Add hedging to year-end accounting change to-do list

The accounting may be simpler under a new standard on hedging, but that doesn’t mean the transition is any simpler than for any other accounting change.

The accounting staff at public companies are plenty busy enough working to adopt new rules taking effect Jan. 1, 2019, that elevate lease-related assets and liabilities out of footnotes and onto the face of primary financial statements. Many of them need to be sure they will be ready to apply new hedge accounting rules by the same effective date as well.

In August 2017, the Financial Accounting Standards Board finalized Accounting Standards Update No. 2017-12 to provide new guidance under Accounting Standards Codification Topic 815 on derivatives and hedging. Although the required adoption date was set well into the future, companies were permitted to adopt the standard early if they wished.

Accounting leaders predicted public companies that use hedging as part of their financial risk management strategy would flock to the new rules because they promised to simplify hedge accounting. The new rules expand hedge accounting to include both non-financial and financial risk components, and they change the measurement methodologies to better align the rules with the risk management activities companies employ. They eliminate the separate measurement and reporting of hedge ineffectiveness, and they generally simplify the assessment of hedge effectiveness, which is critical to achieving the more favorable accounting treatment that hedging rules allow.

Some entities with large-interest-rate portfolios and hedging activity that did not quality for the more favorable hedge accounting under historic rules “jumped on board,” says Helen Kane, founder and CEO of Hedge Trackers. One client who saw the announcement from FASB in late August 2017 even asked if his company could apply the guidance retrospectively to that very quarter, she recalls.

Some accounting leaders even expected companies that have shied away from hedging because of prohibitively difficult accounting to reconsider adding hedging to their risk management practices. Recent analysis at Deloitte, however, would suggest while some companies have adopted the standard before its required effective date, the numbers are not huge.

Jonathan Howard, senior consultation partner at Deloitte, says less than 20 percent of Fortune 500 public companies had adopted the new accounting by the second quarter of 2018. Accounting fatigue may have something to do with it. Revenue recognition was a heavy lift in 2017, followed by leases this year.

“The bigger the book is, the more you want to have a thoughtful adoption. It’s more of a strain the more hedging entities do.”
Jonathan Howard, Senior Consultation Partner, Deloitte

“It could be a resource issue,” says Howard. “It would be nice to early adopt but you need the same people to work on the processes and systems as have been working on revenue recognition and leases. And those have to be adopted.”

Indeed, even a move from difficult accounting to easier accounting is a move nonetheless. “While the accounting in the ASU will create a simpler framework for compliance to get hedge accounting going forward, there’s still a fair amount of complexity to get there,” says William Fellows, a partner in Deloitte’s risk and financial advisory services.

For example, the new accounting also requires companies to carefully think through a number of one-time elections that they must make as they adopt the new rules, especially for any fair-value hedges and cash flow hedges, says Howard. None of the elections are mandatory, but they all must be analyzed and documented upfront.

“The bigger the book is, the more you want to have a thoughtful adoption,” he says. “It’s more of a strain the more hedging entities do.” For companies that may have little or no hedging activity, the adoption effort for them is focused more on education than transition, says Howard, especially if they plan to leverage simpler accounting to engage in new or more hedging activity than they have historically.

In addition, just as companies have had to wait out software solutions to transition to lease accounting, they also need software fixes to get ready for new hedge accounting. “Some of the off-shelf solutions were not ready until recently,” Fellows says.

The first step for any company, says Ryan Brady, a partner in the accounting principles group at Grant Thornton, is to apply the new accounting to existing hedges and then consider how to look for new strategic opportunities to pursue new hedging opportunities. “The focus really is on the transition of existing hedges that have been subject to hedge accounting literature historically,” he says.

Companies also need to keep an eye out for new guidance from FASB, which is still considering or developing some amendments with respect to application of the “last-of-layer” method introduced in the new standard and the permissible benchmark rates. The board is also making some other technical corrections, including revising language around prepayables that had produced questions.

Even with some of the transition issues that companies are still working out, the new standard is still “by and large good news, even great news for most hedge programs,” says Kane. Most of the transition work to move to the new accounting should be done at the end of this year for calendar-year companies, she says, as they finalize their accounting entries for this year. That includes capturing the amount of hedge ineffectiveness under historic rules at the end of the current year that will need to be reclassified to opening retained earnings for the new year.

Kane is offering companies one note of caution. Some have surmised all hedge documentation must be prepared by the end of the quarter, she says, but instead documentation must be prepared “contemporaneously with hedge execution,” except quantitative testing that will be used to support assumptions of high effectiveness.

Brady says preparers are just as receptive or enthusiastic about the new accounting as they were when it was issued, but they have taken some time to understand some of the technical aspects of the guidance and consider some of the new opportunities it presents before jumping to adoption.