14.2 Accounting
14.2.1 Hedge Accounting
14.2.1.1 General
This section discusses how the accounting for debt might be affected by the
application of hedge accounting.
14.2.1.2 Debt Designated as Hedged Item in Fair Value Hedge
When the qualifying criteria for hedge accounting are met,
ASC 815-20-25-12 permits an entity to designate debt (such as fixed-rate
debt) as a hedged item in a fair value hedge. Under ASC 815-20-25-12(f), the
debtor is permitted to designate the hedged risk as the risk of changes in
(1) the debt’s fair value in its entirety or (2) the portion of the debt’s
fair value attributable to changes in (a) a designated benchmark interest
rate (interest rate risk), (b) foreign currency exchange rates (foreign
exchange risk), or (c) changes in credit risk (such as the credit spread
over the benchmark interest rate). Under ASC 815-20-25-12(b), a debtor is
permitted to designate a portfolio of similar liabilities, a percentage of
an entire liability, or the contractual cash flows of one or more liability
as the hedged item (e.g., a partial-term interest rate risk hedge of the
first 5 years of 10-year debt by using an assumed term for the debt that
matches the hedged payments; see ASC 815-25-35-13B). Further, a debtor is
permitted to designate a benchmark rate component of the contractual cash
flows determined at hedge inception as the hedged item in an interest rate
risk hedge of debt (ASC 815-25-35-13). However, a debtor cannot designate a
fair value hedge related to a risk of changes in the debt’s fair value that
is recognized in earnings, such as interest rate risk related to debt for
which the fair value option in ASC 815-15 or ASC 825-10 has been elected or
foreign exchange risk related to foreign-denominated debt that is remeasured
at spot rates under ASC 830-20 (ASC 815-20-25-43(c)(3)).
When fair value hedge accounting is applied, the change in the debt’s fair
value attributable to the hedged risk is recognized as an adjustment to the
debt’s carrying amount, with an offsetting entry to earnings (ASC
815-25-35-1(b)). Except for excluded components, which are amortized to
earnings, gains and losses on the hedging instrument are recognized
immediately in earnings (ASC 815-25-35-1(a)). All amounts recognized in
earnings are presented in the same line item as the earnings effect of the
hedged item (e.g., interest expense). An adjustment to the debt’s carrying
amount is amortized to interest expense and must begin no later than the
debt ceases to be adjusted for changes in its fair value attributable to the
hedged risk (ASC 815-25-35-9). When a debtor uses a pay-variable,
receive-fixed interest rate swap to hedge debt and the conditions for the
shortcut method are met (see ASC 815-20-25-104 and 25-105), the change in
fair value of the hedged debt attributable to the risk being hedged does not
need to be directly measured. Instead, the change in the fair value of the
derivative hedging instrument adjusts the carrying amount of the hedged
debt, and interest expense is recognized on the basis of the variable rate
of the swap, adjusted for any difference between the fixed rate on the swap
and that on the hedged debt (ASC 815-25-55-43).
Fair value hedge accounting must be discontinued prospectively if the hedging
relationship no longer meets the criteria for fair value hedge accounting
(e.g., the hedge is no longer expected to be highly effective), the debtor
dedesignates the hedge, or the derivative expires or is sold, terminated
(except for certain novations), or exercised (ASC 815-25-40-1).
14.2.1.3 Debt Designated as Hedged Item in Cash Flow Hedge
When the qualifying criteria for hedge accounting are met,
an entity is permitted to designate probable variable cash flows associated
with existing debt (such as variable-rate debt or foreign-denominated
fixed-rate debt) or a probable forecasted purchase or issuance of debt (or
probable interest payments on such debt) as a hedged item in a cash flow
hedge. ASC 815-20-25-15(j) permits the debtor to designate the hedged risk
as the risk of changes in (1) overall changes in the hedged cash flows, (2)
forecasted variable-rate interest payments associated with existing debt and
attributable to changes in a contractually specified interest rate (interest
rate risk), (3) forecasted cash flows associated with the forecasted
issuance of debt (or the forecasted interest payments) and attributable to
changes in a benchmark interest rate or an expected contractually specified
interest rate, (4) the functional-currency-equivalent cash flows
attributable to changes in the related foreign currency exchange rate
(foreign exchange risk), or (5) the risk of changes in cash flows
attributable to credit risk (e.g., changes in the credit spread over the
contractually specified interest rate or the benchmark interest rate).
However, a debtor cannot designate a cash flow hedge related to existing
debt or the forecasted issuance of debt if the debt is remeasured, with
changes in fair value attributable to the hedged risk recognized in
earnings, such as foreign exchange risk related to foreign-denominated debt
that is remeasured at spot rates under ASC 830-20.
When cash flow hedge accounting is applied, the accounting
for the hedged item is not altered. Instead, gains and losses on the hedging
instrument related to the hedged risk are recognized in OCI and reclassified
to earnings in the same period or periods during which the hedged forecasted
transaction affects earnings. That reclassification and the amount
recognized in earnings for any excluded components are presented in the same
income statement line item as the earnings effect of the hedged item (e.g.,
interest expense).
Cash flow hedge accounting must be discontinued
prospectively if the hedging relationship no longer meets the criteria for
cash flow hedge accounting (e.g., the hedge is no longer expected to be
highly effective), the debtor dedesignates the hedge, or the derivative
expires or is sold, terminated (except for certain novations), or exercised
(ASC 815-30-40-1). However, in accordance with ASC 815-30-40-4, the amount
in AOCI related to a discontinued hedge is not reclassified to earnings
unless both (1) “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” and (2) no rare, “extenuating circumstances that
are related to the nature of the forecasted transaction and are outside the
control or influence of the reporting entity . . . cause the forecasted
transaction to be probable of occurring on a date that is beyond the
additional two-month period of time.” Further, under ASC 815-30-40-5, “[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.”
14.2.1.4 Debt Designated as Hedging Instrument in Foreign Currency Fair Value Hedge of a Firm Commitment
When the qualifying criteria for hedge accounting are met,
ASC 815-20-25-58 permits an entity to designate foreign-denominated debt as
a hedging instrument in a foreign currency fair value hedge of an
unrecognized firm commitment or a portion thereof (e.g., a firm commitment
to purchase or sell a nonfinancial item). ASC 815-20 does not address how to
account for such debt. Instead, an entity applies ASC 830-20, which requires
foreign-denominated debt to be remeasured at spot rates (see Section 14.2.3).
Certain foreign-denominated intra-entity loans for which an offsetting
third-party loan is in place can also be designated as a hedging instrument
in a foreign currency fair value hedge of an unrecognized firm commitment or
a portion thereof (see ASC 815-20-25-60).
14.2.1.5 Debt Designated as Hedging Instrument in Net Investment Hedge
When the qualifying criteria for hedge accounting are met,
ASC 815-20-25-66 permits an entity to designate foreign-denominated debt as
a hedging instrument in a foreign currency hedge of a net investment in a
foreign operation. However, such designation cannot be applied if the debt
is accounted for at fair value through earnings. When net investment hedge
accounting is applied, the foreign currency transaction gain or loss on the
debt (i.e., the remeasurement of the debt at spot rates) under ASC 835-30
(see Section
14.2.3) is recognized in OCI in a manner similar to a
translation adjustment associated with the hedged net investment. The
cumulative translation adjustment is recognized in earnings in accordance
with ASC 830-30-40 (see Section 5.4 of Deloitte’s Roadmap Foreign Currency Matters).
14.2.2 Fair Value Measurements
Sometimes, the accounting for debt involves fair value
measurements (e.g., the initial measurement of debt that is initially measured
by using present value techniques under ASC 835-30, debt accounted for at fair
value by using the fair value option in ASC 815-15 or ASC 825-10, the
measurement of bifurcated embedded derivatives under ASC 815-15, debt that is
designated as a hedged item in a fair value hedge under ASC 815-20 and ASC
815-25, and initial measurements in transactions that include multiple units of
accounts). In determining fair value, an entity should apply the guidance in ASC
820. In the absence of a specific exception, ASC 820 applies whenever fair value
measurements or disclosures are permitted or required under GAAP.
For a detailed discussion of the guidance in ASC 820, see
Deloitte’s Roadmap Fair
Value Measurements and Disclosures (Including the Fair Value
Option). That Roadmap addresses fair value measurement
considerations specific to notes payable (Section 2.3.1), hedged items in fair value
hedges (Section
2.3.11), liabilities and instruments classified in equity
(Section
10.2.7), fair value disclosures (Chapter 11), and the application of the
fair value option (Chapter
12).
14.2.3 Foreign Currency Matters
ASC 830-20
35-1 A change
in exchange rates between the functional currency and
the currency in which a transaction is denominated
increases or decreases the expected amount of functional
currency cash flows upon settlement of the transaction.
That increase or decrease in expected functional
currency cash flows is a foreign currency transaction
gain or loss that generally shall be included in
determining net income for the period in which the
exchange rate changes.
35-2 At each
balance sheet date, recorded balances that are
denominated in a currency other than the functional
currency of the recording entity shall be adjusted to
reflect the current exchange rate. At a subsequent
balance sheet date, the current rate is that rate at
which the related receivable or payable could be settled
at that date. Paragraphs 830-20-30-2 through 30-3
provide more information about exchange rates.
Under ASC 830-20, a debtor is required to remeasure the carrying
amount of debt that is denominated in a currency other than its functional
currency as of each reporting date by using the current exchange rate. Because
debt issuance costs are presented as a reduction of the debt’s carrying amount,
the remeasurement should be based on the carrying amount after deduction of any
remaining unamortized debt issuance costs. Accordingly, the debt’s carrying
amount will change each reporting date (until the debt is extinguished) as a
result of changes in exchange rates. Generally, the changes in the net carrying
amount are recognized in earnings as transaction gains or losses. For additional
discussion of the application of ASC 830, see Deloitte’s Roadmap Foreign Currency
Matters.
14.2.4 Capitalization of Interest
ASC 835-20
15-5 Interest
shall be capitalized for the following types of assets
(qualifying assets):
- Assets that are constructed or otherwise produced for an entity’s own use, including assets constructed or produced for the entity by others for which deposits or progress payments have been made.
- Assets intended for sale or lease that are constructed or otherwise produced as discrete projects (for example, ships or real estate developments).
- Investments (equity, loans, and advances) accounted for by the equity method while the investee has activities in progress necessary to commence its planned principal operations provided that the investee’s activities include the use of funds to acquire qualifying assets for its operations. The investor’s investment in the investee, not the individual assets or projects of the investee, is the qualifying asset for purposes of interest capitalization.
30-3 The
amount capitalized in an accounting period shall be
determined by applying the capitalization rate to the
average amount of accumulated expenditures for the asset
during the period. The capitalization rates used in an
accounting period shall be based on the rates applicable
to borrowings outstanding during the period. If an
entity’s financing plans associate a specific new
borrowing with a qualifying asset, the entity may use
the rate on that borrowing as the capitalization rate to
be applied to that portion of the average accumulated
expenditures for the asset that does not exceed the
amount of that borrowing. If average accumulated
expenditures for the asset exceed the amounts of
specific new borrowings associated with the asset, the
capitalization rate to be applied to such excess shall
be a weighted average of the rates applicable to other
borrowings of the entity.
ASC 835-20 requires debtors to capitalize certain interest costs as part of the
cost of “qualifying assets.” Generally, capitalization of interest is required
during the period that an entity is getting a qualifying asset ready for its
intended use. Qualifying assets include assets that are (1) constructed or
produced either for the entity’s own use or, as discrete projects, for lease or
sale (e.g., ships or real estate) or (2) accounted for under the equity method
“while the investee has activities in progress necessary to commence its planned
principal operations.” Capitalization is not permitted for assets that are in
use, substantially complete and ready for their intended use, or not in use
unless they are undergoing activities necessary to get them ready for use.
Further, capitalization is not permitted for inventories that are produced in
large quantities on a repetitive basis.
An entity determines the amount to be capitalized by applying a
capitalization rate to the average amount of accumulated expenditure it has
incurred on a qualifying asset during a period. To the extent that the average
accumulated expenditures do not exceed the amount of specific new borrowings
related to a qualifying asset, the entity is permitted to use the rate on those
borrowings as the capitalization rate. Otherwise the entity uses a weighted
average rate applicable to borrowings outstanding during the period. In
determining an appropriate capitalization rate, the entity should also consider
the amortization of any fair value hedge adjustments on its outstanding
borrowings (see ASC 815-25-35-14 and ASC 815-25-55-52).
14.2.5 Reference Rate Reform
14.2.5.1 Background
ASC 848 permits entities to elect optional expedients and
exceptions related to the application of certain accounting requirements for
contracts, hedging relationships, and other transactions that refer to a
reference rate that is expected to be discontinued as a result of the
transition away from the use of interbank offered rates (e.g., LIBOR) to
alternative reference rates.1 An entity can elect to apply the optional expedients and exceptions to
certain contract modifications and hedging relationships from the beginning
of the interim period that includes March 20, 2020, through December 31,
2024. While a comprehensive discussion of ASC 848 is beyond the scope of
this Roadmap, this section briefly discusses the guidance in ASC 848-20 on
contract modifications (see Section 14.2.5.2) and summarizes the
relief available to debtors under ASC 470-50 and ASC 815-15 for such
modifications (see Sections 14.2.5.3 and 14.2.5.4, respectively).
14.2.5.2 Scope
ASC 848-20
General
15-1 This
Subtopic provides guidance on optional expedients
for accounting for contract modifications when one
or more terms are modified because of reference rate
reform.
Modifications of Terms
15-2 The guidance in this
Subtopic, if elected, shall apply to contracts that
meet the scope of paragraph 848-10-15-3 if either or
both of the following occur:
- The terms that are modified directly replace, or have the potential to replace, a reference rate within the scope of paragraph 848-10-15-3 with another interest rate index. If other terms are contemporaneously modified in a manner that changes, or has the potential to change, the amount or timing of contractual cash flows, the guidance in this Subtopic shall apply only if those modifications are related to the replacement of a reference rate. For example, the addition of contractual fallback terms or the amendment of existing contractual fallback terms related to the replacement of a reference rate that are contingent on one or more events occurring has the potential to change the amount or timing of contractual cash flows and the entity potentially would be eligible to apply the guidance in this Subtopic.
- The interest rate used for margining, discounting, or contract price alignment is modified as a result of reference rate reform.
15-3 Other than a
modification of the interest rate used for
margining, discounting, or contract price alignment
in accordance with paragraph 848-20-15-2(b), for
contracts that meet the scope of paragraph
848-10-15-3, the guidance in this Subtopic shall not
apply if a contract modification is made to a term
that changes, or has the potential to change, the
amount or timing of contractual cash flows and is
unrelated to the replacement of a reference rate.
That is, this Subtopic shall not apply if contract
modifications are made contemporaneously to terms
that are unrelated to the replacement of a reference
rate.
15-4 Contemporaneous
modifications of contract terms that do not change,
or do not have the potential to change, the amount
or timing of contractual cash flows shall not
preclude application of the guidance in this
Subtopic, regardless of whether those
contemporaneous contract modifications are related
or unrelated to the replacement of a reference rate
or the modification of the interest rate used for
margining, discounting, or contract price alignment
as a result of reference rate reform.
Identifying
Changes to Terms Related and Unrelated to the
Replacement of the Reference Rate
15-5 Changes
to terms that are related to the replacement of the
reference rate are those that are made to effect the
transition for reference rate reform and are not the
result of a business decision that is separate from
or in addition to changes to the terms of a contract
to effect that transition. . . .
ASC 848-20 permits an entity to elect certain expedients (such as those
described in Sections 14.2.5.3 and
14.2.5.4) related to the modification of contract
terms that will directly replace, or have the potential to replace, an
affected rate with another interest rate index, as well as certain
contemporaneous modifications of other contract terms related to the
replacement of an affected rate. When contemporaneous modifications are
made, an entity’s eligibility to use the optional expedients depends on
whether the contemporaneous modifications to the other terms (1) could
affect the amount or timing of contractual cash flows and (2) are related to
reference rate reform. If a contemporaneous contract modification could
affect the amount or timing of contractual cash flows, the optional
expedients are not available if that modification is unrelated to the
replacement of a reference rate. Changes in contract terms are considered
unrelated to the replacement of a reference rate if they are “the result of
a business decision that is separate from or in addition to changes to the
terms of a contract to effect that transition.” If it is not possible for a
contemporaneous contract modification to affect the amount or timing of
contractual cash flows, an entity is not precluded from applying the
optional expedients even if that modification is unrelated to the
replacement of a reference rate.
The table below provides
examples of possible types of modifications and indicates whether they
generally would be considered related to the replacement of a reference
rate.
Related
|
Unrelated
|
---|---|
Changes to:
|
Changes to:
|
The addition of:
|
The addition of:
|
The addition of or changes to:
|
The addition or removal of:
|
A concession granted to a debtor experiencing
financial difficulty
|
Further, ASC 848-20 permits an entity to disregard circumstances in which
modified fallback terms include or have the potential to include a term
unrelated to reference rate reform if, when the fallback terms are added or
amended, the entity “determines that activation of the term unrelated to
reference rate reform is not probable of occurring if the fallback terms are
triggered.”
14.2.5.3 Evaluation of Debt Modifications Under ASC 470-50
ASC 848-20
35-8 If an entity elects the
optional expedient in this paragraph, the entity
shall account for a modification of a contract
within the scope of Topic 470 that meets the scope
of paragraphs 848-20-15-2 through 15-3 in accordance
with paragraphs 470-50-40-14, 470-50-40-17(b), and
470-50-40-18(b) as if the modification was not
substantial. That is, the original contract and the
new contract shall be accounted for as if they were
not substantially different from one another, and
the modification shall not be accounted for in the
same manner as a debt extinguishment in accordance
with paragraph 470-50-40-13.
35-9 If the
optional expedient in paragraph 848-20-35-8 is
elected, it shall be applied to all contracts under
Topic 470 as described in paragraph 848-20-35-1.
35-10 If the
optional expedient in paragraph 848-20-35-8 is
elected, an entity that applies the 10 percent cash
flow test described in paragraph 470-50-40-10 for
any subsequent contract modification within a year
shall consider only terms and provisions that were
in effect immediately following the election of the
optional expedient for the particular contract.
If a debt modification is within the scope of the elective relief (see
Section 14.2.5.2), the debtor can choose to account
for the modification as if it was not substantial under ASC 470-50 even if
the modification would have been considered an extinguishment under ASC
470-50 (see Section 10.3). When elected, the optional
expedient must be applied consistently for all eligible contracts within the
scope of ASC 470. In performing the 10 percent cash flow test (see
Section 10.3.3) in ASC 470-50-40-10 for any
subsequent contract modifications made within a year, the debtor should
consider only terms and provisions that were in effect immediately following
the election of the optional expedient, which is an exception to the
guidance in ASC 470-10-25-12(f) (see Section
10.3.3.4).
14.2.5.4 Reassessment of Embedded Derivatives Under ASC 815-15
ASC 848-20
35-14 If the
optional expedient in this paragraph is elected,
modification of a contract that meets the scope of
paragraphs 848-20-15-2 through 15-3 (including the
addition of an interest rate floor or cap that is
out of the money in paragraph 848-20-15-5(e)) shall
not require an entity to reassess its original
conclusion about whether that contract contains an
embedded derivative that is clearly and closely
related to the economic characteristics and risks of
the host contract for the purposes of paragraph
815-15-25-1(a).
35-15 If the
optional expedient in paragraph 848-20-35-14 is
elected, it shall be applied to all contracts under
Subtopic 815-15 as described in paragraph
848-20-35-1.
If a debt modification is within the scope of ASC 848 (see Section
14.2.5.2), the debtor can elect not to reassess its
conclusion about whether the debt contains an embedded derivative that is
clearly and closely related to the economic characteristics and risks of the
host contract under ASC 815-15 (see Section 8.5.4).
When elected, the optional expedient must be applied consistently for all
eligible contracts within the scope of ASC 815-15.
Footnotes
1
ASC 848 applies to derivatives that are affected by
reference rate reform as a result of the discounting transition even
if such derivatives do not refer to a rate that is expected to be
discontinued.