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.

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.

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.

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.

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.

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.

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:

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?

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.