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What you should know about hedge accounting

On the Radar: ASC 815 fair value and cash flow hedges

Knowing how to apply the hedge accounting guidance of ASC 815 is vital. Knowing when to apply it is equally so. Our latest On the Radar article breaks down high-level hedge accounting questions to help you understand where ASC 815 requirements fit into your financial picture and how to fulfill them.

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Some entities mitigate certain risks by entering into separate contracts that meet the definition of a derivative instrument. For such circumstances, ASC 815 allows entities to use a specialized hedge accounting for qualified hedging relationships.

If hedge accounting is not applied, changes in the fair values of derivative instruments are recognized in earnings in each reporting period, which may or may not match the period in which the risks that are being hedged affect earnings. Therefore, the objective of hedge accounting is to match the timing of income statement recognition of the effects of the hedging instrument with the timing of recognition of the hedged risk.

On the Radar: Hedge Accounting

What are the different hedge accounting models?

ASC 815 provides three categories of hedge accounting, each with its own accounting and reporting requirements:

Let’s break down each model in a little more detail

If it becomes probable that a hedged forecasted transaction either will not occur or will not occur without significant delay, an entity must immediately reclassify amounts from AOCI into earnings.

Note that derivatives that are used as economic hedges but are not designated in qualifying hedging relationships require special consideration for financial reporting purposes. Finally, some derivatives are entered into for speculative purposes and are not part of a risk mitigation strategy.

On the horizon

In November 2019, the FASB issued a proposed ASU of Codification improvements to hedge accounting. Comments were due in January 2020. The FASB is still considering comment letter feedback on the proposed ASU.

In addition, ASU 2017-12 added the “last-of-layer” method to ASC 815, which enables an entity to apply fair value hedging to closed portfolios of prepayable financial assets without having to consider prepayment risk or credit risk when measuring those assets. On May 5, 2021, the FASB issued a proposed ASU that would expand the current single-layer model to allow multiple-layer hedges of a single closed portfolio of prepayable financial assets under this method. The last-of-layer method would be renamed the “portfolio layer method” to reflect this change. Comments on the proposed ASU were due on July 5, 2021.

Continue your hedge accounting learning

Want to dive deeper on ASC 815, the different hedge accounting models, and when you should apply them? Get a comprehensive breakdown of this timely and nuanced topic in Deloitte’s Roadmap: Hedge Accounting.

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