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Two Big Wins for Simplicity in Hedge Accounting

The FASB met last Wednesday and made several key decisions on the long awaited hedge accounting exposure draft.

The goal of the draft remains the same: “The proposed amendments are intended to better reflect an entity’s hedging strategies on its financial statements and reduce complexity in the hedge accounting model by making targeted improvements.”

Critical Terms Match (CTM)

The SEC had clarified that the match criteria in CTM meant the timing of the derivative and hedged item needed to match “to the day.” Mismatches needed to be assessed and measured. The proposed guidance will formally broaden the “match” criteria so that CTM would be appropriate for hedges that mature within a 31-day period of the hedged item – as long as all other requirements for the CTM method are met. This change should substantially reduce the need for inception hedge effectiveness testing for FX and commodity hedgers.

Previous released insights to the pending proposal note that a “back-up test” will be required for CTM and other assumptions of perfect effectiveness.

Partial-Term Fair Value Hedges

The board decided to ease the short-cut criteria for fair value hedges of fixed interest rate exposures. The proposal, when issued, will allow fair value hedgers to use the shortcut method even when the derivative/hedge matures earlier than the hedged item (partial-term hedging).

Other decisions published by the FASB:

  • When a forecast is missed, OCI will be released to the same income statement line item in which the hedged forecasted transaction would have been recorded had the transaction occurred.
  • Only the modified retrospective approach will be permitted when transitioning to the new rules.
  • There will be a 75-day comment period to address the new rules, once they are issued.

We will continue to monitor FASB developments and post them to the Hedge Trackers blog. If you’d like to receive our FASB Updates directly in your inbox, sign up for our newsletter.