Hedging — FASB Discusses Feedback on Key Implementation Issues
At its February 14, 2018, meeting, the FASB discussed a number of implementation issues related to ASU 2017-12,1 which arose from technical inquiries received by the FASB staff from various constituents. The staff shared with the Board its technical inquiry responses and asked whether the Board agreed with the conclusions. Additional details are included in the meeting handout. The following issues were addressed:
Issue 1 — General Technical Inquiries on ASU 2017-12
Since the ASU’s issuance, the staff has answered approximately 90 technical inquiries from different stakeholders. At the February 14 meeting, the FASB staff discussed its responses to the following general technical inquiries about the ASU that had broad applicability to stakeholders:
- Under the transition provisions in the ASU, an entity may elect to change its way of measuring the hedged item in an existing fair value hedge of interest rate risk to use the benchmark rate component of the contractual cash flows instead of using the total contractual cash flows. An entity that makes this election may rebalance its hedging relationship by dedesignating a portion of the hedged item and reclassifying the related basis adjustment to opening retained earnings as of the initial application date. In its responses to technical inquiries, the FASB staff clarified that entities may also rebalance such hedging relationships in a manner other than that specified in the ASU (e.g., by increasing or decreasing the designated notional amount of the hedging instrument or increasing the notional amount of the hedged item). The staff has cautioned, however, that entities are prohibited from rebalancing a hedging relationship by entering into either a new hedging instrument or a new hedged item.
- The staff clarified that the ASU provided no transition guidance for entities switching from a full-term fair value hedging strategy to a partial-term hedging strategy because implementation of a partial-term hedging strategy would require an entity to enter into a new hedging instrument. Under the ASU, this can only be accomplished by dedesignating and redesignating the hedging relationship.
- The staff indicated that the purpose of the ASU’s fair value hedge basis adjustment disclosures is to provide users with the information they need to evaluate the amount, timing, and uncertainty of future cash flows associated with hedged assets or liabilities. Specifically, the ASU’s disclosures provide users with additional information about fair value basis adjustments that will not affect future cash flows; therefore, basis adjustments that will affect future cash flows, such as foreign exchange risk basis adjustments, are excluded from the ASU’s disclosure requirements. In addition, for a hedged available-for-sale debt security, the carrying amount that an entity should disclose should be its amortized cost basis and not its fair value.
The staff will post additional information on these issues on the Hedge Accounting Implementation page on the FASB’s Web site.
Issue 2 — Prepayable Financial Instruments
The FASB staff presented its interpretation of which financial instruments meet the definition of “prepayable,” as that term is defined in the ASC master glossary. Under the ASU, the characterization of whether an instrument is prepayable may affect (1) the measurement of the hedged item, (2) whether the instrument is eligible for application of the last-of-layer method, and (3) whether the entity can reclassify the instrument from held to maturity to available for sale without penalty as part of the transition upon adoption of the ASU. As indicated in the summary of the Board’s tentative decisions for the meeting, the Board tentatively agreed with the following FASB staff interpretation:
Financial instruments that meet the definition of prepayable include the following:
- Instruments that are currently exercisable and prepayable at any time
- Instruments with certain contingent prepayment features (that is, based on the passage of time, the occurrence of a specified event other than the passage of time, and the movement in a specified interest rate)
- Instruments with conversion features.
However, instruments for which contractual maturity can be accelerated due to credit would not meet the definition of prepayable.
The Board indicated that the FASB staff should research the need for a potential technical correction to reflect these tentative decisions about the term “prepayable.” The staff also clarified, and the Board tentatively agreed, that (1) an entity’s transfer, in transition, of prepayable financial assets from held to maturity to available for sale upon adoption and (2) the subsequent sale of such instruments before their contractual maturity would not call into question the entity’s intent to hold other financial assets to maturity (i.e., it would not cause a “taint”).
Issue 3 — Net Investment Hedges Under the Spot Method
The Board discussed a number of questions related to how an entity would account for excluded components when using the spot method to account for a net investment hedge. The Board tentatively agreed with the following staff views communicated at the meeting:
- An entity cannot account for the cross-currency basis spread as a separate component of the hedging derivative that can be excluded from the assessment of effectiveness; however, under the mechanics of the spot method, the cross-currency basis spread would still be an element of the overall excluded amount.
- Entities should follow the general principle that changes in the fair value of the hedging derivative attributable to changes in the spot rate should be recorded in the currency translation adjustment (CTA) in other comprehensive income and, at the end of the hedging relationship, the only amounts remaining in CTA related to the swap should be the “spot changes on the notional amount of the net investment.”
- An entity would apply the preceding principle in circumstances in which the hedging instrument is an off-market cross-currency interest-rate swap (i.e., the swap has a fair value of other than zero at hedge inception). Therefore, “any systematic and rational [amortization] approach [for the excluded component] that results in the off-market nature of the swap equaling zero at the end of the hedging relationship” will be acceptable. The staff and the Board acknowledged stakeholder concerns that the amortization approach for the excluded component under the ASU could lead to certain structuring opportunities. However, the staff indicated, and the Board tentatively agreed, that “structuring [the terms] of cross-currency interest-rate swaps . . . to achieve a specific accounting result is not considered rational in the context of a systematic and rational approach.”
The Board expects to discuss additional implementation issues in future meetings.
FASB Accounting Standards Update (ASU) No. 2017-12, Targeted Improvements to Accounting for Hedging Activities.