The Financial Accounting Standards Board is proposing some changes to hedge accounting rules recommended by its Emerging Issues Task Force meant to make it easier for companies to apply the rules consistently.
One proposed update to accounting standards would try to resolve different approaches that have developed in practice around how to apply a four-step decision sequence specified in accounting guidance meant to determine whether certain instruments should be treated as embedded derivatives that must be separated from the host contract. Another proposal would address different views around whether a change in counterparty in a derivative contract means that the instrument must be dedesignated as a hedge for accounting purposes.
In the call-and-put options proposal, FASB says companies have interpreted existing guidance around a four-step decision sequence in different ways, leading to potentially different accounting conclusions. Some companies have applied only the four-step process to the assessment of whether contingent call or put options are clearly and closely related to a debt instrument, and therefore should be bifurcated, or accounted for separately. Others, says FASB, also have considered whether the event that triggers an ability to exercise the call or put option is indexed only to interest rates or credit risk.
FASB’s proposal would amend accounting standards to say an entity would be required to assess an embedded call or put option solely under the four-step decision sequence. “The proposed amendments would be an improvement to GAAP because they would eliminate diversity in practice in assessing embedded contingent call (put) options in debt instruments,” FASB says in its proposal.
As for the proposal focused on counterparties, FASB says it has heard questions about whether a change in counterparty to a derivative instrument means the original derivative has been terminated in the context of existing hedge accounting guidance. Counterparties might change for a variety of reasons, FASB says, such as when financial institutions merge or engage in intercompany transactions, or when an entity takes steps to manage internal credit limits or respond to legal or regulatory requirements.
The proposal would clarify that a change in counterparty does not all by itself require dedesignation of the hedge accounting relationship, as long as all other hedge accounting criteria continue to be met, FASB says. FASB is accepting comments on both proposals through Oct. 5. Effective dates will be determined after the board considers feedback.