On August 28, 2017, the FASB issued Accounting Standards Update (ASU) 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The amendments in ASU 2017-12 apply to any entity that elects to apply hedge accounting in accordance with U.S. generally accepted accounting principles (U.S. GAAP). The main changes introduced by ASU 2017-12 are highlighted below.
Changes to Align Hedge Accounting with a Company’s Risk Management Activities
The amendments in ASU 2017-12:
- Permit more flexibility in hedging interest rate risk for both variable rate and fixed rate financial instruments, and introduce the ability to hedge risk components for nonfinancial hedges
- Change the guidance for designating fair value hedges of interest rate risk and for measuring the change in fair value of the hedged item in fair value hedges of interest rate risk
- Require an entity to present the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported
- Introduce an approach that no longer separately measures and reports hedge ineffectiveness
- Expand and change the reporting of amounts excluded from the assessment of hedge ineffectiveness to allow entities to use an amortization approach or to continue mark-to-market accounting consistent with current U.S. GAAP
Changes to Simplify Hedge Effectiveness Testing
The amendments in ASU 2017-12:
- Allow a company to perform subsequent assessments of hedge effectiveness qualitatively if certain conditions are met.
- Allow companies more time to perform the initial quantitative hedge effectiveness assessment.
- Allow a company to apply the “long-haul” method for assessing hedge effectiveness when use of the shortcut method was not or no longer is appropriate if certain conditions are met.
CPEA Observation: An entity must specify, at hedge inception, which quantitative method it would use to assess effectiveness and measure hedge results if the shortcut method was not or no longer is appropriate during the life of the hedging relationship. Many private companies may not specify which quantitative method it would use if the shortcut method was not or no longer is appropriate. This failure would disqualify these entities from this relief. The timing and content of the documentation at hedge inception has been relaxed for some private companies in other areas (see below). As a result, this new documentation requirement may be overlooked.
- Clarify that a company may apply the “critical terms match” method for a group of forecasted transactions if the transactions occur and the derivative matures within the same 31-day period or fiscal month, and the other requirements for applying the critical terms match method are satisfied.
- Provide relief to private companies. Specifically, private companies that are not financial institutions and not-for-profit (NFP) entities (except for NFP entities that have issued, or are a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market) may select the method of assessing hedge effectiveness, and perform the initial quantitative effectiveness assessment and all quarterly hedge effectiveness assessments before the date on which the next interim (if applicable) or annual financial statements are available to be issued. This incremental relief does not affect the simplified hedge accounting approach for private companies (ASU 2014-03).
Practice Note: This amendment is meant to provide private companies with relief by aligning documentation requirements with the issuance of financial statements. (Many private companies and NFP entities lack the resources to complete the required hedge documentation and initial and subsequent effectiveness assessments in a timely manner.) At hedge inception, private companies still will have to identify the hedging instrument, the hedged item or transaction, and the nature of the risk being hedged. But they will get more time to prepare the documentation of effectiveness testing.
The amendments in ASU 2017-12 modify current disclosure requirements, including:
- Requiring new tabular disclosures related to cumulative basis adjustments for fair value hedges
- Requiring a tabular disclosure related to the effect on the income statement of fair value and cash flow hedges
- Eliminating the requirement to disclose the ineffective portion of the change in fair value of hedging instruments
The amendments in ASU 2017-12 take effect for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the amendments take effect for fiscal years beginning after December 15, 2019, and interim periods beginning after December 15, 2020. Early adoption is permitted.
In the near future, the CPEA will issue a full report on ASU 2017-12, more fully explaining the amendments to accounting for hedging activities.