FASB Floats 5 Areas of Key Reforms to Simplify Hedge Accounting Rules

The FASB proposed five areas of targeted changes to hedge accounting rules on September 25, 2024, to better align financial reporting with economic realities and simplify the rules.

The proposal aims to simplify hedge accounting rules under Topic 815, Derivatives and Hedging, which have been complicated by global reference rate reform. The changes could help companies reduce the risk of unexpected events and errors, and better align financial reporting with economic hedging strategies.

According to the FASB, the proposal will provide investors and other financial statement users with more useful information, while reducing the cost and complexity of managing hedge accounting programs.

The FASB is inviting public feedback on its proposed changes, outlined in Proposed Accounting Standards Update (ASU) No. 2024-ED200 Derivatives and Hedging (Topic 815), Hedge Accounting Improvements, with comments due by November 25.

Hedge accounting is a specialized accounting technique used by companies to manage and report on their financial risk exposures. It involves designating a specific financial instrument, such as a derivative (e.g., option, futures, or swap), as a “hedge” to offset the potential losses or gains from an underlying asset or liability. Among the reasons companies use hedge accounting is to mitigate the impact of market fluctuations on their financial performance. For instance, an airline company might use hedge accounting to lock in a fixed fuel price, protecting itself from potential losses due to rising fuel costs.

The proposal tackles five traditionally complex areas of hedge accounting:

• Similar Risk Assessment for Cash Flow Hedges: Today, companies have to show that a group of transactions has a shared risk exposure to use hedge accounting. The FASB proposes to change this to a “similar risk exposure” requirement. This means companies will be able to use hedge accounting for a broader range of transactions.
• Hedging Forecasted Interest Payments on Adjustable-Rate Debt: Currently, companies have a hard time using hedge accounting for loans with adjustable interest rates. The FASB proposes to make it easier for companies to use hedge accounting for these types of loans. This will help companies reduce the risk of mistakes and better reflect their risk management strategies in their financial reports.
• Expanding Cash Flow Hedges to Non-Financial Forecasted Transactions: Right now, companies can only use hedge accounting for certain types of forecasted transactions. The FASB proposes to expand this to include forecasted purchases and sales of non-financial assets, like commodities. This change could help companies use hedge accounting for more situations and reduce the chance of mistakes.
• Allowing Net Written Options as Hedging Instruments: Currently, to qualify for hedge accounting, a company needs to show that its investments (like options and derivatives) balance out potential gains and losses. But since the London Interbank Offered Rate (LIBOR) stopped, it’s been hard to do this because of small differences in interest rates. The proposed change would make it easier by allowing companies to assume that the interest rates and timing of their investments match, as long as they come from the same source and happen within a short 31-day period. This makes it more likely that companies can use hedge accounting for their investments, even if the rates and timing are slightly different.
• Simplifying Hedge Accounting for Foreign Currency-Denominated Debt: Currently, companies have to report their foreign currency-denominated debt in a way that can be confusing. The FASB proposes to simplify this by excluding certain adjustments from the net investment hedge effectiveness assessment. This change aims to help companies show how changes in interest rates and exchange rates affect their finances in a more accurate way.