The Financial Accounting Standards Board (FASB) on Monday issued an update designed to further align its derivatives and hedging standard with risk management strategies employed by organizations.
The 2017 standard change relaxed limitations on how a company can measure changes in fair value in certain hedging relationships. The provisions included the “last-of-layer” method, which “allows an entity to hedge its exposure to fair value changes due to changes in interest rates for a portion of the portfolio that is not expected to be affected by prepayments, defaults, and other events affecting the timing and amount of cash flows,” as explained by FASB.
The new update allows multiple layers of a single closed portfolio to be hedged under the method after stakeholder feedback indicated such a change would better reflect risk management activities. As a result of the change, the last-of-layer method has been renamed the “portfolio layer” method.
“The expanded hedge accounting method better reflects the effects of risk management activities in the financial statements and ultimately provides investors and other allocators of capital with more transparent, decision-useful information around an entity’s use of derivatives,” stated FASB Chair Richard Jones in a press release.
Other changes as part of the update include the addition of nonprepayable assets to the scope of the portfolio layer method and additional guidance on accounting for and disclosure of hedge basis adjustments under the method. Further amendments specify eligible hedging instruments in a single-layer hedge and “how hedge basis adjustments should be considered when determining credit losses for the assets included in the closed portfolio,” FASB said.
The update applies to all entities that elect to utilize the new portfolio layer method. For public companies, it is effective for fiscal years beginning after Dec. 15, 2022, and interim periods within those fiscal years. For all other entities, the update is effective for fiscal years beginning after Dec. 15, 2023, and interim periods within those fiscal years.