The FASB has published over 2,800 comment letters related to the proposed update to Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities. The overwhelming majority of letters addressed only the substantial changes proposed to financial instruments yet there were a number of letters, including ours, that also addressed hedge accounting. We have summarized below the points addressing hedge accounting submitted by the four largest accounting firms and provided excerpts from their letters on the following pages. We encourage you to read their complete statements at fasb.org.
Three of the four firms supported the move from a “highly effective” standard to a “reasonably effective” standard and the introduction of inception qualitative assessments for less obvious hedge relationships. Deloitte, however, felt “that the changes will replace existing complexities with other complexities that may prove equally or more challenging in practice.” The Big Four Firms unanimously opposed the move to reporting both over and underperformance of cash flow derivatives in earnings. In addition, they opposed the inability to voluntarily dedesignate hedge relationships indicating it was not clear on what “abuses” the FASB was trying to prevent with this proposal. All four also recommended the FASB expand bifurcation of risk concepts for both financial and non-financial instruments. Given that the proposed ASC Update did not specifically address intercompany hedging, it was interesting that three of the firms either indicated their support of intercompany hedging or their belief that changes should not be made to intercompany hedging without “due process”. The firms seemed comfortable with the abandonment of critical terms and short-cut concepts. Each of the firms were interested in retaining the ability to include option time value in the measurement of the hedged item, but there appears to be differences in interpretation of how that included time value will come through income.
PWC Excerpt – Comment Letter #250:
“We support eliminating the high effectiveness threshold, as well as streamlining hedge documentation through the elimination of the current initial and ongoing quantitative effectiveness assessment requirements . . .
We encourage the FASB to work with the IASB to develop principles that would expand the ability of entities to hedge risk components of financial instruments beyond the current specific risks that are eligible and, as indicated earlier, to align other elements of hedge accounting, including portfolio and macro hedging. We do not view the ability to de-designate hedging relationships to be problematic or an area of abuse under the current model.”
Ernst & Young Excerpt – Comment Letter #396:
“We support the Board’s efforts to simplify hedge accounting by moving from a “highly effective” standard to a “reasonably effective” standard for achieving hedge accounting . . . However, there are other aspects of the hedge accounting proposals that we do not support, including (a) the recording of hedge ineffectiveness for “underhedges” in cash flow hedges, (b) the elimination of voluntary de-designations . . . and (c) the requirement (as opposed to an election) to expense the cost of an option when an option is used in a cash flow hedging relationship . . .
We continue to support cash flow hedge accounting for these intercompany cash flows and urge that the existing practice in this area not be curtailed in the final standard . . .
We have long believed that the arguments to permit hedging of components of non-financial risk are compelling and comparable to the arguments used to permit the hedging of components of financial risk.”
KPMG Excerpt – Comment Letter #260:
“We support the proposal’s changes to the assessment of hedge effectiveness to require (1) that a hedging relationship be reasonably effective (rather than highly effective), (2) a qualitative assessment of the effectiveness of a hedging relationship at inception (unless a quantitative assessment is necessary based on facts and circumstances), (3) no ongoing assessment of effectiveness, unless facts and circumstances suggest that the hedging relationship would no longer be reasonably effective and (4) no assumption of perfect effectiveness.
We also support the use of a single hypothetical derivative for purposes of the assessment of effectiveness and measurement of ineffectiveness in a cash flow hedge of a group of transactions . . .
We agree with the proposal that entities should be permitted to use total changes in cash flows or intrinsic value when measuring ineffectiveness related to a purchased option. We support the amortization of the time value component of the purchased option beginning earlier than current practice . . .
We do not agree with the proposal’s limitation on an entity’s ability to dedesignate a hedging relationship . . . We also do not agree with the proposed change that would require entities to record in earnings ineffectiveness related to underhedges for cash flow hedging relationships.”
Deloitte – Comment Letter #255
“We do not support the contemplated changes to existing hedge accounting requirements because we do not believe that the benefits will outweigh the costs or that the proposed changes will simplify hedge accounting. Instead we believe that the changes will replace existing complexities with other complexities that may prove equally or more challenging in practice . . .
We propose that an assessment related to current measurements be required each reporting period . . .
We believe that when the cumulative change in fair value of the hedging instrument is less than the cumulative change in the hedged item, no ineffectiveness should be recognized in earnings . . . such ineffectiveness in earnings would be to defer in accumulated OCI (AOCI) a nonexistent gain or loss on the hedging instrument and to recognize in earnings a nonexistent loss or gain on the hedged item . . . The Board had not made publicly available its proposed amendments to Codification . . . We strongly encourage the Board to release these proposed amendments for public comment and to provide interested parties with adequate time (e.g., 90 days) to review them and submit comments to the Board.”
Hedge Trackers – Comment Letter #1494
The proposed guidance provides greater flexibility and simplicity in establishing hedge relationships and appropriately focuses efforts on calculating and properly recording derivative gains and losses. We remain concerned with the proposal to report gains and losses on anticipated transactions in earnings . . .
Please provide real examples across risk categories that include appropriate strategies for estimating forward pricing on exposure inputs that are illiquid and not publically available …
We are very concerned about the substantial increase in audit fees and possible Type 3 valuation disclosures that may be a natural extension of the need to support the earnings and OCI effects of commodity or other “overall” change in cash flow hedges where the underlying is often impacted by noisy, illiquid and non-transparent components of the change in value.
Please provide an example of the requirement to amortize the option premium “in a rational manner” . . . Please distinguish between circumstances that would result in (involuntary) dedesignation of a hedge relationship and those circumstances that would require an amendment to inception documentation . . . consider clarifying ASC 815-20-25-35 as follows: “If two separate hedges are designated, the cash flow hedge relationship would terminate (that is, be dedesignated as qualifying criteria are no longer met) when the hedged sale or purchase occurs and the foreign-currency-denominated receivable or payable is recognized.” (Suggested additions are in bold.)
Overall, we believe the implementation guidance requires more details on practical application of both existing and proposed rules. We believe the FASB should 1) affirm that companies may hedge non-functional currency transactions that do eliminate in consolidation, perhaps inserting an additional requirement that the long/short currency position of the hedge be reflected in 3rd party transactions on the consolidated level or 2) offer a functional currency election holiday . . . We believe that eliminating short-cut and match term treatments together with eliminating burdensome statistical analysis, that generally provides limited value, substantially reduces restatement risk . . .
We applaud the recognition of foreign currency changes in value of 3rd party debt being recorded in OCI. Recording currency gains and losses in OCI supports this “natural hedge” relationship without forcing the parent to hedge the remeasurement gain/loss on the debt, thereby nullifying the economic hedge and necessitating cash flow hedges to re-establish the relationship between the debt and the revenue . . . We would invite the FASB to reconsider the current inability to bifurcate separately identifiable commodity and other risks.