8.3 Summary of ASU 2021-01
As briefly discussed in Section 8.1, the FASB issued ASU 2021-01 in
January 2021 to expand the scope of ASC 848 in response to discounting transition
activities in the marketplace. The optional amendments in ASU 2021-01 are effective for
all entities as of March 12, 2020, through December 31, 2024.16 See Section 8.3.6 for
more information on the ASU’s effective and expiration dates.
8.3.1 Scope of ASC 848 (ASC 848-10)
The FASB acknowledges that not all derivative contracts subject to the discounting
transition reference LIBOR or other interbank offered rates that are expected to be
discontinued. For example, the discounting transition will affect derivative
contracts that currently reference and will continue to reference other interest
rates (e.g., EFFR, SOFR, the SIFMA Municipal Swap Rate). However, the scope of ASC
848 established by ASU 2020-04 does not include such contracts. As stated in
paragraph BC10 of ASU 2021-01, ASC 848 was intended to provide relief related to
“contracts and transactions that reference LIBOR or a reference rate that is
expected to be discontinued as a result of reference rate reform.” Accordingly, ASU
2021-01 expands the scope of ASC 848 to include all affected derivatives and to
enable market participants to apply certain aspects of the contract modification and
hedge accounting expedients to derivative contracts affected by the discounting
transition.
In addition, ASU 2021-01 adds implementation guidance (codified in ASC 848-10-55-1)
to clarify which optional expedients in ASC 848 may be applied to derivative
instruments that do not reference LIBOR or a reference rate that is expected to be
discontinued, but that are being modified as a result of the discounting transition.
The ASU presents that implementation guidance in a table, which is reproduced
below.
Codification Subtopic
|
Provisions That Apply to Derivatives That Meet the Scope of
Paragraph 848-10-15-3A
|
---|---|
848-20
|
|
848-30
|
|
848-40
|
|
848-50
|
|
8.3.2 Contract Modifications (ASC 848-20)
As originally issued, the guidance in ASC 848-20-35-1 indicated that an entity that
elects to use a contract modification expedient under a particular Codification
topic, subtopic, or industry subtopic must apply the expedient to all contract
modifications accounted for under that guidance. ASU 2021-01 amends that guidance to
state that the election to apply the contract modification expedients to the
modifications related to the discounting transition is separate from the election to
apply the contract modification expedients to modifications related to broader
reference rate reform activities. In addition, the ASU clarifies that if an entity
elects to apply the contract modification expedients in ASC 848 to modifications
resulting from the discounting transition, it must apply those expedients to all
discounting transition modifications.
Connecting the Dots
ASC 848-20-35-4 and ASC 848-20-55-2 can be applied to derivative contracts
affected by the discounting transition. That is, an entity can conclude that
a contract previously determined to be a derivative in accordance with ASC
815 continues to meet the definition of a derivative and not a hybrid
instrument in situations in which the terms of the contract change as a
result of the discounting transition. Further, in accordance with ASC
815-10-45-11 through 45-15, an entity does not need to reassess whether the
contract includes a financing element.
8.3.3 Hedging — General (ASC 848-30)
ASU 2021-01 permits an entity to elect certain hedging relief if it
has designated a derivative as a hedging instrument in a hedging relationship and
the terms of the derivative (e.g., discount rate) have changed as a result of the
discounting transition.
Connecting the Dots
In situations in which a derivative is designated as a
hedging instrument in a hedging relationship and the interest rate used for
discounting cash flows to calculate variation margin settlements and PAI has
changed as a result of the discounting transition, questions have arisen
about whether the change was made to critical terms of the hedging
relationship. ASU 2021-01 clarifies that ASC 848-30-25-7 continues to apply
to the affected derivative; that is, a change in the interest rate as a
result of the discounting transition would not be considered a change to the
critical terms of a hedging relationship. An entity can continue to apply
hedge accounting without dedesignating the existing hedging relationship;
see ASC 848-10-55-1 (added by the ASU).
A cash settlement (or equivalent) may be exchanged to neutralize the change in the
fair value of a derivative affected by the discounting transition. If such a
derivative is designated as a hedging instrument in a cash flow hedging
relationship, that cash settlement may create a mismatch between the fair value of
the hedging instrument and the amount deferred in AOCI.
Under ASU 2021-01, an entity that assesses the effectiveness of a cash flow hedging
relationship by using a method that allows an assumption of perfect hedge
effectiveness is permitted to elect the relevant optional expedients and
subsequently apply the original effectiveness assessment method under which it
continues to assume that the hedge is perfectly effective after the discounting
transition. Alternatively, the entity can elect to change to any applicable
quantitative method of assessing the effectiveness of a cash flow hedge in ASC
815-20 and ASC 815-30 without dedesignating the hedging relationship. The ASU
requires an entity that originally applied a quantitative or qualitative method in
accordance with ASC 815-20 and ASC 815-30 to continue to apply the same method when
performing its subsequent effectiveness assessment of a cash flow hedging
relationship that was affected by the discounting transition.
In addition, for all cash flow hedging relationships affected by the discounting
transition, an entity can use a reasonable approach to adjust the amount recorded in
AOCI for the cash settlement (or equivalent) as a result of the discounting
transition. Any adjustment to AOCI would be recognized in the income statement in
the same manner as other reclassifications out of AOCI related to the hedging
relationship.
Connecting the Dots
ASC 848 does not specify the method an entity should use to adjust the amount
in AOCI for the cash settlement (or equivalent) as a result of the
discounting transition; rather, the guidance only requires the use of a
reasonable method. However, an entity should apply its elected method
consistently to similar hedges. An entity that does not elect to adjust the
amount recorded in AOCI as a result of the discounting transition should
ensure that this amount is reclassified into earnings when the hedged
transaction affects earnings or when it is probable that the hedged
transaction will no longer occur.
In fair value hedging relationships for which the shortcut method is used, a receipt
or payment of a cash settlement (or equivalent) as a result of the discounting
transition may also cause a mismatch in the cumulative change in the fair value of
the hedging instrument (e.g., an interest rate swap) and the cumulative-basis
adjustments applied to the hedged item (e.g., fixed-rate debt hedged for changes in
fair value because of changes in LIBOR). That is, the cumulative-basis adjustments
will not be naturally unwound as settlements occur on the hedging instrument. ASU
2021-01 addresses this issue by adding an optional expedient that permits an entity
to use a reasonable approach to adjust the cumulative-basis adjustment for the
amount equal to the fair value change in the hedging instrument (i.e., a cash
settlement or equivalent) as a result of the discounting transition. An entity could
also elect, as an optional expedient, to continue to apply the shortcut method when
assessing the effectiveness of the hedging relationship affected by the discounting
transition.
As originally issued, the guidance in ASC 848-30-25-9 provided that an entity may
combine two or more derivative instruments, or proportions of those instruments, to
be jointly designated as the hedging instrument in a hedging relationship without
dedesignating the hedging relationship in response to reference rate reform. ASU
2021-01 adds a provision to ASC 848-30-25-9(b) that allows an entity to subsequently
remove one or more, or proportions of, those derivatives without dedesignating the
hedging relationship. Further, the ASU adds that an entity that applies any of the
expedients in ASC 848 that allow an entity to assume perfect effectiveness may
disregard any condition that prohibits more than one derivative from being
designated as the hedging instrument.
In net investment hedging relationships involving receive-variable-rate,
pay-variable-rate cross-currency interest rate swaps that reference a rate within
the scope of ASC 848-10-15-3, an entity is not required to dedesignate the hedging
relationship if the index of one leg of the swap changes as a result of reference
rate reform. In that case, an entity may also disregard the condition in ASC
815-20-25-67(a)(2) that both legs of the swap have the same repricing intervals and
dates until (1) neither of the variable legs of the cross-currency interest rate
swap designated references a rate within the scope of ASC 848-10-15-3 or (2) the
guidance in ASC 848 is no longer applicable (e.g., when the provisions sunset).
Connecting the Dots
The optional expedient allowing the terms of a receive-variable-rate,
pay-variable-rate cross-currency interest rate swap that is the designated
hedging instrument in a net investment hedge to be modified as a result of
reference rate reform without requiring a dedesignation of the hedging
relationship is not directly related to the discounting transition. However,
the FASB decided to amend ASC 848 to clarify its intent regarding the impact
of reference rate reform on such derivatives on the basis of feedback
received from constituents since the issuance of ASU 2020-04.
8.3.4 Fair Value Hedges (ASC 848-40)
ASU 2021-01 provides that if a designated derivative is affected by the discounting
transition, an entity is allowed to change the designated benchmark interest rate
and the component of cash flows designated as the hedged item in a fair value
hedging relationship without dedesignating the hedging relationship.
As discussed above, the ASU allows an entity to continue to apply
the shortcut method when subsequently assessing the effectiveness of a fair value
hedging relationship affected by the discounting transition. This optional expedient
will be available for the remainder of the original hedging relationship, including
periods after December 31, 2024.17 However, if an entity also elects the expedient that permits it to add one or
more, or proportions of, derivatives to an existing hedging relationship for which
the shortcut method is applied, the entity cannot continue to apply the shortcut
method after December 31, 2024.18 That is, the entity must cease the application of the shortcut method after
December 31, 2024,19 and change to another effectiveness assessment method in ASC 815-20 and ASC
815-25.
Connecting the Dots
The election to apply any of the expedients discussed would not result in
dedesignation of the existing fair value hedging relationship, but the
entity would be required to update the hedge documentation to identify the
elections.
8.3.5 Cash Flow Hedges (ASC 848-50)
ASU 2021-01 provides that if a derivative affected by the discounting transition was
designated in a cash flow hedging relationship through the use of a hedge
effectiveness method under which perfect effectiveness was assumed, an entity may do
either of the following:
-
Apply the corresponding optional expedient to assume perfect effectiveness in accordance with the expedients previously provided by ASU 2020-04.
-
Change its effectiveness approach to a quantitative method in accordance with ASC 815-20 and 815-30.
Regardless of which alternative it selects, an entity can make its election without
dedesignating the hedging relationship.
In addition, ASU 2021-01 amends ASC 848-50-25-3 to allow an entity to change the
designated benchmark interest rate for any cash flow hedging relationship involving
the forecasted issuance or purchase of a fixed-rate debt instrument in which (1) the
designated hedged risk is variability in cash flows attributable to changes in the
benchmark rate and (2) the hedging instrument is affected by reference rate reform
in accordance with ASC 848-10-15-3 (i.e., the hedging instrument references LIBOR or
a reference rate that is expected to be discontinued as a result of reference rate
reform).
8.3.6 Effective Date and Transition
The amendments in ASU 2021-01 are
effective for all entities as follows:
Type of Expedient
|
Effective Date and Expiration Date
|
---|---|
Contract modifications
|
Entities should use either of the following approaches to
apply the amendments to modifications to the terms of the
derivatives affected by the discounting transition:
|
Hedging relationships20
|
Entities should apply the amendments to either of the
following types of eligible hedging relationships affected
by the discounting transition:
|
The amendments do not apply to (1) contract modifications made or
new hedging relationships entered into after December 31, 2024,21 or (2) existing hedging relationships evaluated for periods after December 31,
2024,22 unless an entity elects to apply certain optional expedients that permit the
accounting effects to be retained through the end of the hedging relationships that
extend beyond December 31, 2024. Under those optional expedients, an entity
would:
-
Use a reasonable approach to modify the basis adjustment in a fair value hedge accounted for under the shortcut method.
-
No longer periodically evaluate the conditions in ASC 815-20-25-104(d) and (g) when using the shortcut method for a fair value hedge. However, the entity’s application of the shortcut method would cease after December 31, 2024,23 if the entity elects the optional expedient to add one or more, or a proportion of, basis swaps to a fair value hedging relationship as a result of the discounting transition.
-
Use a reasonable approach to adjust the amount recorded in AOCI for a cash flow hedge affected by a receipt or payment of a cash settlement (or equivalent) as a result of the discounting transition.
-
Continue to use a subsequent assessment method under which perfect effectiveness is assumed in accordance with ASC 848-50-35-4 through 35-9 for a cash flow hedge if the entity elected the practical expedient that permits it to use a reasonable approach to adjust the amount recorded in AOCI as a result of the discounting transition.
Connecting the Dots
Under ASU 2021-01, any private company that has not yet adopted ASU 2017-12
is only allowed to elect the expedient permitting it to change the method
designated for use in assessing the effectiveness of a hedging relationship
if it elects the optional expedient under which it may apply “the simplified
hedge accounting approach for eligible private companies for subsequent
hedge effectiveness in paragraph 848-50-35-7” after the discounting
transition.
Footnotes
16
See footnote 2.
17
See footnote 2.
18
See footnote 2.
19
See footnote 2.
20
Under ASU 2021-01, if an entity
adopts any of the amendments related to a hedging
relationship and the entity is either (1) a private
company that is not a financial institution as
described in ASC 942-320-50-1 or (2) a
not-for-profit entity (other than a not-for-profit
entity that has issued, or is a conduit bond obligor
for, securities that are traded, listed, or quoted
on an exchange or an OTC market), the entity is
required to update its hedge documentation before
the next interim (if applicable) or annual financial
statements are available to be issued. All other
entities that adopt any such amendments are required
to update their hedge documentation no later than
when those entities perform the first quarterly
hedge effectiveness assessment after making any
elections in the ASU for that hedging
relationship.
21
See footnote 2.
22
See footnote 2.
23
See footnote 2.