The FASB’s most recent board minutes announced that the hedge accounting model to be included in the exposure draft to ammend ASC815 will incorporate all changes to current hedge accounting proposed in the June 2008 FASB Exposure Draft, Accounting for Hedging Activities, except that the proposed Update would retain hedging of risk components (bifurcation-byrisk), which the Exposure Draft proposed to eliminate. Following are a few of the key elements in the original Exposure Draft that we feel might most impact our clients.
Effectiveness Testing & Measurement
As part of the hedge effectiveness assessment, entities would be required to demonstrate that changes in fair value of the hedging instrument would be reasonably effective in offsetting risk, as opposed to the current highly effective requirement.
Entities would be required to perform a qualitative (rather than quantitative) test at inception to demonstrate that a reasonably effective economic relationship exists between the hedging instrument and the hedged item or forecasted transaction. However, in certain situations a quantitative test may be necessary at inception. (No specifics have been provided as to what the qualitative testing might look like, or when a quantitative test might be required.) On an ongoing basis, an entity would only need to reassess effectiveness when circumstances suggest that the hedging relationship may no longer be reasonably effective.
The shortcut method and critical terms match method would be eliminated. An entity would no longer have the ability to assume a hedging relationship is reasonably effective and recognize no ineffectiveness in net income during the term of the hedge. This would converge with IAS39.
In a cash flow hedging relationship, ineffectiveness will be recognized on both over and under-hedging. Currently, ineffectiveness is only recognized to the extent the change in value of the derivative exceeds the change in value of the hedged item. This would introduce a divergence from IAS39.
The focus will move away from “testing” to “measurement” of actual ineffectiveness in the relationship.
Dedesignation of Hedging Relationship
Entities would not be permitted to discontinue hedge accounting by simply removing the designation of a hedging relationship. Hedge accounting can be discontinued only if the criteria for hedge accounting are no longer met or the hedging instrument expires, is sold, terminated, or exercised. Currently the designation can be removed at any time at the discretion of the entity. This would introduce a divergence from IAS 39.
Treatment of Option Premiums
Entities would be required to amortize the option premium to income on a “rational basis” over the hedging period, although incremental time value is still captured in OCI. This differs from current treatment under DIG G20 where the change in value of the option, including the premium, is captured in OCI until the underlying transaction is recognized, at which time the premium is reclassified to the P&L along with gains, if any. The rational basis is not clear. This may result in amortizing the option effect straightline, so the derivative would be recorded at fair value on balance sheet, an amount reflecting the straightline amortization to-date would be recorded in income, any ineffective amounts would be recorded in income and “the rest” would end up recorded in OCI. We will be issuing representative journal entries as soon as an exposure draft is issued should this be included. Anything other than marking to marketthe time value of the option through income will diverge from IAS39.
Hedging of Intercompany Items
The FASB may not be including the intercompany features originally represented in the exposure draft. Under the original proposals many corporate felt entities would be specifically prevented from hedging intercompany transactions unless the earning effect of that transaction survived consolidation.
It is unclear under the original draft how direct the connection needed to be between the intercompany and third party transactions.
Keep an Eye Out
We expect the exposure draft to be issued before the end of April and will be following the changes closely and will keep you updated on the timing, details and interpretations of these proposed changes as they are made available.
Most recent Board Minutes are available: