Currently, entities accounting for options under DIG Issue G20 may elect to include time value in effectiveness testing. Under the current approach both the entire fair value time value and intrinsic value of the option are considered effective and are included in the effective component and deferred in OCI until the underlying transaction is recognized, at which time the effective components (time and intrinsic, if any) is reclassified to the effective account. This is a popular approach as it allows for deferral of the option cost, providing matching of the timing of the option cost recognition and income statement geography with the hedged transaction(s).
Under the proposed guidance the entity would still record the effective changes in time value and intrinsic value to OCI, but the option cost would then be separately amortized to income “on a rational basis” over the life of the option. It is unclear what that rational basis might be, possibly straight line, but certainly the timing will not align with the underlying. The premium will impact earnings over the life of the option not when the underlying is recorded. The complexity multiplies if entries need to contemplate the amortization of each caplet or floorlet in interest rate caps, floors and collars. We will be looking for more clarification on this issue in the redline version.
