Is Hedge Accounting Right For You? Simplification in Policy May Lead You To Reconsider

Recent changes are coming for hedge accounting that will likely have a positive impact on your company’s hedging strategies. Currently, hedge accounting is very complex, and many companies avoid using it to avoid errors and misstatements. This could change, as hedge accounting has been simplified under The Accounting Standards Update ((ASU) No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities).

Current Hedging Strategies

Hedging strategies protect earnings from unexpected changes such as fluctuations in foreign currencies, changes in interest rates, and price jumps in raw materials. Hedging includes purchasing futures, options or swaps, and designating these derivative instruments to hedged items. This process recognizes gains and losses in the same period, which in turn stabilizes earnings.

Currently, hedging transactions must be “highly effective,” and documented from the outset. Periodically, businesses must assess the transactions of their hedging instruments for effectiveness.

The complexity, and consequently, avoidance of hedging strategies leaves investors frustrated. Without the use of hedge accounting rules, stakeholders do not get a full picture of how a business operates.

Updates in Hedge Accounting

ASU 2017-12 has added flexibility and ease in reporting hedging strategies on financial statements. The addition of practical expedients makes it easier for private businesses to apply the hedge accounting guide.

In addition, strategies that are eligible for hedge accounting have been expanded. Now included in the strategies are:

  1. Hedges of the benchmark rate component of the contractual coupon cash flows of fixed-rate assets or liabilities
  2. Hedges of the portion of a closed portfolio of prepayable assets not expected to prepay
  3. Partial-term hedges of fixed-rate assets or liabilities

The updated standard also includes:

Hedging of nonfinancial components, such as rubber in a tire, or corrugated material in a cardboard box

  1. Elimination of a penalty in the “shortcut” method of hedge accounting for interest rate swaps that meet specific criteria
  2. Elimination of the concept of recording hedge “ineffectiveness”
  3. Adding the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate to the list of acceptable benchmark interest rates for hedges of fixed-interest-rate items
  4. Revision of the presentation and disclosure requirements for hedging to be more user-friendly

Transition to Updates

ASU 2017-12 will be effective for public companies for reporting periods starting after December 15, 2018. Private companies will have another year to comply with the changes. The advantages offered in these updates are expected to cause many companies to adopt them prior to the effective date.

If you are using hedging strategies, we can help to determine if it makes sense to use the new rules before the effective date. We can also discuss how to report complex hedging transactions. Transferring to the amendments may be complicated, we can help with the process. Contact us at 818-334-8623 or click here and we will contact you.

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