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The ability of many private companies to borrow funds at a fixed rate of interest is often limited. As a result, these companies will typically borrow on a floating rate basis, and at the same time, enter into an interest rate swap to economically convert the borrowing into a fixed rate.
As discussed in DH 5, for an interest rate swap to be accounted for as a cash flow hedge under the hedge accounting rules, a reporting entity is required to document its election and assess the effectiveness of the hedging relationship. If a reporting entity does not contemporaneously document the hedging relationship, the interest rate swap would not qualify for hedge accounting and would be recorded at fair value, with changes in fair value recorded in earnings.
The simplified hedge accounting approach makes qualifying for hedge accounting simpler and measurement of the swap less complex. Under the simplified approach, private companies are allowed to assume perfect effectiveness for qualifying receive-variable, pay-fixed interest rate swaps designated in a cash flow hedging relationship provided certain criteria are met. In addition, the simplified hedge accounting approach relaxes the requirements for contemporaneous documentation.
The simplified hedge accounting approach is elective. If an eligible entity does not elect the simplified hedge accounting approach, it should apply the general cash flow hedge accounting guidance or choose to not apply hedge accounting and record the interest rate swap at fair value with changes in value recorded in earnings. See DH 5 for general information on cash flow hedge accounting, DH 6 for information on cash flow hedges of debt, and DH 11.3 for information on private company hedge documentation requirements if the simplified hedge accounting approach is not applied.

11.2.1 Electing to use the simplified hedge accounting approach

Before adopting the simplified hedge accounting approach, an eligible private company should weigh both the impact of applying the approach on its key financial metrics, and the potential cost of unwinding the accounting and reapplying the general hedge accounting requirements if its reporting requirements change because it no longer meets the definition of a private company.
A reporting entity that is private today could later meet the definition of a public business entity (e.g., by becoming a public company through an initial public offering or through acquisition or investment by a public company). Once a reporting entity meets the definition of a public business entity, it may no longer apply the simplified hedge accounting approach.
Additionally, if upon becoming a public business entity, it is subject to standalone SEC reporting requirements, it will need to retrospectively adjust its historical financial statements to remove the effect of applying the simplified hedge accounting approach for all prior periods.

11.2.2 Eligibility to use the simplified hedge accounting approach

Public business entities (as defined the ASC Master Glossary) may not apply the simplified hedge accounting approach. The simplified hedge accounting approach may be applied by private companies that are not:
  • Financial institutions, as defined in ASC 942-320-50-1, which includes banks, savings and loan associations, savings banks, credit unions, finance companies and insurance companies
  • Not-for-profit-entities
  • Employee benefit plans within the scope of ASC 960 through ASC 965
Question DH 11-1
If a reporting entity is not a public business entity itself, but a subsidiary of a public business entity, may it use the simplified hedge accounting approach in its standalone financial statements?
PwC response
Yes. The reporting entity may elect the simplified hedge accounting approach in its standalone financial statements (provided those financial statements are not publicly filed). A reporting entity that meets the definition of a public business entity solely because its financial statements are included in another entity’s SEC filings is only a public business entity for purposes of the financial statements filed with the SEC.

Question DH 11-2
How should a private company applying the simplified hedge accounting approach apply hedge accounting after becoming a public business entity?
PwC response
A public business entity should dedesignate the simplified hedge accounting relationship and could prospectively designate a new hedging relationship. It is unlikely that the requirements for applying the shortcut method would be met on the date the new hedging relationship is designated.

11.2.3 The simplified hedge accounting approach

Private companies that elect the simplified hedge accounting approach can assume perfect effectiveness for qualifying receive-variable, pay-fixed interest rate swaps designated in a cash flow hedging relationship provided the criteria in ASC 815-20-25-137 are met. Interest rate swaps entered into by a private company for any other purpose do not qualify for the simplified approach.

ASC 815-20-25-137

An eligible entity under paragraph 815-20-25-135 must meet all of the following conditions to apply the simplified hedge accounting approach to a cash flow hedge of a variable-rate borrowing with a receive-variable, pay-fixed interest rate swap:

  1. Both the variable rate on the swap and the borrowing are based on the same index and reset period (for example, both the swap and borrowing are based on one-month London Interbank Offered Rate [LIBOR] or both the swap and borrowing are based on three-month LIBOR).
  2. The terms of the swap are typical (in other words, the swap is what is generally considered to be a “plain-vanilla” swap), and there is no floor or cap on the variable interest rate of the swap unless the borrowing has a comparable floor or cap.
  3. The repricing and settlement dates for the swap and the borrowing match or differ by no more than a few days.
  4. The swap’s fair value at inception (that is, at the time the derivative was executed to hedge the interest rate risk of the borrowing) is at or near zero.
  5. The notional amount of the swap matches the principal amount of the borrowing being hedged. In complying with this condition, the amount of the borrowing being hedged may be less than the total principal amount of the borrowing.
  6. All interest payments occurring on the borrowing during the term of the swap (or the effective term of the swap underlying the forward starting swap) are designated as hedged whether in total or in proportion to the principal amount of the borrowing being hedged.

Question DH 11-3
Can a private company apply the simplified hedge accounting approach to a variable-rate borrowing that is based on an index other than LIBOR, which is the rate referenced in ASC 815-20-25-137(a)?
PwC response
Yes. A variable-rate borrowing and a swap may be indexed to any variable interest rate (including rates that are not benchmark interest rates) and still be eligible for the simplified hedge accounting approach provided the variable rate for both the borrowing and the swap are based on the same index, have the same reset period, and all other requirements are met.

SOFR considerations
With the replacement of LIBOR, new reference rates such as the Secured Overnight Financing Rate (SOFR) are used as the variable interest rate in borrowings and interest rate swaps. We understand that different SOFR products may have varying calculation methodologies for determining cash flows, including calculation periods, settlement date, and reset periods. SOFR can also be computed in several different ways in between each reset (e.g., in advance, in arrears, compounded). Subject to certain regulatory restrictions, instruments may also reference forward-looking term SOFR rates in which the interest rate would be set at the beginning of the interest accrual period and remain fixed until the next interest reset date. Consider whether the simplified hedge accounting approach is appropriate if entering into a hedge relationship involving a SOFR-based asset or liability and/or a SOFR hedging instrument. Ensure all the qualifications for applying the simplified hedge accounting approach are met.

Question DH 11-4
How many days is considered “no more than a few days” with regard to the repricing and settlement date requirements in ASC 815-20-25-137(c)?
PwC response
The FASB did not provide a bright line, but we believe a week or less between repricing and settlement dates on the interest rate swap and the borrowing would generally represent a reasonable time period.

Question DH 11-5
If a private company elects the simplified hedge accounting approach for one eligible hedging relationship, must it elect the simplified approach for all hedging relationships that meet the requirements?
PwC response
No. ASC 815 generally requires reporting entities to use the same method to assess hedge effectiveness for all similar hedges; however, the decision to apply the shortcut method can be elected on a swap-by-swap basis. By analogy, we believe that private companies can elect to apply the simplified hedge accounting approach on a swap-by-swap basis.

11.2.3.1 Index and reset period

Certain borrowing arrangements provide the borrower with the option to periodically select the interest rate index and reset period. For example, when the interest rate on a borrowing resets, assume the borrower has the ability to designate the interest rate index as overnight SOFR, one-month term SOFR, or the Prime rate. The existence of this option does not preclude a private company from applying the simplified hedge accounting approach as long as the interest rate index and reset period on the swap and the borrowing match. For example, if the private company elects one-month term SOFR as the interest rate for the borrowing at inception of the hedge, the swap must also be based on one-month term SOFR.
If the private company subsequently elects to change the interest rate or reset period such that the rate on the swap no longer matches the borrowing, the relationship will no longer qualify for the simplified hedge accounting approach. The private company would have to dedesignate the hedging relationship and discontinue hedge accounting under the simplified approach. However, it would be able to attempt to designate a new hedging relationship. See DH 11.2.6 for information on discontinuance of the simplified hedge accounting approach.

11.2.3.2 Fair value at inception

ASC 815-20-25-137(d) requires the swap’s fair value at inception of the hedging relationship to be at or near zero. Therefore, if a private company enters into an interest rate swap with terms that do not reflect the prevailing market rates and pays or receives a significant premium or designates an existing interest rate swap with a significant fair value at the inception of the hedging relationship, the simplified hedge accounting approach should not be applied.
This guidance may also come into play when a private company acquires another private company that was applying the simplified approach. Because the date the acquisition is consummated is considered the inception of the hedging relationship for the acquirer, and the interest rate swap is not likely to have a fair value at or near zero at that date, the simplified approach cannot be continued by the acquirer in its consolidated financial statements.

11.2.3.3 Forward starting swap

As discussed in ASC 815-20-25-138, a private company may apply the simplified hedge accounting approach to a forward-starting interest rate swap entered into to hedge variable-rate interest payments on future debt issuances provided the qualifying criteria are met. Example DH 11-1 illustrates the application of the simplified hedge accounting approach to a forward-starting interest rate swap.
EXAMPLE DH 11-1
Use of the simplified hedge accounting approach for a forward-starting swap
Private Co expects to issue $5 million in a 10-year variable rate borrowing one year from today. To hedge the interest rate risk associated with the forecasted variable-rate interest payments, Private Co enters into a forward-starting receive-variable, pay-fixed interest rate swap with a notional amount of $5 million, 10-year effective term, and commencement date on the same date Private Co plans to borrow. Private Co designates the swap as a cash flow hedge of the interest payments on the forecasted 10-year variable-rate borrowing.
Can Private Co apply the simplified hedge accounting approach for this cash flow hedging relationship?
Analysis
Provided the remaining criteria for applying the simplified hedge accounting approach are met, Private Co could apply the simplified hedge accounting approach to this hedging relationship. However, if Private Co delays its debt issuance (for example, it issues the debt two months after originally forecasted), it would no longer qualify for simplified hedge accounting. Private Co would have to dedesignate the hedging relationship and discontinue hedge accounting. If the forward-starting swap were to meet the requirements for long-haul hedge accounting, then Private Co could dedesignate the simplified hedge accounting approach hedging relationship and prospectively designate a new long-haul hedging relationship.

11.2.4 Documentation of a hedge under the simplified approach

ASC 815 requires contemporaneous documentation of hedging relationships to be prepared at hedge inception. The simplified hedge accounting approach relaxes the requirements for contemporaneous documentation. Under the simplified approach, hedge accounting documentation must be completed by the date on which the first annual financial statements are available to be issued after hedge inception. For example, if a calendar year-end private company enters into an interest rate swap on January 1, 20X1, and has until March 31, 20X2 to issue the annual financial statements, it would have until the financial statements are available to be issued (i.e., on or before March 31, 20X2) to complete the required hedge documentation.
Although a private company has additional time to complete its hedge documentation, all of the formal hedge documentation requirements in ASC 815-20-25-3 are applicable. These requirements are extensive and include documentation of the following:
  • The hedging relationship
  • The private company’s risk management objective and strategy for undertaking the hedge, including identification of all of the following:
    • The hedging instrument
    • The hedged item or transaction
    • The nature of the risk being hedge
    • The method that will be used to retrospectively and prospectively assess the hedging instrument’s effectiveness in offsetting the exposure to the hedged transaction’s variability in cash flows attributable to the hedged risk
  • The date the forecasted hedged interest payments are expected to occur (this must be described with sufficient specificity that when an interest payment occurs it is clear whether it is the hedged interest payment)
See DH 6.3.3.4 for information on the identification of the hedged forecasted transaction and the impact it may have on hedge accounting and DH 5.7 for additional information on hedge documentation requirements.
Although the simplified hedge accounting approach allows some latitude with regard to when hedging documentation must be completed, private companies should complete the hedge accounting documentation as soon as possible. If it is determined that an interest rate swap does not meet all of the requirements for the simplified approach, the private company would not be able to retroactively apply the long-haul method.
See DH 11.3 for information on private company hedge documentation requirements if the simplified hedge accounting approach is not applied.

11.2.5 Accounting under the simplified hedge accounting approach

If all of the criteria for applying the simplified hedge accounting approach are satisfied, a private company may assume the hedging relationship is perfectly effective and elect to recognize the interest rate swap at its settlement value instead of fair value. Since the swap is considered perfectly effective, the change in settlement value of the swap (or fair value, if elected) is recorded in other comprehensive income and the swap accruals are recorded in interest expense. As a result, the amount of interest expense recognized in the income statement under this approach would approximate the amount that would have been recognized if the private company had borrowed at a fixed rate.
The primary difference between settlement value and fair value is that nonperformance risk (the risk that an entity will not fulfill an obligation) is not considered in the measurement of settlement value. ASC 815-10-35-1B provides guidance on determining the settlement value of a swap.

Excerpt from ASC 815-10-35-1B

One approach for estimating the receive-variable, pay-fixed interest rate swap’s settlement value is to perform a present value calculation of the swap’s remaining estimated cash flows using a valuation technique that is not adjusted for nonperformance risk.

We believe the discount rate used in the present value calculation may either be the current market rate of interest adjusted for credit risk or the appropriate current risk free/benchmark rate.
Banks and other swap counterparties periodically send statements of an interest rate swap’s value. The value furnished by the counterparty is typically a settlement value consistent with the guidance in ASC 815-10-35-1B. A private company should gain an understanding of the valuation techniques used by the swap counterparty to ensure the value provided is representative of settlement value before recording that value in its financial statements.
Question DH 11-6
Is a private company that elects the simplified hedge accounting approach required to record the swap using settlement value?
PwC response
No. Use of settlement value is optional under the simplified approach. A private company may elect the simplified hedge accounting approach for purposes of assessing hedge effectiveness but record the swap at fair value. Settlement value is provided as a practical expedient and can be elected on a swap-by-swap basis. As such, settlement value does not have to be used for all similar hedging relationships.

Question DH 11-7
Is a swap accounted for at settlement value under the simplified hedge accounting approach subject to the disclosures for fair value measurements required by ASC 820, Fair Value Measurement?
PwC response
Yes. The disclosures for fair value measurements required by ASC 820 are still required for amounts disclosed at settlement value. Disclosures related to swaps measured at settlement value should be clearly identified separate from the fair value disclosures. In addition, all of the presentation and disclosure requirements of ASC 815 continue to apply. See FSP 19.6.1 and FSP 20.7.3 for additional information on disclosures for swaps accounted for using the simplified hedge accounting approach and fair value measurements.

11.2.5.1 Monitoring the hedging relationship and swap counterparty

A private company should periodically assess whether the terms of the hedging relationship have been modified (i.e., confirm that the “critical terms” have not changed during the period) and that the forecasted interest payments are probable of occurring. As part of this assessment, a private company should consider the likelihood of the counterparty’s compliance with the contractual terms of the swap.
ASC 815 requires a reporting entity to assess counterparty credit risk on at least a quarterly basis. If there are no adverse developments regarding counterparty default risk and the terms of the swap continue to mirror the terms of the borrowing in accordance with the simplified hedge accounting approach criteria, a private company can conclude that the hedge is perfectly effective. However, if there have been adverse developments regarding counterparty credit risk such that it is no longer probable that the counterparty will not default, a private company can no longer apply the simplified hedge accounting approach. A private company should perform this assessment on a quarterly basis but can defer the documentation to no later than the date the annual financial statements are available to be issued.

11.2.6 Discontinuance of a simplified hedge accounting relationship

If a hedging relationship no longer meets the criteria to qualify for the simplified hedge accounting approach, the hedging relationship must be prospectively discontinued from the date the criteria were no longer met. A private company can also elect to discontinue a simplified hedge accounting relationship.
On the date the simplified hedge accounting approach is discontinued, a private company must calculate the fair value of the swap (not the settlement value) and record the difference between settlement value and fair value in other comprehensive income. Subsequent changes in the fair value of the swap will be reported in earnings unless the private company meets the requirements for cash flow hedge accounting using a method other than the simplified hedge accounting approach; in that case, the private company may designate a new hedging relationship prospectively.
Treatment of the gains and losses previously deferred in accumulated other comprehensive income upon discontinuance of a simplified hedge accounting relationship will depend on the cause of discontinuance and the original hedge documentation.
  • If the forecasted hedged interest payments are still probable of occurring, amounts in accumulated other comprehensive income should be released when the interest payments are recorded in earnings.
  • If the forecasted interest payments are considered probable of not occurring, amounts in accumulated other comprehensive income are reclassified to earnings in the current period.
Example DH 11-2 and Example DH 11-3 illustrate this distinction.
EXAMPLE DH 11-2
Hedged forecasted interest payments are probable of not occurring
On January 1, 20X1, Private Co enters into a $5 million, 10-year loan with an interest rate of one-month term SOFR plus 2.50%.
Private Co concurrently enters into an at-market 10-year receive one-month term SOFR, pay-fixed interest rate swap with a notional amount of $5 million to economically convert the loan’s variable rate interest payments to a fixed rate.
All of the requirements to qualify for the simplified hedge accounting approach are met. Private Co designates the interest rate swap as a cash flow hedge of the variable-rate interest payments and elects to apply the simplified hedge accounting approach. In its hedge documentation it defines the hedged transactions as the forecasted SOFR interest payments associated with the specific January 20X1 loan.
Five years later, Private Co repays the loan. The hedging relationship no longer qualifies for hedge accounting because the hedged interest payments will no longer occur.
Should Private Co recognize the gains and losses on the swap accumulated in other comprehensive income in earnings immediately?
Analysis
Yes. The gains and losses on the swap accumulated in other comprehensive income should be reclassified to earnings immediately because the hedged forecasted transactions (i.e., the interest payments on the January 20X1 loan) are probable of not occurring.
EXAMPLE DH 11-3
Hedged forecasted interest payments are probable of occurring
On January 1, 20X1, Private Co enters into a $5 million, 10-year loan with an interest rate of one-month term SOFR plus 2.50%.
Private Co concurrently enters into an at-market 10-year receive one-month term SOFR, pay-fixed interest rate swap with a notional amount of $5 million to economically convert the loan’s variable rate interest payments to a fixed rate.
All of the requirements to qualify for the simplified hedge accounting approach are met. Private Co designates the interest rate swap as a cash flow hedge of the variable-rate interest payments and elects to apply the simplified hedge accounting approach. In its hedge documentation it defines the hedged transactions as the first forecasted SOFR-based interest payments to occur each quarter on $5 million of borrowings over the next 10 years (i.e., the hedging relationship is not tied to a specific borrowing).
Five years later, Private Co refinances its debt with a new lender. The new loan has interest payments based on overnight SOFR. The hedging relationship no longer qualifies for the simplified hedge accounting approach because the variable interest rate on the loan (overnight SOFR) does not match the variable interest rate on the swap (one-month term SOFR) so Private Co dedesignated the hedging relationship and discontinues hedge accounting.
Should Private Co recognize the gains and losses on the swap accumulated in other comprehensive income in earnings immediately?
Analysis
No. The gains and losses on the swap accumulated in other comprehensive income should continue to be deferred because the forecasted transactions (as defined) are still probable of occurring since Private Co will continue to incur interest payments indexed to SOFR on $5 million of borrowings for the term of the hedge. The gains and losses on the interest rate swap deferred in accumulated other comprehensive income would not be reclassified until the forecasted interest payments are recorded in earnings.

PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

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