FASB Provides Interpretations on ASU 2017-12 Implementation, and Tentatively Decides on Certain Targeted Improvements to Accounting for Hedging Activities
At the FASB’s September 5, 2018, board meeting, the FASB staff shared its responses to certain technical inquiries it received related to the implementation of ASU 2017-12.1 In addition, the Board tentatively agreed to amend certain aspects of ASU 2017-12.
Staff Interpretations of Technical Inquiries Received on ASU 2017-12
At the meeting, the FASB staff noted the following interpretations, and the Board did not raise any questions or concerns related to the interpretations. Additional details about these interpretations are available on the FASB’s Web site.
Issue 1 — Switching Hedge Effectiveness Assessment Methods for Net Foreign Investment Hedges
An entity may change its method of assessing effectiveness for net investment hedges (from the forward method to the spot method (or vice versa)) at transition or in any subsequent period. However, to do so an entity must satisfy the requirements in ASC 815-20-55-55 and 55-562 and “demonstrate that the revised effectiveness assessment method is an improved method in accordance with [ASC] 815-20-35-19.”3
Issue 2 — Timing of Initial Quantitative Hedge Effectiveness Assessment
An entity must complete its “initial prospective quantitative assessment of hedge effectiveness . . . for a cash flow hedge of a group of forecasted transactions . . . before the first forecasted transaction [in the group] occurs.”
Issue 3 — Simultaneous Designation of Hedged Item for Fair Value and Cash Flow Hedges
The staff discussed an entity’s inquiry about whether an entity may “simultaneously designate the same hedged item in a fair value hedge and a cash flow hedge if hedging different risk components.” The inquirer cited an example of Treasury Inflation-Protected Securities, in which semiannual payments are determined on the basis of (1) a fixed-rate coupon and (2) a principal amount that is inflation-adjusted and fluctuates on the basis of changes in an inflation index. The staff believes that because this is a variable-rate financial instrument, an entity may designate only the variability in a contractually specified interest rate or overall cash flows as the hedged risk in a cash flow hedge. Therefore, “[t]he fixed-rate component and the variable-rate inflation index must be considered together as the contractually specified interest rate of the financial instrument.”
Issue 4 — Sale or Transfer of Assets Out of a Closed Portfolio in a Last-of-Layer Hedge
An entity may “voluntarily remove[, by sale or transfer,] assets from the closed portfolio of which an amount is designated as the hedged item in a last-of-layer hedging relationship . . . without requiring dedesignation” of the existing hedging relationship. The FASB staff expects to provide additional clarification about how to interpret the term “closed portfolio” as part of the Board’s separate project on the last-of-layer method. However, the FASB staff added that “entities currently applying or intending to apply the last-of-layer method before the issuance of any amendments to the last-of-layer method are not precluded from selling or transferring assets out of a last-of-layer pool.”
Issue 5 — Documentation of Fallback Long-Haul Hedge Effectiveness Assessment Method
An entity that applies the critical-terms-match method may subsequently “assess the effectiveness of a hedging relationship using a long-haul method when the critical terms change or adverse developments regarding the risk of counterparty default occur.” ASU 2017-12 “did not meaningfully change the guidance concerning the misapplication of a critical-terms-match method”; therefore, entities should retain their current accounting practice in such circumstances.
Issue 6 — Change in Hedged Risk Guidance for a Cash Flow Hedge of Forecasted Issuance of Fixed-Rate Debt
The “change in hedged risk guidance does not encompass allowing an entity to recharacterize its borrowing during the hedging relationship from a variable-rate instrument to a series of fixed-rate debt instruments and then to amend the designation to the variability of a benchmark rate component as the hedged risk.” However, “an entity could treat [a] rolling series of fixed-rate instruments as a variable-rate instrument (as demonstrated in [ASC] 815-30-55-54) and designate the hedged risk as the variability in the contractually specified interest rate or all of the cash flows related to the revised variable rate, not just a benchmark component of those variable cash flows as [the inquirer had] proposed.”
Issue 7 — Reclassification of Prior Period Information
Entities are permitted, but are not required, to conform their preadoption financial statement presentation to postadoption presentation (i.e., an entity may choose to reclassify its comparative information to conform to the postadoption presentation requirements).
Amendments to Guidance in ASU 2017-12
The FASB tentatively decided to amend the guidance in ASU 2017-12 as follows:
Issue 8 — Partial-Term Fair Value Hedges of Both Interest Rate Risk and Foreign Exchange Risk
To allow an entity to designate (1) a partial-term fair value hedge of both interest rate and foreign exchange risk (however, an entity cannot apply the partial-term hedge guidance to a hedge of only foreign exchange risk) and (2) multiple partial-term hedges of portions of a single financial instrument.
Issue 9 — Amortization of Fair Value Hedge Basis Adjustments
To clarify that (1) “the amortization period guidance for partial-term hedges is applicable only if an entity elects to begin amortization of a fair value hedge basis adjustment while the hedging relationship is outstanding” and (2) “the remaining life of a partial-term fair value hedge is the period until the hedged item’s assumed maturity, as documented concurrent with hedge inception.”4
Issue 10 — Disclosure of Fair Value Hedge Basis Adjustments
To clarify that an entity should (1) exclude cumulative fair value hedge basis adjustments arising from hedges of foreign exchange risk from the fair value hedge disclosures required by ASC 815-10-50-4EE and (2) disclose the amortized cost basis of an available-for-sale debt security as its carrying amount, instead of its fair value.
Issue 11 — Consideration of the Hedged Contractually Specified Interest Rate Under the Hypothetical Derivative Method
To indicate that the hypothetical derivative that an entity uses to assess hedge effectiveness for certain cash flow hedges should consider the contractually specified interest rate being hedged.
Issue 12 — Not-for-Profit Scope
To make several corrections to the scope paragraphs in ASC 815-10 and ASC 815-20, the most significant being to clarify “that entities that do not report earnings separately are not permitted to use the amortization approach for amounts excluded from the assessment of effectiveness in fair value hedges because it would require those entities to recognize amounts in other comprehensive income, which is a caption that these entities do not report.”
Issue 13 — Hedge Accounting Provisions Applicable to Certain Private Companies and Not-for-Profit Entities
To clarify that (1) an entity must document its assertion that “the last of layer is expected to remain outstanding at the hedged item’s maturity date” as of the inception of that hedging relationship and (2) “the same documentation and effectiveness testing relief would be provided to certain not-for-profit entities as was provided to private companies that are not financial institutions.”
Issue 14 — Application of a “First of” Cash Flow Hedging Technique to Overall Cash Flows on a Group of Variable Interest Payments
To indicate that “designating overall cash flows as the hedged risk under a ‘first of’ hedging technique remains [a] permissible [designation technique].”
Issue 15 — Transition Guidance Clarification
To clarify that, on transition, (1) “an entity may increase or decrease the [notional amounts] of the hedged item or hedging instrument [when it rebalances] a fair value hedge of interest rate risk” but “may not add new hedged items or new hedging instruments to an existing hedging relationship” and (2) an entity may change its method of assessing hedge effectiveness for a hedging relationship from a quantitative long-haul approach to a qualitative critical-terms-match method if the hedging relationship satisfies all of the requirements for application of the critical-terms-match method.
Furthermore, the amendments would clarify that an entity that reclassifies debt securities from the held-to-maturity category to available-for-sale would not (1) call into question “[i]ts assertion as of the most recent reporting date that it had the intent and ability to hold those debt securities to maturity,” (2) be required to “designate reclassified securities in a last-of-layer hedging relationship,” or (3) be “restricted from selling the reclassified securities.”
The FASB directed its staff to draft a proposed ASU reflecting the Board’s tentative decisions. The proposed ASU will also ask whether “partial-term fair value hedging should be expanded to all risks eligible for hedge accounting.”
FASB Accounting Standards Update (ASU) No. 2017-12, Targeted Improvements to Accounting for Hedging Activities.
For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s “Titles of Topics and Subtopics in the FASB Accounting Standards Codification.”
Quotes for Issues 1 through 7 are from “Staff Interpretations of Technical Inquiries Received on Update 2017-12 Discussed at the September 5, 2018 Board Meeting."