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FASB finalizes new approach to hedge accounting

Tammy Whitehouse | August 28, 2017

The Financial Accounting Standards Board has issued its long-awaited new accounting standard to simplify hedge accounting, allowing companies to adopt the new approach almost immediately if they choose.

Accounting Standards Update No. 2017-12 edits the Accounting Standards Codification under Topic 815 to make some “targeted improvements” to the accounting for derivative financial instruments, which companies routinely acquire as part of their risk management strategies to hedge various types of financial and operational risks. The new approach to hedge accounting “better aligns the accounting rule with a company’s risk management activities, better reflects the economic results of hedging in the financial statements, and simplifies hedge accounting treatment,” said FASB Chairman Russ Golden in a statement.

Hedge accounting has long been a problematic area for companies, fraught with stringent, complex requirements that have won it the reputation as being among the difficult chapters in GAAP. Current rules requires companies to very carefully match the terms of a derivative to the risk it is meant to hedge in order to qualify for the more favorable hedge accounting treatment in financial statements. Missteps in matching terms and testing for hedge effectiveness have proven challenging, leading to errors and restatements.

Several years ago, when FASB planned an overhaul of financial instrument accounting as part of its movement to converge GAAP with International Financial Reporting Standards, the board initially proposed a single overarching standard for all financial instruments, including derivatives. After feedback, however, the board proceeded with a standard on classifying and measuring financial instruments and a standard on recognizing impairments, tabling hedge accounting for another day.

That day arrived a few years ago when FASB dusted off the hedge accounting project and determined the best approach was to retain existing GAAP with targeted improvements rather than writing a new rulebook from scratch. FASB says its outreach determined that’s ultimately what both preparers and users of financial statements wanted.

The amendments under the new standard expand hedge accounting for financial and non-financial risk components to align the rules with typical corporate risk management activities. That includes allowing more flexibility in hedging interest rate risk both for variable-rate and fixed-rate instruments.

The new rules relax limitations on how a company can measure changes in fair value in certain hedging relationships. They also expand fair value hedges of interest rate risk for closed portfolios of certain pre-payables.  FASB eliminated the separate measurement and recording of hedge effectiveness and made improvements to disclosure and presentation provisions.

The new standard takes effect in 2019 but FASB is permitting early adoption. Early adopters have to comply with a catch, however, says Jon Howard, senior consultation partner at Deloitte & Touche. “When you adopt, it’s not just for new hedging strategies going forward,” he says. “You can refine existing hedges too, but you have to do it all at once when you implement.”

Accounting experts have said they expected companies to seize onto this particular standard when it was published because it makes accounting easier, not more difficult. The requirement upon adoption to revise any existing hedge, if companies are planning to do so, is slowing folks down a little, says Howard.

As many companies continue to work toward adoption of the new revenue recognition standard by the end of this year, Howard predicts most companies will save new hedge accounting processes and procedures for early in 2018.