Most Significant Revision of the Hedge Accounting Standard

The recent Accounting Standards Update (ASU) No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities is a major development in the industry. The Financial Accounting Standards Board (FASB) has promulgated the update to improve and simplify the rules on Hedge Fund Accounting and address effectiveness concerns.

According to FASB, the new regulations refine and expand hedge accounting for both financial and commodity risks. The provisions create more transparency around how economic results are presented both on the financial statements and footnotes. They are designed to make hedge accounting simpler for financial statement preparers and easier for the users to understand.

The ASU will be effective for public companies starting after December 15, 2018. The standards will take effect for private companies after Dec. 15, 2019. However, many businesses are expected to adopt the changes early. This update is viewed as the most significant revision of the hedge accounting standard since the issuance of FASB Statement No. 133 in 1998.

Key Changes to Accounting or Hedging Activities

The American Institute of CPAs has summarized the key amendments of the new ASU:

Changes to Align Hedge Accounting with Company Risk Management Activities

• 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 (Generally Accepted Accounting Principles)

Changes to Simplify Hedge Effectiveness Testing

• 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 is not or no longer appropriate if certain conditions are met

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