14.2 Accounting | DART – Deloitte Accounting Research Tool

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. In accordance with ASC 848-20-15-5, 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: The referenced interest rate index (e.g., from LIBOR to another interest rate index) The reset period, reset dates, day-count or business-day conventions, payment dates or frequency, or the repricing calculation The strike price of an existing interest rate option (including an embedded interest rate option) The terms necessary to comply with laws or regulations or to align with market conventions for the replacement rate	Changes to: The notional amount The maturity date The stated rate from a referenced interest rate index to a fixed rate (except for the last published rate of an interest rate index that is discontinued) The loan structure (e.g., changing a term loan to a revolver loan) The counterparty (except as already permitted by specified sections of ASC 815) The priority or seniority of an obligation in the event of a default or liquidation
The addition of: An out-of-the-money interest rate floor or cap A prepayment option whose exercise is contingent on the inability of the replacement reference interest rate index to be determinable on the basis of the agreement’s terms	The addition of: An in-the-money interest rate floor or cap An underlying or variable not related to the referenced interest rate index (e.g., payments indexed to gold prices)
The addition of or changes to: A spread adjustment for the difference between an existing reference rate and the replacement reference rate Contractual fallback terms if such changes are consistent with fallback terms recommended by a regulator or a private-sector working group convened by a regulator	The addition or removal of: A prepayment option (except for the addition of a prepayment option that is contingent on the replacement reference interest rate index not being determinable) A conversion option A leverage feature The right to use one or more underlying assets in a lease contract
	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.