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A fair value hedge is discontinued when any of the following occurs:
  • Hedge is no longer highly effective (DH 10.3.1)
  • Hedging instrument is sold, extinguished, terminated, exercised, or expired (DH 10.3.2)
  • Hedging instrument is dedesignated in its entirety (DH 10.3.3) or in part (DH 10.3.3.1), although it may be redesignated in a new hedging relationship (DH 10.3.4)
  • Hedged item no longer meets the definition of a firm commitment in ASC 815-10-20 (DH 10.3.5)
  • Hedged item is sold or extinguished, in its entirety (DH 10.3.6) or in part (DH 10.3.6.1)
  • Portfolio layer method hedge is required to be fully or partially dedesignated (DH 10.3.8). Note that portfolio layer method hedges have unique rules regarding the treatment of basis adjustments when dedesignating a hedge and other aspects of ASC 815 may not be applicable to these specific hedges.

When a fair value hedging relationship is no longer intact or effective, a reporting entity should stop adjusting the carrying amount of the hedged item for changes in fair value due to the hedged risk. Unlike the accounting for the hedged item, if there were no components excluded from the assessment of effectiveness in the hedging relationship, the measurement of the derivative may not change when a fair value hedge is discontinued. If there were excluded components in the hedging relationship recognized in earnings under an amortization approach, when the derivative is no longer in the hedging relationship, that treatment would not be appropriate. As such, prospectively, the entire derivative should be measured at fair value through earnings, but without any offset, unless it is redesignated in a new hedging relationship.
Upon discontinuance of a fair value hedge, excluded components deferred in AOCI because they were recognized through an amortization approach are released to earnings consistent with how other components of the carrying amount of the hedged item are recognized in earnings. However, if the hedged item is derecognized, ASC 815-25-40-7 requires any amounts remaining in AOCI related to the excluded components to be recorded in earnings. Excluded components are discussed in DH 6.3.1.2 for hedges of financial items and DH 7.2.1.3 for hedges of nonfinancial items.

10.3.1 Hedge is no longer highly effective

If a fair value hedging relationship does not pass the prospective effectiveness test, hedge accounting should be discontinued going forward.
If a hedging relationship does not pass the retrospective effectiveness test, hedge accounting should be discontinued as of the last date when the hedged item was assessed and demonstrated high effectiveness. The reporting entity would stop adjusting the carrying amount of the hedged item for the hedged risk as of that date, unless it can determine a specific point that it failed to be effective.
Adjustments to the carrying amount of the hedged item (basis adjustments) should be recognized in earnings consistent with how other components of the carrying amount of the hedged item are recognized in earnings. For example, adjustments to the basis of an interest-bearing loan are recognized in accordance with ASC 310-20, Receivables - Nonrefundable Fees and Other Costs.
Assume a reporting entity determines that a hedging relationship did not pass the retrospective and prospective effectiveness assessments during its monthly effectiveness assessment on July 31, 20X1. Hedge accounting should be discontinued as of June 30, 20X1, the last date on which the hedged item was assessed and demonstrated high effectiveness. The reporting entity would stop adjusting the carrying amount of the hedged item for the hedged risk as of that date, unless it can determine a specific point in July of 20X1 on which it failed to be effective.
For a discontinued fair value hedge in which the hedged item is not derecognized, ASC 815-25-40-7 indicates that amounts related to the excluded components remaining in AOCI should be recorded in earnings in the same manner as other components of the carrying amount of the hedged item are recognized in earnings.

10.3.2 Hedging instrument is sold, terminated, exercised, or expired

At maturity of a derivative, any final amounts due are settled, there are no further rights or obligations of either party, and the fair value of the expired contract (after final settlement) is zero. There is no further accounting for the derivative because it no longer exists.
Similarly, a derivative settled in its entirety with the counterparty prior to its maturity date, or sold or novated/assigned to a third party no longer exists from the perspective of the reporting entity.
For a discontinued fair value hedge in which the hedged item is not derecognized, basis adjustments are recognized in earnings consistent with how other components of the carrying amount of the hedged item are recognized in earnings. For example, adjustments to the basis of an interest-bearing loan are recognized in accordance with ASC 310-20. In addition, ASC 815-25-40-7 indicates that amounts related to the excluded components remaining in AOCI are recorded in earnings in the same manner as basis adjustments.

10.3.3 Hedging instrument is dedesignated

When a fair value hedging instrument is dedesignated, continues to exist, and is not redesignated in a new hedging relationship, the hedging instrument should be measured at fair value with changes recorded in current earnings prospectively. However, there is no basis adjustment on the hedged item to fully or partially offset the gain or loss on the derivative.
For a discontinued fair value hedge in which the hedged item is not derecognized, adjustments to the carrying amount of the hedged item are recognized in earnings consistent with how other components of the carrying amount of the hedged item are recognized in earnings. For example, adjustments to the basis of an interest-bearing loan are recognized in accordance with ASC 310-20. In addition, ASC 815-25-40-7 indicates that amounts related to the excluded components remaining in AOCI should be recorded in earnings in the same manner as basis adjustments.

10.3.3.1 Partial dedesignation of the hedging instrument

Within Example 19, Hedging a Portfolio of Fixed Rate Financial Assets, ASC 815-20-55-178 and the portfolio layer method guidance indicate that a partial dedesignation of a fair value hedge is permitted. In that example, a reporting entity dedesignated the portion of the notional amount of a swap that was in excess of the portfolio of fixed-rate loans that it had available to hedge. Changes in the fair value of the portion of the derivative that was dedesignated would be recorded in earnings with no offsetting basis adjustment to the hedged item from the point of partial dedesignation onward. However, changes in the fair value of the portion of the derivative that remains in the hedging relationship would be offset in earnings by changes in the fair value of the hedged item for the hedged risk.
The dedesignated portion of the derivative may be redesignated in a new hedging relationship.

10.3.4 Hedging instrument is dedesignated and redesignated

When a fair value hedging instrument is dedesignated and subsequently redesignated in a new fair value hedging relationship, the accounting for the derivative may change depending on the reporting entity’s elections for excluded components on the original and the new hedging relationships. As discussed in DH 10.3.3, for a discontinued fair value hedge in which the hedged item is not derecognized, basis adjustments and excluded components recognized in AOCI are recognized in earnings consistent with how other components of the carrying amount of the hedged item are recognized in earnings. Any excluded components in the new hedging relationship would be recognized in accordance with the reporting entity’s election, as discussed in DH 6.3.1.2 for hedges of financial items and DH 7.2.1.3 for hedges of nonfinancial items.

10.3.5 Hedged item no longer meets definition of a firm commitment

Although rare, when a hedged firm commitment no longer meets the definition of a firm commitment, 815-25-40-5 states that any asset or liability that was recognized under a fair value hedge through cumulative fair value adjustments of the firm commitment must be derecognized, and a corresponding gain or loss recorded in earnings.
A pattern of discontinuing hedge accounting and derecognizing firm commitments would call into question the application of hedge accounting to firm commitments in the future.

10.3.6 Hedged item is sold or extinguished in its entirety

The fair value hedge model provides for recording a basis adjustment on the hedged item. As a result, when the hedged item is sold or extinguished, the basis adjustment is derecognized with the hedged item and impacts any gain or loss recorded on sale or extinguishment of the hedged item.
Amounts in AOCI related to excluded components recognized through an amortization approach should be reclassified to earnings currently when the hedge is discontinued because the hedged item was derecognized, per the guidance in ASC 815-25-40-7.
Because the derivative is no longer in a hedging relationship, it is measured at fair value through current earnings without any offset, unless it is redesignated in another hedging relationship.
See DH 10.3.8 for the treatment of basis adjustments for portfolio layer method hedges.

10.3.6.1 Hedged item is partially sold, prepaid, or extinguished

If part of the hedged item is sold, prepaid, or otherwise extinguished, consistent with the treatment of a full extinguishment discussed in DH 10.3.6, a portion of the basis adjustment is derecognized.
In the case of partial sale or extinguishment, we believe the portion of the amount in AOCI related to excluded components recognized through an amortization approach on the partially sold or prepaid derivative should be reclassified to earnings currently.
See DH 10.3.8 for the treatment of basis adjustments for portfolio layer method hedges.
The hedging relationship may no longer be effective if a portion of the hedged item no longer exists. If so, the reporting entity will have to dedesignate the entire relationship (because it will no longer qualify for hedge accounting). Alternatively, it may partially dedesignate the hedging instrument if done concurrent with the change to the hedged item.
Example DH 10-1 illustrates a partial dedesignation of a hedging instrument when the hedged item is partially extinguished.
EXAMPLE  DH 10-1
Partial dedesignation of hedging instrument upon partial extinguishment of hedged item
DH Corp issues $100 million of fixed-rate non-callable debt and enters into a receive-fixed/pay-floating interest rate swap with a notional amount of $70 million. DH Corp designates the interest rate swap as a fair value hedge of benchmark interest rate risk of 70% of the debt.
One year after issuing the debt, DH Corp repurchases $20 million of the debt in the market so that the new debt balance is $80 million.
What is the impact of the debt extinguishment on the hedging relationship?
Analysis
After the debt extinguishment, the amount of debt hedged would be $56 million (70% of the $80 million new debt balance). To maintain a highly effective hedge, DH Corp could partially dedesignate (concurrent with the extinguishment) the portion of the hedging instrument no longer needed once the debt balance decreases to $80 million. Once the unnecessary portion of the swap is dedesignated, $56 million of the notional amount would be designated as a hedge of 70% of the debt and $14 million would not.
DH Corp may redesignate the $14 million of swap notional in a new hedging relationship, including as a hedge of the originally unhedged portion of the debt.

10.3.7 Amortization of basis adjustments upon discontinuance

When a reporting entity discontinues a fair value hedging relationship of an interest-bearing asset or liability by either dedesignating or terminating the derivative, the basis adjustment should generally be amortized over the remaining life of the hedged item, with the amortization included in interest income or interest expense. Amortization must commence when the hedged item ceases to be adjusted for changes in fair value attributable to the hedged risk.
If the hedged item is not an interest-bearing financial instrument and the hedge is discontinued, the basis adjustment is generally recognized in the income statement when the hedged item impacts earnings in the same line item. For example, if a hedge of a commodity held in inventory is discontinued, the basis adjustment to the inventory balance would be recognized in earnings when the inventory is sold (as part of cost of goods sold).
Basis adjustments to interest-bearing and non-interest-bearing assets should be considered in ongoing credit loss and impairment analyses.
There are unique rules to account for basis adjustment of portfolio layer method hedges. Refer to DH 10.3.8 for the treatment of basis adjustments for portfolio layer method hedges.

10.3.7.1 Basis adjustment on a redesignated hedged item

Any subsequent hedging relationship following a dedesignation would be considered a new designation accounted for prospectively. If the new hedging relationship is a fair value hedge, changes in the fair value of the hedged item that are attributable to the hedged risk from the date of the new designation onward will result in an adjustment of the carrying amount of the hedged item and offset the fair value changes of the derivative currently in earnings. Both changes in value (i.e., on the hedged item and the derivative) should be measured from the date that the new hedging relationship was established.
If a new hedging instrument is designated as a hedge of 100% of the existing hedged item for the same hedged risk, the carrying amount of the hedged item would resume being adjusted.
If only a portion of an item is redesignated as the hedged item in a new hedging relationship, only that portion of the carrying amount of the hedged item attributable to the risk being hedged will be adjusted for changes in fair value due to the hedged risk. The remaining portion of the hedged item would not be measured at fair value for the risk being hedged because it is not part of the hedging relationship.
Whether full or partial redesignation, basis adjustments from previous hedging relationships that were hedging interest rate risk of interest bearing hedged items generally should be amortized over the hedged item’s remaining contractual life.

10.3.7.2 Amortization of basis adjustments in partial-term hedges

For interest-bearing assets and liabilities, if a partial-term hedge is discontinued early, the remaining basis adjustment would be amortized in accordance with the applicable guidance for the hedged item. For example, for hedges of interest bearing loans, amortization of the basis adjustment would be calculated in accordance with ASC 310-20. Thus, the amortization period may change upon termination because basis adjustments amortized while the partial-term hedge is in place are amortized over the assumed term of the hedged item while amortization upon discontinuance under ASC 310-20 may be over the contractual life.

10.3.8 Discontinuance of portfolio layer method hedges

This chapter assumes adoption of ASU 2022-01. ASU 2022-01 expanded the ability to use portfolio layer method hedges (previously referred to as the last-of-layer method) and clarified how portfolio layer method hedges should be accounted for. The standard is required to be adopted by public business entities for fiscal years beginning after December 15, 2022 and for all other entities for fiscal years beginning after December 15, 2023, however, can be adopted early at any time. As described in ASC 815-25-35-7A, when a hedged item qualifies and is designated under the portfolio layer method, the reporting entity is required to perform an analysis at each effectiveness assessment date (at a minimum) to determine whether the amount of assets supporting the hedged layer is still expected to be fully outstanding for the period hedged..
A portfolio layer hedge may be dedesignated voluntarily, either partially or fully, at any time, but must be at least partially dedesignated when an anticipated or actual breach occurs. An actual breach occurs when, on a testing date, the outstanding amount of the closed pool is less than the amount being hedged. An anticipated breach occurs when a reporting entity cannot, on a forward-looking basis, support that the hedged item will be outstanding through the period hedged, but an actual breach has not occurred. In that case, the reporting entity must dedesignate the portion of the derivative related to the portion of the hedged layer no longer expected to be outstanding. An entity may also choose to dedesignate the entire derivative.
Upon a voluntary discontinuance or as a result of an anticipated breach, whether full or partial, the portion of the outstanding basis adjustment associated with the amount dedesignated is allocated to the remaining individual assets in the closed portfolio and amortized over a period consistent with amortization of other discounts or premiums on the assets. If the closed portfolio has multiple hedged layers, the basis adjustment should be allocated to the remaining individual assets in the closed portfolio that supported the dedesignated hedged layer (i.e., only assets that have a contractual maturity date longer than the dedesignated hedged layer would be eligible to support that layer, see DH 6.5.1). The reporting entity needs to use a systematic and rational method to allocate the outstanding basis adjustment associated with the amount of the hedged item that is dedesignated as of the discontinuance date to the individual assets in the portfolio.
If an actual breach occurs, an entity must at least partially dedesignate the hedged layer in order to cure the breach. The proportion of the basis adjustment associated with the amount by which the hedged item exceeds the amount outstanding in the closed portfolio is required to be recognized in earnings as interest income. If there is also an anticipated breach, an entity must also at least partially dedesignate the hedged layer as discussed above.
When a reporting entity has multiple hedged layers designated against a closed portfolio, an entity must follow its existing accounting policy for dedesignations. This may require dedesignating one or multiple hedged layers. See DH 10.3.8.1.
Example DH 10-2 illustrates how to account for basis adjustments when a hedged layer has both an actual as well as an anticipated breach.
EXAMPLE DH 10-2
Accounting for basis adjustments in a dedesignation of a portfolio layer hedge
DH Corp has an active portfolio layer hedge with a single designated hedged layer of $800 and a hedged term of five years. The hedge was entered into on December 31, 20X0 and at the time of hedge designation, the amount of assets in the closed pool totaled $1,000. Based on DH Corp’s expectations of prepayments, defaults, and other events, it projected that it would have sufficient assets (more than $800) in the closed pool for the entire five-year hedged term. Just prior to the paydowns and the assessment that is performed on December 31, 20X3 (as further described below), the remaining balance of the assets in the closed portfolio is as follows:
Asset
Amortized cost basis
Assumed maturity date
1
75.00
12/31/20X5
2
100.00
12/31/20X5
3
100.00
12/31/20X5
4
100.00
12/31/20X5
5
50.00
12/31/20X5
6
100.00
12/31/20X5
7
100.00
12/31/20X5
8
50.00
12/31/20X5
9
100.00
12/31/20X5
10
25.00
12/31/20X5
Total
$800.00

As can be seen in the table above, the amount of assets remaining in the closed pool exactly equals the hedged amount such that if any further events occur that decrease the asset balance, a breach will occur. As of December 31, 20X3, there is a $500 basis adjustment associated with the closed portfolio of assets. Also, on December 31, 20X3, asset 9 prepays in its entirety. Additionally, based on DH Corp’s updated expectations, asset 1 is expected to prepay in its entirety prior to December 31, 20X4.
How should DH Corp account for the actual as well an anticipated breach as of December 31, 20X3?
Analysis
Due to the prepayment of asset 9 on December 31, 20X3, DH Corp would recognize an actual breach since the amount of assets remaining in the closed portfolio total $700 compared to the hedged amount of $800. In accordance with ASC 815-25-40-9A(a), upon discovering that an actual breach has occurred, DH Corp would determine the portion of the basis adjustment associated with the amount of the hedged layer that exceeds the closed portfolio using a systematic and rational method.
DH Corp determines the amount of basis adjustment based on the proportion of the hedged layer needing to be dedesignated in order to cure the breach. In order to cure the actual breach, DH Corp would have to dedesignate $100 of the hedged layer, or 12.5%. Therefore, 12.5% of the basis adjustment would be determined to be associated with the actual breach, which equals $62.50. In accordance with ASC 815-20-45-1CC, the $62.50 would be recognized immediately in earnings through interest income. Since an actual breach has occurred, DH Corp is also required to disclose the amount of basis adjustment recognized in interest income in the period and the circumstances that led to the breach.
Next, DH Corp would determine whether after dedesignating to cure the actual breach, any anticipated breaches exist or if DH Corp wishes to voluntarily dedesignate any other portion of the hedge. Since DH Corp now projects that asset 1 will prepay in its entirety before the end of the hedge period, it would also have an anticipated breach and would be required to further dedesignate a portion of the hedged layer to cure the anticipated breach. Assuming all other assets will remain outstanding at their current amortized cost amounts through the end of the hedge period, DH Corp would only need to dedesignate the portion of the hedged layer associated with asset 1.
Since DH Corp is dedesignating $75 of the hedged layer to cure the anticipated breach, which is 10.7% of the remaining hedged layer, and the remaining hedge basis adjustment after the actual breach is $437.50 (since $62.50 was already recorded through income), an additional $46.88 of the basis adjustment would be associated with the anticipated breach. Unlike for actual breaches that are immediately recorded through income, in an anticipated breach, the amount of the basis adjustment should be allocated to the individual assets that continue to support the hedged layer, as detailed in ASC 815-25-40-9A(b). Therefore, DH Corp would allocate the $46.88 to assets 1-8 and asset 10 proportionally based on each asset’s amortized cost basis. DH Corp would account for the basis adjustments allocated to individual assets in a manner consistent with any premium or discount on those assets. The remaining $390.63 of basis adjustments would remain allocated to the closed portfolio of assets and not allocated to individual assets.

10.3.8.1 Dedesignation sequence of a multiple layer portfolio layer hedge

When a voluntary dedesignation, anticipated breach, or actual breach occurs on a portfolio layer hedge with multiple layers, a reporting entity must determine which layer or layers it will dedesignate. This will determine the amount and how the basis adjustments will be allocated.
ASC 815-25-40-8A requires that when an anticipated or actual breach occurs, a reporting entity should decide which hedged layer or layers to dedesignate based upon an entity-wide accounting policy. The accounting policy must establish a systematic and rational methodology for determining which layer or layers should be dedesignated. It should be in sufficient detail that it is clear to an independent third party which layer or layers would be dedesignated in any anticipated or actual breach scenario and it should not permit the exercise of any discretion at the time of dedesignation. This policy should be established prior to any anticipated or actual breach occurring and needs to be applied consistently to all future anticipated or actual breaches. Any change in this accounting policy would have to follow the guidance in ASC 250, Accounting Changes and Error Corrections.
Voluntary dedesignations are not required to follow the established policy and, as a result, any layer can be dedesignated as long as that dedesignation is voluntary and not in connection with an actual or anticipated breach.
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