The Financial Accounting Standards Board (FASB) has issued a proposed Statement, Accounting for Hedging Activities - an amendment of FASB Statement No. 133, which is intended to simplify hedge accounting. Currently, difficulties exist in hedge accounting related to, among other things, quantitatively assessing effectiveness of hedging relationships, measuring ineffectiveness in a cash flow hedge, and measuring the change in value of a hedged item attributable to the hedged risk in a fair value hedge. The proposed Statement would eliminate the multiple methods of hedge accounting, including the shortcut and critical terms matching methods, currently being used for the same transaction under Statement No. 133, Accounting for Derivative Instruments and Hedging Activities.
The proposed Statement would establish a fair value approach to hedge accounting, which would eliminate many elements that exist under the current hedge accounting model, including bifurcation-by-risk and the requirement to quantitatively assess effectiveness in order to qualify for hedge accounting. With two exceptions, the proposed Statement also would require an entity to designate all risks as the hedged risk in the hedged item or transaction. The two exceptions are that an entity would be permitted to designate only foreign currency risk if it so desired, and an entity would be permitted to designate only interest rate risk for hedges of its own fixed- or variable-rate debt if hedging at initial recognition of that debt.
Formal, contemporaneous documentation of the hedging instrument and hedged item or forecasted transaction would still be required along with a qualitative assessment of the effectiveness of the hedging relationship. The qualitative assessment must demonstrate that (a) an economic relationship exists between the hedging instrument and hedged item or forecasted transaction and (b) the derivative should
be expected to reasonably offset changes in fair value or the variability in the hedged cash flows attributable to the hedged risks. The proposed Statement also notes that in certain situations, a quantitative assessment may be more effective in demonstrating the relationship between the derivative instrument and the hedged risk.
Per the proposed Statement, the measurement of hedge ineffectiveness would be based on a comparison of the change in fair value of the actual derivative designated as the hedging instrument and the present value of the cumulative change in expected future cash flows on the hedged transaction. After inception, an entity would need to reassess effectiveness only if circumstances suggest that the hedging relationship may no longer be reasonably effective. These circumstances would depend on the nature of the hedged item or transaction and hedging instrument and on market developments. The ability to discontinue hedge accounting by simply removing the designation of the hedging relationship would not be permitted. Hedge accounting would be discontinued prospectively for an existing fair value hedge only if certain conditions are met.
The proposed Statement would require application of the amended hedging requirements for financial statements issued for fiscal years beginning after June 15, 2009, and interim periods within those fiscal years. Early application will not be permitted. The proposed Statement is available for comment until August 15, 2008 at http://www.fasb.org/draft/ed_hedging_amendment_st133.pdf.
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