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On The Horizon: Details on FASB’s new hedge accounting guidance

RFP
Contents FASB       New standard issued to amend hedge accounting guidance
      Highlights from August 30 meeting posted

SEC staff releases Small Entity Compliance Guide AICPA       Standard on selected procedures engagements proposed
      FinREC releases revenue recognition implementation working drafts

PCAOB issues Staff Inspection Brief on audit risks
Comment letter issued



FASB New standard issued to amend hedge accounting guidance On August 28, the Board issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities, to improve how the economic results of an entity’s risk management activities are reported in the financial statements for hedging relationships, and to simplify how the current hedge accounting guidance is applied.

The key provisions of the ASU are summarized below.

Alignment of risk management activities and financial reporting
The ASU better aligns an entity’s risk management activities and financial reporting for hedging relationships by expanding and refining hedge accounting for both nonfinancial and financial risk components. It also aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. Specifically, the amendments (1) permit hedge accounting for certain hedging relationships, (2) change the guidance for measuring changes in fair value of the hedged item attributable to interest-rate risk in certain fair value hedging relationships, and (3) address where an entity reports the effect of the hedging instrument.

Risk component hedging

To address current limitations on how an entity can designate the hedged risk in certain cash flow and fair value hedging relationships, the amendments permit hedge accounting for risk components in hedging relationships involving nonfinancial risk and interest-rate risk for the following types of hedge transactions:

  • Cash flow hedge of a forecasted purchase or sale of a nonfinancial asset: An entity may designate as the hedged risk the variability in cash flows attributable to changes in a contractually specified component in the contract, thereby removing the existing requirement that allows only the overall variability in cash flows or variability related to foreign-currency risk to be designated as the hedged risk in a cash flow hedge of a nonfinancial asset.
  • Cash flow hedge of interest-rate risk of a variable-rate financial instrument: The requirement to designate only the overall variability in cash flows as the hedged risk in a cash flow hedge of a variable-rate instrument indexed to a nonbenchmark interest rate is eliminated, and an entity may designate as the hedged risk the variability in cash flows related to the contractually specified interest rate.
  • Fair value hedge of interest-rate risk: An entity that issues or invests in fixed-rate, tax-exempt financial instruments may designate as the hedged risk changes in fair value attributable to interest-rate risk related to the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate, rather than overall changes in fair value.

Accounting for the hedged item in fair value hedges of interest-rate risk

The ASU amends the existing guidance for designating fair value hedges of interest-rate risk and for measuring the changes in fair value of the hedged items in fair value hedges of interest-rate risk by removing certain limitations.

Recognition and presentation of the effects of hedging instruments
To better portray the economic results of an entity’s risk management activities in its financial statements, the amendments align the recognition and reporting of the effects of the hedging instrument and the hedged item in the financial statements, and no longer require separate measurement and reporting of hedge ineffectiveness.

ASU 2017-12 includes the following recognition and reporting guidance for fair value, cash flow, and net investment hedges:

  • Fair value hedges – The entire change in the fair value of the hedging instrument included in the assessment of hedge effectiveness is reported in the same income statement line item where the earnings’ effect of the hedged item is reported. Existing guidance does not specify where the change in fair value of this form of hedging instrument should be reported in the income statement.
  • Cash flow and net investment hedges – Under the existing guidance, the entire change in fair value of the hedging instrument included in the assessment of hedge effectiveness is initially recorded in either other comprehensive income (OCI) for cash flow hedges or in the currency translation adjustment section of OCI for net investment hedges. ASU 2017-12 requires an entity to report the reclassification of such amounts included in OCI to earnings in the same income statement line item that is used to report the earnings’ effect of the hedged item. Existing guidance does not specify where these changes in fair value should be reported in the income statement. The existing guidance related to when these changes in fair value should be reported in earnings could change because hedge ineffectiveness is no longer reported in earnings under the ASU.
     
Amounts excluded from the assessment of hedge effectiveness 

Any portion of a hedging instrument’s change in fair value that is excluded from the assessment of hedge effectiveness is referred to as an “excluded component.” The amendments permit an entity to exclude the portion of the change in fair value of a currency swap that is due to a cross currency–basis spread from the assessment of hedge effectiveness.

An entity may elect to recognize all fair value changes in an excluded component currently in earnings, which is consistent with the existing guidance. For all types of hedges, the amendments also permit an entity to report in earnings the initial value of an excluded component of a hedging instrument’s change in fair value using a systematic and rational method over the life of the hedging instrument. However, if an entity elects to follow this approach, any difference between the change in the fair value of the excluded component and the amounts reported under the systematic and rational method is reported in OCI. If the difference relates to a net investment hedge, it is instead reported in the currency translation adjustment section of OCI.

An entity should report amounts related to the excluded components for fair value hedges and cash flow hedges that are recognized in earnings in the same income statement line item that is used to report the earnings’ effect of the hedged item.

Other simplifications of hedge accounting guidance
The amendments also include certain targeted improvements to the application of existing guidance related to the quantitative and qualitative assessments of initial and ongoing hedge effectiveness, including the requirements that must be met for an entity to forgo quantitative hedge accounting assessments for qualifying relationships, and to apply other methods, such as the shortcut and the critical-terms-match methods. The amendments change effectiveness testing as follows:

  • An entity may perform the initial prospective quantitative assessment of hedge effectiveness any time after hedge designation, but no later than the quarterly effectiveness testing date, using data applicable as of the date of hedge inception.
  • When initial quantitative testing is required, an entity has the option to perform subsequent assessments of hedge effectiveness qualitatively if certain conditions, which must be verified and documented at least quarterly, are met, and may also elect to perform qualitative assessments on a hedge-by-hedge basis.
  • In assessing whether the criteria for the critical-terms-match method are met for a group of forecasted transactions, an entity may assume that the hedging derivative matures at the same time as the forecasted transactions if the maturity dates of the derivative and the forecasted transactions occur within 31 days (or a fiscal month period) of each other.
  • An entity is permitted, when the hedge is highly effective and certain documentation criteria are met at inception, to apply the long-haul method for assessing hedge effectiveness if the entity determines that the shortcut method was not or is no longer appropriate.
  • Private companies that are not financial institutions and certain not-for-profit (NFP) entities may select the method of assessing hedge effectiveness, and may perform the initial quantitative effectiveness assessment and all quarterly hedge effectiveness assessments any time prior to the date when the next interim or annual financial statements are available to be issued. This amendment does not apply to private companies that are not financial institutions that have already elected to apply the simplified hedge accounting approach.

Disclosures
The ASU amends certain disclosures required by the existing guidance, including revisions to tabular disclosures, to add the effect of fair value and cash flow hedges on the income statement. It also removes the existing requirement to disclose the ineffective portion of the change in the fair value of hedging instruments.

The ASU also adds required disclosures related to cumulative-basis adjustments for fair value hedges.

Effective date and transition
For public business entities, the ASU is effective in fiscal years, and in interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the ASU is effective in fiscal years beginning after December 15, 2019 and in interim periods within fiscal years beginning after December 15, 2020.

Early adoption is permitted in any interim period after the ASU has been issued. However, if an entity early adopts the guidance in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes the interim period.

For existing cash flow and net investment hedges, an entity must apply the cumulative-effect adjustment related to eliminating the separate measurement of ineffectiveness to accumulated OCI, with a corresponding adjustment to retained earnings as of the beginning of the fiscal year of adoption. The new and modified disclosure guidance is required only on a prospective basis. Also upon adoption, an entity can make several transition elections on a stand-alone basis to allow existing hedging relationships to transition to the new alternatives available within the ASU.


Other FASB resources
See the August 31 On the Horizon for links to other FASB resources.

Highlights from August 30 meeting posted All decisions reached at Board meetings are tentative and may be changed at future meetings.

The FASB met on August 30 to discuss the conceptual framework and Codification improvements, and took the actions summarized below.

Conceptual framework – elements
The Board discussed the definitions of an asset and a liability, and tentatively decided to eliminate the following terms from these definitions:

  • Probable
  • Future economic benefits
  • Sacrifices of economic benefits
  • Past transactions or events
The Board also directed the staff to further analyze whether the term control is necessary in defining an asset.

Codification improvements (formerly Technical corrections and improvements)
The Board discussed and agreed with a staff analysis of proposed amendments to, and minor clarifications of, the Codification. The Board tentatively decided that transition guidance would be provided for certain amendments, but that a separate Basis for Conclusions section is unnecessary for the forthcoming proposed ASU.

The staff was directed to draft a proposed ASU for vote by written ballot, with a comment period of 60 days.



SEC staff releases Small Entity Compliance Guide Small Entity Compliance Guides summarize and explain rules adopted by the SEC, but they are not a substitute for SEC rules. Only an SEC rule provides complete and definitive information regarding its requirements.

The staff of the SEC’s Division of Corporation Finance recently issued a Small Entity Compliance Guide to summarize key provisions of the Final Rule, Exhibit Hyperlinks and HTML Format, which requires certain registrants to include a hyperlink to each exhibit listed in their filings.

Most registrants are required to comply with the Final Rule in filings submitted on or after September 1, 2017; however, smaller reporting companies and non-accelerated filers that submit their filings in ASCII format are required to comply in filings submitted on or after September 1, 2018.

For more information on the Final Rule, refer to the March 9, 2017 On the Horizon.



AICPA Standard on selected procedures engagements proposed The Accounting and Review Services Committee in a joint project with the Auditing Standards Board of the AICPA issued an exposure draft of a Proposed Statement on Standards for Attestation Engagements (SSAE), Selected Procedures, to expand a practitioner’s ability to perform procedures and report in a procedures and findings format beyond the requirements in AT-C Section 215, Agreed-Upon Procedures Engagements.

Under the proposed standard, a selected procedures engagement would be different from an agreed-upon procedures engagement in the following key respects:

  • The practitioner would not be required to request or obtain an assertion from any party.
  • There is no requirement regarding who determines the procedures to be applied, and the practitioner may determine such procedures.
  • The specified parties would not be required to take responsibility for the sufficiency of the procedures for any purpose, although the practitioner, the engaging party, or another party may take such responsibility.
  • The practitioner would not be required to restrict the use of the report but would be able to allow use of it by a wider audience.

The effective date is expected to be for reports dated on or after May 1, 2019, but in no event earlier than that date.

Comments are due by December 1.

FinREC releases revenue recognition implementation working drafts
The AICPA Financial Reporting Executive Committee (FinREC) released working drafts of several revenue recognition implementation issues for comment. This latest set of working drafts discusses considerations about, and provides illustrative examples for, entities implementing the new revenue standard in the following industries:

  • Aerospace and defense
  • Asset management
  • Brokers-dealers
  • Engineering and construction
  • Power and utilities
  • Software
  • Timeshare

These implementation issues will be added to the AICPA audit and accounting guide on revenue recognition after the review of public comments and finalization of the issues.

The comment period for these working drafts ends November 1.



PCAOB issues Staff Inspection Brief on audit risks The PCAOB issued a Staff Inspection Brief providing information on the areas of significant audit risk targeted by PCAOB inspectors during its ongoing 2017 inspections of auditors of public companies and other issuers.

The key focus for 2017 audits includes

  • Areas where inspectors have identified deficiencies in the past
  • Areas affected by recent economic developments
  • Financial reporting areas that require significant judgment
  • Firm compliance with the new transparency rules and Form AP
  • Preparation for new accounting standards for revenue recognition and lease accounting
  • Work by other auditors on multinational engagements
  • Auditor use of information technology, particularly software audit tools
  • The firm’s system of quality control



Comment letter issued On August 25, the firm issued a comment letter in response to the FASB’s proposed ASU on targeted improvements to related-party guidance for variable-interest entities.



© 2017 Grant Thornton LLP, U.S. member firm of Grant Thornton International Ltd. All rights reserved. This Grant Thornton LLP On the Horizon provides information and comments on current accounting and SEC reporting issues and developments. It is not a comprehensive analysis of the subject matter covered and is not intended to provide accounting or other advice or guidance with respect to the matters addressed in this publication. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this publication. For additional information on topics covered in this publication, contact a Grant Thornton client-service partner.