hedging instrument or designated proportion of the hedged item. An entity may not add a new hedging instrument or hedged item to an existing relationship without dedesignating the existing relationship and redesignating a new hedging relationship. If an entity changes the designated proportion of the hedged item, the cumulative effect of changing the designated portion of the hedged item should be recognized as the related basis adjustment to the opening balance of retained earnings as of the initial application date.
- An entity that uses cross-currency swaps to fair value hedge foreign exchange risk may, without dedesignating the hedging relationship, modify its hedge documentation to exclude the cross-currency basis spread component of the currency swap from its assessment of hedge effectiveness and recognize that excluded component through an amortization approach. The entity should adjust AOCI for the cumulative effect of applying this election as if it has been applied since the inception of the hedging relationship and make a corresponding adjustment to opening retained earnings as of the initial application date.
- For existing fair value hedges in which the hedged item is a tax-exempt financial instrument, the hedged risk may be modified to changes in fair value attributable to the SIFMA Municipal Swap Rate. This modification would be considered a dedesignation and immediate redesignation. The cumulative basis adjustment from the dedesignated hedging relationship should be amortized to earnings on a level-yield basis over a period based on the applicable GAAP for that financial instrument.
Transition elections for cash flow hedges that exist on the date of adoption:
- For cash flow hedging relationships in which an entity previously used a quantitative method to assess effectiveness, the entity may apply the critical-terms-match method (see Section 2.5.2.2.2) prospectively without having to dedesignate the hedge.
- For cash flow hedges (1) in which the entity previously designated as the hedged risk the variability in total cash flows and (2) that now qualify for designation of the variability in cash flows attributable to changes in a contractually specified component or interest rate as the hedged risk, the entity may:
  - Modify the hedging relationship documentation to designate the variability in the contractually specified component or contractually specified interest rate as the hedged risk, without having to dedesignate the hedge.
  - Establish the terms of the instrument that it uses to estimate changes in the value of the hedged risk (under either the hypothetical derivative method or another acceptable method) in its hedge effectiveness assessment on the basis of market data as of the inception of the hedging relationship.
  - Consider any hedging relationship ineffectiveness previously recognized as part of the transition adjustment for cash flow hedges.
Additional transition election:
- An entity may reclassify a debt security from HTM to AFS if the debt security is eligible to be hedged under the last-of-layer method. Any unrealized gain or loss on the transfer date should be recorded in AOCI in accordance with ASC 320-10-35-10(c).
- Any reclassification, in and of itself, would not:
  - Call into question the entity’s assertion on the most recent reporting date that it had the intent and ability to hold to maturity those debt securities that continue to be classified as HTM.
  - Require the entity to designate the reclassified security in a last-of-layer hedging relationship.
  - Restrict the entity from selling the reclassified security.

Private companies that are not financial institutions as well as not-for-profit entities (except those that have issued, or are a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an OTC market) must make the transition elections before their next set of interim (if applicable) or annual financial statements is available to be issued. All other entities must make the elections before the first effectiveness testing date after adoption.

7.4.1.1 Exception to Similar Methods of Assessment for Similar Hedges

With respect to the transition elections to (1) amend shortcut method hedge documentation, (2) change the designated hedged risk to the variability in cash flows attributable to changes in a contractually specified component or a contractually specified interest rate, and (3) apply the amortization approach to recognized excluded components, an entity is not required to apply the guidance in ASC 815-20-25-81, which states, in part, that “[o]rdinarily, an entity shall assess effectiveness for similar hedges in a similar manner, including whether a component of the gain or loss on a derivative instrument is excluded in assessing effectiveness for similar hedges.” Therefore, an entity may treat postadoption hedging relationships differently than it treats similar preadoption hedging relationships.

7.4.2 Presentation and Disclosures

In each annual and interim reporting period in the fiscal year of adoption, entities will also be required to provide certain disclosures required by ASC 250 about (1) the nature and reason for the change in accounting principle and (2) the cumulative effect of the change on the opening balance of affected components of equity or net assets as of the date of adoption.

In all interim periods and fiscal years ending after the date of adoption, entities should prospectively (1) present the entire change in the fair value of a hedging instrument in the same income statement line item(s) as the earnings effect of the hedged item when that hedged item affects earnings (other than amounts excluded from the assessment of net investment hedge effectiveness, for which ASU 2017-12 does not prescribe presentation) and (2) provide the amended disclosures required by the new guidance (see Section 6.6).

Footnotes

This refers to hedging relationships in which “the hedging instrument has not expired, been sold, terminated, or exercised” and that have not been dedesignated by the entity as of the date of adoption.

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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.