Finalized Improvements to Hedge Accounting Released

MAYER HOFFMAN MCCANN P.C. – AN INDEPENDENT CPA FIRM
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MHM (Mayer Hoffman McCann P.C.) is an independent CPA firm that is a member firm of Kreston International Limited, a global network of independent accounting firms.
A publication of the Professional Standards Group
November 2017
Finalized Improvements to Hedge Accounting Released
The Financial Accounting Standards Board (FASB)
released its long-awaited improvements to ASC Topic
815, Derivatives and Hedging in late August. The
hedging project began as a significant overhaul to hedge
accounting as proposed in 2008 and 2010 Exposure
Drafts. However, upon reactivating the hedging project,
the FASB determined such broad based changes were
not necessary; rather, several targeted improvements
could achieve the objectives.
These amendments, provided in Accounting Standards
Update (ASU) 2017-12, are designed to address
concerns expressed by preparers and users of financial
statements regarding difficulties in applying hedge
accounting as well as the clarity with which hedging
activities are presented in the financial statements.
Significant changes provided by the amendments of
ASU 207-12 include:
• Expanded number of strategies that qualify for
hedge accounting (financial and nonfinancial
transactions)
• Changes to the measurement of the hedged item in
a fair value hedge
• Provisions for qualitative testing of ongoing hedge
effectiveness
• Elimination of the requirement to calculate hedge
ineffectiveness for cash flow hedges
• Additional time to complete the initial hedge
designation documentation (i.e. no longer required
to be contemporaneous)
• Guidance on income statement presentation and
additional disclosure requirements in the notes to
the financial statements
Hedge Accounting Strategies
The amendments in ASU 2017-12 permit entities more
options to hedge the interest rate risk for both variable
rate and fixed rate financial instruments. Cash flows
hedges have historically been limited to only qualifying
benchmark interest rates, however, the amendments
allowcashflowhedgesofinterestrateriskbydesignating
as the hedged risk the variability in cash flows attributed
to any contractually specified interest rate. Therefore,
entities will no longer be required 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 non-benchmark interest rate.
This changes does not apply to fair value hedges
of interest rate risk, but the Securities Industry and
Financial Markets Association (SIFMA) Municipal Swap
Rate has been added as an allowable benchmark
interest rate for fair value hedges, which allows entities
that invest in fixed-rate, tax-exempt financial instruments
to hedge fair value changes attributable to interest rate
risk related to the SIFMA Swap Rate.
The amendments will also allow entities to hedge risk
components for nonfinancial assets. This will likely have
the biggest impact on hedging strategies associated
with components of a forecasted purchase or sale of a
nonfinancial asset as entities will no longer be required
to designate the overall variability in cash flows as
the hedged cash flows, which often includes a basis

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difference for commodities. This allows an entity to
designate the hedged risk as the variable in cash flows
attributable to the changes in a contractually specified
component in the contract.
Also, when assessing whether the qualifying 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 transaction if both the derivative maturity
and the forecasted transactions occur within the same
31-day period or fiscal month.
Accounting for the Hedged Item in a Fair Value
Hedge of Interest Rate Risk
To address concerns regarding limitations on the
measurement of the fair value of the hedged items in a
fair value hedge of interest rate risks, the amendments
include certain accommodations for determining the
fair value of the hedged item, including permitting:
• Entities to measure the change in fair value of the
hedged item on the basis of the benchmark rate
component of the contractual coupon cash flows
determined at hedge inception, rather than the
full contractual coupon cash flows as required by
current U.S. GAAP;
• An entity to measure the hedged item in a partial-
term fair value hedge of interest rate risk by
assuming the hedge item has a term that reflects
only the designated cash flows being hedged; and
• Entities to consider how changes in the benchmark
interest rate affect the decision to settle a debt
instrument before its scheduled maturity in the fair
value determination.
Additionally,foraclosedportfolioofprepayablefinancial
assets, an entity can designate an amount that is not
expected to be affected by prepayments, defaults, or
other events affecting the timing and amount of cash
flows. As a result, prepayment risk is not incorporated
intothemeasurementofthefairvalueofthehedgeditem.
Effectiveness Testing
Initial quantitative testing remains required in most
instances. Entities can elect to perform subsequent
assessments of hedging effectiveness using qualitative
measures. This eliminates the current requirement
to perform a quantitative assessment in connection
with each quarterly assessment. Entities that choose
the qualitative assessment election must verify and
document on a quarterly basis that the facts and
circumstances related to the hedging relationship have
not changed such that the entity can assert qualitatively
that the hedging relationship continues to be highly
effective. The election can be made on a hedge-by-
hedge basis. Changes in the reporting of effectiveness
include the following:
Cash Flow & Net Investment Hedges
Entities will record the entire change in the fair value
of the hedging instrument included in the assessment
of hedge effectiveness in other comprehensive income
(cash flow hedges) or in the currency translation
adjustment section of other comprehensive income
(net investment hedges), eliminating the need to
calculate and report ineffectiveness. Changes in the
fair value of the hedging instrument reporting in other
comprehensive income will be recognized in earnings
at the same time that the hedged item impacts income.
Fair Value Hedges
Entities will present the entire change in the fair value
of the hedging instrument included in the assessment
of hedge effectiveness in the same income statement
line as the earnings effect of the hedged item. The
timing of recognition in the change in fair value of the
hedging instrument is the same as under current U.S.
GAAP.
To further simplify accounting for hedge effectiveness,
the amendments allow entities to exclude option
premiums and forward points as well as certain
components of a hedging instrument’s change in
fair value from the hedge effectiveness assessment.

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Entities can also exclude the portion of the change in
fair value of a currency swap that is attributable to a
cross-currency basis spread from the assessment of
hedge effectiveness. If entities elect to exclude certain
components of a hedging instrument’s change in fair
value from the assessment of hedge effectiveness,
they can elect to either recognize the changes in the
fair value of the excluded components of the hedging
instrument in current period earnings or defer the
amounts and recognize over the life of the hedge. If
an entity elects deferral, any difference between the
change in fair value of the excluded components
and amounts deferred and recognized under a
systematic and rational method is recognized in other
comprehensive income (for net investment hedges, the
difference is recognized in the cumulative translation
adjustment section of other comprehensive income).
As a result, entities may now report amounts in other
comprehensive income related to fair value hedging
strategies.
The changes are designed to assist entities in
reporting the economic results of fair value and cash
flow hedges. They are also expected to assist financial
statement users in seeing the results of an entity’s
hedging program.
Documentation Requirements
Existing GAAP requires entities to complete the hedge
documentation contemporaneous with the date of
designation, although certain relief has been granted
to non-public entities applying the simplified approach.
The amendments in ASU 2017-12 allow all entities a
grace period in completing the hedge documentation,
so long as it is completed no later than the first quarterly
effectiveness testing date (i.e. completed during the
completion of the interim period of designation).
Private entities that are not financial institutions may
elect the method of assessing hedge effectiveness,
perform the initial qualitative effectiveness assessment
and perform all quarterly hedge effectiveness
assessments before the next interim or annual financial
statement is issued.
Inappropriate application of the short cut method
of hedge accounting has resulted in a significant
number of prior period errors and financial statement
restatements. In order to address this perceived
application issue, the FASB included provisions in
ASU 2017-12 that allow an entity to apply short cut
accounting. Entities can apply the long haul method of
hedge accounting if it is later determined the hedging
strategy does not qualify for the short cut method. The
ability to apply the long haul method, and not consider
the accounting in the prior period to be an error, is only
available to a reporting entity if the hedge is highly
effective and the details regarding the application of
the long haul method are included in the original hedge
designation documentation.
Presentation and Disclosure
As part of an effort to better portray the economic
results of an entity’s risk management activities,
the amendments include certain changes to the
presentation and disclosure requirements. Entities will
present the earnings effect of the hedging instrument
in the same income statement line item in which the
earnings’ effect of the hedged item is reported.
The amendments to the disclosures are designed
to provide users with a more complete picture of the
effect of hedge accounting on the income statement
and balance sheet, which may provide more decision-
useful information. The amendments include additional
information in the tabular disclosure related to the
effect of cash flow and fair value hedges on the income
statement designed to focus on the effect of the
hedging strategies on the individual income statement
line items. Cumulative basis adjustments for fair value
hedges will also have new tabular disclosures.

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The information in this MHM Messenger is a brief summary and may not include all the details relevant to your situation. Please
contact your MHM auditor to further discuss the impact on your audit or audit report.
Effective Date
Public business entities will be required to adopt these
amendments for fiscal years and interim periods
beginning after Dec. 15, 2018. All other entities will be
required to adopt for fiscal years beginning after Dec.
15, 2019, and interim fiscal periods beginning after
Dec. 15, 2020.
Early adoption is permitted, and based on the changes,
it is expected many entities will take advantage of
the improvements by adopting early. Upon adoption,
entities will apply the new guidance to existing hedging
relationships. Cash flow and investment hedges will
require a cumulative-effect adjustment that relates
to the elimination of the separate measurement of
ineffectiveness to accumulated income. Entities will
also need to make a corresponding adjustment to the
opening balance of retained earnings in the year of
adoption for their cash flow and investment hedges.
Presentation and disclosure guidance will be adopted
prospectively.
For More Information
If you have specific comments, questions or concerns
about the new guidance for financial instruments,
please contact Mike Loritz or James Comito of MHM’s
Professional Standards Group. Mike can be reached
at mloritz@cbiz.com or 816.945.5611. James can be
reached at jcomito@cbiz.com or 858.795.2029.

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