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Why Is the FASB Issuing This Accounting Standards Update (Update)?
The amendments in this Update provide optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting.
In response to concerns about structural risks of interbank offered rates (IBORs), and, particularly, the risk of cessation of the London Interbank Offered Rate (LIBOR), regulators in several jurisdictions around the world have undertaken reference rate reform initiatives to identify alternative reference rates that are more observable or transaction based and less susceptible to manipulation.
Stakeholders raised certain operational challenges likely to arise in accounting for contract modifications and hedge accounting because of reference rate reform. Some of those challenges relate to the significant volume of contracts and other arrangements, such as debt agreements, lease agreements, and derivative instruments, which will be modified to replace references to discontinued rates with references to replacement rates. For accounting purposes, such contract modifications are required to be evaluated in determining whether the modifications result in the establishment of new contracts or the continuation of existing contracts. Stakeholders indicated that due to the significant volume of affected contracts and other arrangements, together with a compressed time frame for making contract modifications, the application of existing accounting standards on assessing modifications versus extinguishments could be costly and burdensome. In addition, stakeholders indicated that financial reporting results should reflect the intended continuation of such contracts and arrangements during the period of the market-wide transition to alternative reference rates.
Stakeholders raised additional accounting issues specific to hedge accounting. In particular, changes in a reference rate could disallow the application of certain hedge accounting guidance, and certain hedging relationships may not qualify as highly effective during the period of the market-wide transition to a replacement rate. Stakeholders indicated that the inability to apply hedge accounting because of reference rate reform could result in financial reporting outcomes that do not reflect entities’ intended hedging strategies.
Who Is Affected by the Amendments in This Update?
The amendments in this Update are elective and apply to all entities, subject to meeting certain criteria, that have contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform.
What Are the Main Provisions?
The amendments in this Update provide optional expedients and exceptions for applying generally accepted accounting principles (GAAP) to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met.
The amendments in this Update apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The expedients and exceptions provided by the amendments do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, except for hedging relationships existing as of December 31, 2022, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship.
Optional Expedients for Contract Modifications
The amendments in this Update apply to contract modifications that replace a reference rate affected by reference rate reform (including rates referenced in fallback provisions) and contemporaneous modifications of other contract terms related to the replacement of the reference rate (including contract modifications to add or change fallback provisions).
The following optional expedients for applying the requirements of certain Topics or Industry Subtopics in the Codification are permitted for contracts that are modified because of reference rate reform and that meet certain scope guidance:
  1. Modifications of contracts within the scope of Topics 310, Receivables, and 470, Debt, should be accounted for by prospectively adjusting the effective interest rate.
  2. Modifications of contracts within the scope of Topics 840, Leases, and 842, Leases, should be accounted for as a continuation of the existing contracts with no reassessments of the lease classification and the discount rate (for example, the incremental borrowing rate) or remeasurements of lease payments that otherwise would be required under those Topics for modifications not accounted for as separate contracts.
  3. Modifications of contracts do not require an entity to reassess its original conclusion about whether that contract contains an embedded derivative that is clearly and closely related to the economic characteristics and risks of the host contract under Subtopic 815-15, Derivatives and Hedging— Embedded Derivatives.
For other Topics or Industry Subtopics in the Codification, the amendments in this Update also include a general principle that permits an entity to consider contract modifications due to reference rate reform to be an event that does not require contract remeasurement at the modification date or reassessment of a previous accounting determination.
When elected, the optional expedients for contract modifications must be applied consistently for all eligible contracts or eligible transactions within the relevant Topic or Industry Subtopic within the Codification that contains the guidance that otherwise would be required to be applied.
Exceptions to Topic 815 Guidance Related to Changes in Critical Terms of a Hedging Relationship
The amendments in this Update provide exceptions to the guidance in Topic 815 related to changes to the critical terms of a hedging relationship due to reference rate reform. The following changes should not result in the dedesignation of the hedging relationship if certain criteria are met:
  1. Certain changes in the critical terms of a designated hedging instrument, a hedged item, or a forecasted transaction in a fair value hedge, a cash flow hedge, or a net investment hedge.
  2. A change to rebalance or adjust the hedging relationship as follows:
    1. In a fair value hedge, a change in the proportion of the derivative designated as the hedging instrument or in the proportion of the designated hedged item or both.
    2. In a fair value hedge or a cash flow hedge, a change in the designated hedging instrument to add one or more additional derivatives (or proportions of those derivatives).
  3. For a cash flow hedge, a change in the method used to assess hedge effectiveness when initially applying an optional expedient method and when reverting to the requirements in Subtopics 815-20, Derivatives and Hedging—Hedging—General, and 815-30, Derivatives and Hedging—Cash Flow Hedges.
Optional Expedients for Excluded Components
The amendments in this Update provide the following optional expedients for fair value hedging relationships, cash flow hedging relationships, and net investment hedging relationships for which the component excluded from the assessment of hedge effectiveness is affected by reference rate reform:
  1. An entity may change its systematic and rational method used to recognize in earnings the components excluded from the assessment of effectiveness.
  2. If the changes to the hedging instrument’s contractual terms cause a change in the fair value of the excluded component, an entity may elect to recognize the change in fair value of the excluded component in current earnings.
The optional expedients for excluded components may be elected on an individual hedging relationship basis.
Optional Expedients for Fair Value Hedges
The amendments in this Update provide the following optional expedients for fair value hedging relationships for which the derivative designated as the hedging instrument is affected by reference rate reform if certain criteria are met:
  1. An entity may change the designated benchmark interest rate documented at hedge inception to a different eligible benchmark interest rate under Subtopic 815-20. The amendments permit an entity to apply a method to change the designated benchmark interest rate that either adjusts the hedged item’s cumulative fair value hedge basis adjustment or maintains the hedged item’s cumulative basis adjustment. The method applied to change the designated benchmark interest rate must be reasonable and must be applied consistently across similar fair value hedging relationships. If an entity elects an approach that would result in a change to the cumulative fair value hedge basis adjustment, that change should be recognized in current earnings in the same income statement line item used to present the earnings effect of the hedged item.
  2. An entity may disregard certain qualifying conditions for the shortcut method that are not met because of reference rate reform and may continue to disregard those qualifying conditions for the remainder of the fair value hedging relationship (including for the remainder of hedging relationships that end after December 31, 2022).
The optional expedients for fair value hedging relationships may be elected on an individual hedging relationship basis. The method applied by an entity to change the designated benchmark interest rate should be applied consistently across similar fair value hedging relationships.
Optional Expedients for Cash Flow Hedges
The amendments in this Update provide the following optional expedients for cash flow hedging relationships affected by reference rate reform if certain criteria are met:
  1. If the designated hedged interest rate risk is a rate that is affected by reference rate reform:
    1. An entity should disregard the potential change in the designated hedged interest rate risk that may occur because of reference rate reform when the entity assesses whether the hedged forecasted transaction is probable in accordance with the requirements of Topic 815.
    2. An entity may continue hedge accounting for a cash flow hedge for which the hedged interest rate risk changes if either the hedge is highly effective under an assessment method in Subtopics 815-20 and 815-30 or an optional expedient method in this Update is elected.
  2. For cash flow hedges for which the shortcut method or another method that assumes perfect hedge effectiveness has been applied in accordance with Subtopic 815-20, an entity may disregard certain qualifying conditions for those methods that are not met because of reference rate reform and continue to apply the shortcut method.
  3. For cash flow hedges for which either the hedging instrument or hedged forecasted transactions reference a rate that is expected to be affected by reference rate reform, an entity may adjust how it applies the methods in Subtopics 815-20 and 815-30 used to initially and subsequently assess hedge effectiveness (including the shortcut method and other assessment methods that assume perfect hedge effectiveness) to disregard certain mismatches between the designated hedging instrument and the hedged item.
  4. If an entity has performed an initial hedge effectiveness assessment for a cash flow hedge using a method in Subtopics 815-20 and 815-30, or has adjusted those methods using an optional expedient in this Update, the entity may elect to subsequently assess hedge effectiveness using a qualitative method. This qualitative method effectively suspends subsequent hedge effectiveness assessments that would otherwise be required by Subtopics 815-20 and 815-30.
  5. For cash flow hedges of portfolios of forecasted transactions that reference a rate that is expected to be affected by reference rate reform, an entity may disregard the requirement in Subtopic 815-20 that the group of individual transactions must share the same risk exposure for which they are designated as being hedged.
The optional expedients for cash flow hedging relationships may be elected on an individual hedging relationship basis. After electing an optional expedient method, an entity may revert to hedge accounting requirements in Subtopics 815-20 and 815-30 without dedesignating the hedging relationship. Use of the optional expedients (including the optional expedient for application of the shortcut method and other methods that assume perfect hedge effectiveness) must be discontinued either as of the date that neither the hedging instrument nor the hedged forecasted transaction references a rate that is affected by reference rate reform or after December 31, 2022. An entity must revert to applying the qualifying criteria and hedge assessment methods in Subtopics 815-20 and 815-30 to assess whether a cash flow hedging relationship may continue after the entity discontinues applying an optional expedient method.
One-Time Election to Sell or Transfer Debt Securities Classified as Held to Maturity
In accordance with the amendments in this Update, an entity may make a onetime election to sell, transfer, or both sell and transfer debt securities classified as held to maturity that reference a rate affected by reference rate reform and that are classified as held to maturity before January 1, 2020.
When Will the Amendments Be Effective and What Are the Transition Requirements?
The amendments in this Update are effective for all entities as of March 12, 2020 through December 31, 2022.
An entity may elect to apply the amendments for contract modifications by Topic or Industry Subtopic as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. Once elected for a Topic or an Industry Subtopic, the amendments in this Update must be applied prospectively for all eligible contract modifications for that Topic or Industry Subtopic.
An entity may elect to apply the amendments in this Update to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020 and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020.
If an entity elects to apply any of the amendments for an eligible hedging relationship existing as of the beginning of the interim period that includes March 12, 2020, any adjustments as a result of those elections must be reflected as of the beginning of that interim period and recognized in accordance with the guidance in Reference Rate Reform Subtopics 848-30, 848-40, and 848-50 (as applicable). If an entity elects to apply any of the amendments for a new hedging relationship entered into between the beginning of the interim period that includes March 12, 2020 and March 12, 2020, any adjustments as a result of those elections must be reflected as of the beginning of the hedging relationship and recognized in accordance with the guidance in Reference Rate Reform Subtopics 848-30, 848-40, and 848-50 (as applicable).
For private companies that are not financial institutions as described in paragraph 942-320-50-1 and not-for-profit entities (except for not-for-profit entities that have issued, or are a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market), an entity must update its hedge documentation noting the changes made before the next interim (if applicable) or annual financial statements are available to be issued. For all other entities, an entity must update its hedge documentation noting the changes made no later than when the entity performs its first quarterly assessment of effectiveness after the election.
The amendments in this Update do not apply to contract modifications made after December 31, 2022, new hedging relationships entered into after December 31, 2022, and hedging relationships evaluated for periods after December 31, 2022, except for hedging relationships existing as of December 31, 2022, that apply the following optional expedients that are retained through the end of the hedging relationship (including for periods evaluated after December 31, 2022):
  1. An optional expedient to the systematic and rational method used to recognize in earnings the components excluded from the assessment of effectiveness
  2. An optional expedient to the rate to discount cash flows associated with the hedged item and any adjustment to the cash flows for the designated term or the partial term of the designated hedged item in a fair value hedge
  3. An optional expedient to not periodically evaluate certain conditions when using the shortcut method for a fair value hedge.
If an entity has not adopted the amendments in Accounting Standards Update No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, the entity may elect only the following optional expedients for hedge accounting:
  1. An optional expedient allowing changes in critical terms of a hedging relationship
  2. An optional expedient allowing a change in the method designated for use in assessing hedge effectiveness in a cash flow hedge, if the optional expedient method being elected is the simplified hedge accounting approach for eligible private companies for initial hedge effectiveness or for subsequent hedge effectiveness
  3. An optional expedient allowing the entity to assume that the hedged forecasted transaction in a cash flow hedge is probable of occurring
  4. An optional expedient allowing the entity to assume that the reference rate will not be replaced for the remainder of the hedging relationships for initial and subsequent hedge effectiveness when the entity is using any of the methods for assessing and measuring hedge effectiveness in a cash flow hedge on a quantitative basis and if both the hedged forecasted transaction and the hedging instrument have an eligible reference rate
  5. An optional expedient allowing the entity to disregard certain requirements of the simplified hedge accounting approach for eligible private companies for initial hedge effectiveness or for subsequent hedge effectiveness in a cash flow hedge.
The one-time election to sell, transfer, or both sell and transfer debt securities classified as held to maturity may be made at any time after March 12, 2020 but no later than December 31, 2022.
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