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17.5 Hedge accounting
Publication date: 30 Sep 2021
us IFRS & US GAAP guide
The FASB and IASB shared the goal of providing relief to allow hedge accounting relationships affected by reference rate reform to continue without being dedesignated/discontinued. However, differences in the hedge accounting models between ASC 815 and IFRS 9 necessitate differences in how that relief is applied.
Under both ASC 848 and the amendments to IFRS 9, entities are allowed to change the risk being hedged in a hedge relationship affected by reference rate reform without dedesignating the hedge relationship. For instance, in a cash flow hedge when the hedged risk is the variability in cash flows due to changes in IBOR, the relief under both US GAAP and IFRS would allow an entity to change the hedged risk to an alternative reference rate such as SOFR or SONIA without discontinuing the hedge relationship.
With slight differences described below, both US GAAP and IFRS require updates to the designation of the hedge relationship following changes such as substituting an alternative benchmark rate as the hedged risk or amending the description of the hedged item or hedging instrument. Updating of the hedge designation/documentation does not cause automatic dedesignation of the hedge relationship under either US GAAP or IFRS.
The US GAAP and IFRS relief allow an entity that has a cash flow hedge of a forecasted transaction based on a reference rate expected to be discontinued to disregard the potential for the rate to be discontinued when assessing if the transaction is probable (IFRS - highly probable) of occurring. This would prevent amounts in other comprehensive income for US GAAP and amounts in the cash flow hedge reserve under IFRS from needing to be recycled into earnings.
There is also additional relief under both US GAAP and IFRS when performing the prospective assessment of effectiveness. An entity can assume that the interest rate benchmark upon which the cash flows of the hedged item, hedging instrument, or hedged risk are based is not altered by IBOR reform.
US GAAP | IFRS |
An entity may make an election to change the method of assessing effectiveness used in a cash flow hedge if either the hedging instrument or hedged forecasted transaction references a rate expected to be discontinued and the new method for assessing effectiveness is an allowed optional expedient within ASC 848. Under this relief, an entity is not required to prove that the new effectiveness method is an improved methodology as would have been required under ASC 815.
ASC 848 requires an entity to update its hedge documentation upon changing a critical term of a hedging relationship due to the election of an optional expedient no later than when the reporting entity is required to perform its first assessment of hedge effectiveness after electing the optional expedient. This is also required if an entity changes its method of assessing hedge effectiveness for the hedging relationship.
ASC 848 also allows for an entity to prospectively change its systematic and rational method used to recognize excluded components in earnings if the changes to the contractual terms of a hedging instrument replace or have the potential to replace a reference rate expected to be discontinued and do not modify any terms unrelated to reference rate reform.
| IFRS 9 requires a forward-looking prospective assessment of an economic relationship between the hedged item and the hedging instrument. During the period of relief, an entity assumes that the interest rate benchmark on which the cash flows of the hedged item, hedging instrument, or hedged risk are based is not altered by IBOR reform.
IFRS requires quantitative ineffectiveness to be recorded in net income (subject to the “lower of” test in cash flow hedging relationships). There is no relief provided in relation to the ongoing recording of ineffectiveness.
The IFRS amendments require an entity to make changes to the formal designation of the hedge relationship to reflect the changes that are required by IBOR reform when the entity ceases to apply the Phase 1 relief. The hedge designation is required to be amended to make one or more of the following changes:
● Designating an alternative benchmark rate as a hedged risk
● Amending the description of the hedged item (including the description of the designated portion of the cash flows or fair value being hedged)
● Amending the description of the hedging instrument
The hedge documentation is required to be amended by the end of the reporting period during which a change required by IBOR reform is made to the hedged risk, hedged item, or hedging instrument.
Certain reliefs are provided related to the measurement of amounts accumulated in a cash flow hedging reserve at the point when an entity amends the description of a hedged item. Certain additional reliefs are also provided for non-contractually specified risk components that are not separately identifiable at the time of designation.
When applying the “changes to hedge designations and hedge documentation” temporary exception to hedges of groups of items under IFRS 9, hedged items must be allocated to sub-groups based on the benchmark rate being hedged, and the benchmark rate for each sub-group is designated as the hedged risk. As a result, some items in the group could be changed at different times. Each sub-group must be assessed separately to determine if it meets the requirements for eligible hedged items. Hedge accounting must be discontinued prospectively, for the hedge relationship in its entirety, if any sub-group fails to meet the eligible hedged item requirements. An entity should also account for the ineffectiveness related to the hedging relationship in its entirety.
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