The FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815)
: Targeted Improvements to Accounting for Hedging Activities
, which makes targeted improvements to the hedge accounting model in order to improve financial reporting of hedging relationships and simplify the application of hedge accounting guidance. As a result of feedback during implementation, the FASB determined that certain areas require clarification to better align with the objectives in ASU 2017-12.
Issue 1: Change in Hedged Risk in a Cash Flow Hedge
Under ASU 2017-12, uncertainty about when an entity should apply missed forecast guidance was identified. This proposed ASU would clarify that the forecasted transaction and hedged risk are distinct, and thus, the forecasted transaction would be relevant in the application of the missed forecast guidance.
Based on this clarification, the proposed ASU would clarify that the designated hedge risk should represent an entity’s best estimate of the hedged risk expected to cause variability in the cash flows of the forecasted transaction. Additionally, the forecasted transaction must be documented with enough specificity so that the entity can identify a transaction that is eligible to be identified as hedged.
The proposed ASU would also clarify that an entity should assess effectiveness using its then-best estimate of the hedged risk and should not revise previous assessments. Forecasted transactions hedged in a group should share the risk exposure for which they are being hedged at hedge inception and prospectively based on the then-best estimate of the hedged risk.
The proposed ASU clarifies that hedges of foreign exchange risk and credit risk are excluded from the scope of the change in hedged risk guidance.
Issue 2: Contractually Specified Components in Cash Flow Hedges of Nonfinancial Forecasted Transactions
The proposed ASU would clarify the nature of documentation that may evidence a contractually specified component and such documentation may be received before or after the forecasted transaction occurs.
The proposed ASU would clarify that the entity need apply only the portion of the normal purchases and normal sales scope exception that requires all underlyings in the agreement to be clearly and closely related to the asset being sold or purchased in such instances.
For non-spot-market transactions, the proposed ASU would clarify that the pricing formula that includes the contractually specified component must determine the price of the nonfinancial asset but no prescribed method is required. For spot-market transactions, the pricing formula that includes the contractually specified component must be based on how the price is determined in that nonfinancial asset’s spot market.
If the physical settlement of the contract accounted for as a derivative is probable and the forecasted transaction is not the acquisition of a nonfinancial asset that will subsequently be remeasured with changes in fair value reported in earnings, the proposed ASU would clarify that the purchase or sale of a nonfinancial asset may be designated by either the variability of the overall price changes or the variability in the contractually specified component.
Issue 3: Foreign-Currency-Denominated Debt Instrument as Hedging Instrument and Hedged Item (Dual Hedge)
The proposed ASU would eliminate the recognition and presentation mismatch related to dual hedges as a result of ASU 2017-12. The entity would be required to exclude the foreign-currency-denominated debt instrument’s fair value hedge basis adjustment from the net investment hedge effectiveness assessment. Gain and losses from remeasurement of the debt instrument’s fair value hedge basis adjustment at the spot exchange rate would be immediately recognized in earnings.
Issue 4: Using the Term Prepayable under the Shortcut Method
The term “prepayable” would be replaced with “early settlement feature”.
The proposed ASU would be effective for all entities for fiscal years beginning after December 15, 2020. For public business entities, the proposed ASU would be effective for interim periods within fiscal years beginning after December 15, 2020. For all other entities, the proposed ASU would be effective for interim periods within fiscal years beginning after December 15, 2021. Early adoption would be permitted for all entities on any date on or after issuance of a final ASU, if the entity has already adopted ASU 2017-12.
Entities that adopt ASU 2017-12 and this proposed ASU on the same date would apply the same transition method for both ASUs as described in ASU 2017-12. Entities that have adopted ASU 2017-12 as of the adoption date of the final amendments in this proposed ASU would be permitted to apply the proposed amendments on a prospective basis from the date of adoption or on a retrospective basis to the date of adoption of ASU 2017-12 with certain exceptions.
Comments are due on this Exposure Draft to the FASB by January 13, 2020. The full text of the Exposure Draft is available here.
Readers should not act upon information presented without individual professional consultation.