Search within this section
Select a section below and enter your search term, or to search all click Not-for-profit entities
Favorited Content
11.8 Derivatives
Publication date: 30 Nov 2022
us NFP guide
Like business entities, NFPs report derivatives as assets or liabilities on the balance sheet, measured at fair value on an ongoing basis in accordance with ASC 815, Derivatives and hedging. The discussion in this section focuses on the incremental guidance provided in ASC 815 and ASC 954-815 for NFPs related to derivatives, including the use of hedge accounting. For a comprehensive discussion of accounting considerations related to derivatives, refer to PwC's Derivatives and hedging guide (DH).
Hedge accounting links derivative instruments with items or transactions whose changes in fair values or cash flows are expected to offset each other. ASC 815 segregates hedges into three categories – cash flow, fair value, and net investment. DH 5 provides helpful background on hedge accounting and how it works.
To qualify for hedge accounting, the hedged items or transactions and the hedging instruments must be eligible for hedging treatment. In addition, the hedging relationship must be highly effective in offsetting changes in fair values or cash flows, both at the hedge’s inception and on an ongoing basis thereafter. Hedge effectiveness must be evaluated and demonstrated at least quarterly, even if an entity only issues financial statements on an annual basis (as is the practice of most NFPs).
Hedge accounting is allowed only if appropriate documentation is prepared. NFPs that are not conduit bond obligors may elect to perform the initial and all quarterly effectiveness assessments before the date on which the next interim (if applicable) or annual financial statements are available to be issued.
Although ASC 815 provides a simplified hedge accounting approach as an accounting alternative for private companies, NFPs are not considered “private companies” and thus, cannot utilize the simplified hedge accounting alternative.
Many NFPs will enter into derivatives for purposes of hedging specific risks or transactions, but not designate them as hedges under the accounting literature. For example, an NFP might enter into a floating-to-fixed swap as a hedge of interest rate risk; however, unless it is an NFP HCO, it will be precluded from applying ASC 815’s cash flow hedge accounting provisions (see NP 11.8.2). Similarly, an NFP that enters into a fixed-to-floating swap might be unwilling to commit the time and resources that would be needed (initially and on an ongoing basis) to apply fair value hedge accounting. Such situations, which are common in the NFP sector, are referred to as “economic hedging.”
11.8.1 Interest rate swaps
A common hedging strategy used by NFPs is to enter into an interest rate swap in connection with issuing municipal bonds. Most often, the objective of using an interest rate swap is that the combined cash flows of the derivative and the debt will effectively convert fixed rate debt to variable-rate debt or vice versa. Swaps can also be used to convert variable rate bonds from one interest rate to another (a basis swap), as discussed in DH 6.3.6.
If the NFP qualifies (and elects) to use hedge accounting for the swap, the accounting differs based on the type of hedge. An NFP HCO with floating rate debt that enters into a floating-to-fixed swap would account for it as a cash flow hedge (see ASC 815-30). If an NFP has fixed rate debt and enters into a fixed-to-floating swap to hedge the fair value of its debt (essentially the payoff value), it would account for the hedge as a fair value hedge (see ASC 815-25).
For certain plain-vanilla hedges of interest rate risk, a “shortcut method” allows an entity to assume that the hedge is perfectly effective without having to perform ASC 815’s quantitative effectiveness assessments either at inception or on an ongoing basis, significantly simplifying hedge accounting (see DH 9.4). “Interest rate risk” is defined as the risk of changes in the hedged item’s fair value or cash flows attributable to changes in a designated benchmark interest rate. ASC 815-20-25-6A identifies the designated benchmark interest rates as eligible for the shortcut method (the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate, the Secured Overnight Financing Rate (SOFR) Overnight Index Swap Rate, direct obligations of the US Government, LIBOR, or the Fed Funds Effective Rate Overnight Index Swap (OIS) Rate). NFPs most commonly use swaps for which the underlying is the SIFMA Municipal Swap Rate (a benchmark floating rate derived from interest rate resets on a selected group of municipal variable rate demand obligation issues).
11.8.2 Presentation of derivative gains and losses–NFPs other than HCOs
NFPs other than HCOs recognize the gain or loss on all derivative instruments, whether hedging or nonhedging, as changes in net assets in the period of change. The gains or losses are classified as changes in net assets without donor restrictions unless they are donor-restricted (as might be the case for certain investments in derivative instruments).
If the NFP qualifies for and uses fair value hedge accounting, the changes in the fair value of the hedged item are reported in the same line item as the changes in the fair value of the derivative, so that they effectively offset in whole or in part (see ASC 815-25-35-19). NFPs are not permitted to use cash flow hedge accounting because they do not report a standardized earnings measure (see ASC 815-30-15-2). Therefore, most NFPs will account for economic hedges of cash flows as nonhedging derivatives that are presented in accordance with ASC 815-10-35-3. However, we believe that NFPs that voluntarily report a performance measure that is identical to the earnings measure (performance indicator) reported by NFP HCOs may apply cash flow hedge accounting by analogy. See NP 11.8.3 for information on cash flow hedge accounting by NFP HCOs.
Excerpt from ASC 815-25-35-19
An entity that does not report earnings as a separate caption in a statement of financial performance (for example, a not-for-profit entity [NFP] or a defined benefit pension plan) shall recognize the gain or loss on a hedging instrument as a change in net assets in the period of change unless the hedging instrument is designated as a hedge of the foreign currency exposure of a net investment in a foreign operation. In that circumstance, the provisions of paragraphs 815-20-25-66 and 815-35-35-1 through 35-2 shall be applied. Entities that do not report earnings shall recognize the changes in the carrying amount of the hedged item pursuant to paragraphs 815-25-35-1 through 35-4 in a fair value hedge as a change in net assets in the period of change.
Excerpt from ASC 815-30-15-2
The guidance in [the cash flow hedges subtopic] does not apply to … entities that do not report earnings. Those entities are not permitted to use cash flow hedge accounting because they do not report earnings separately.
An entity that does not report earnings as a separate caption in a statement of financial performance (for example, a not-for-profit entity or a defined benefit pension plan) shall recognize the gain or loss on a nonhedging derivative instrument as a change in net assets in the period of change.
Although ASC 815 does not provide specific guidance on how gains and losses on derivatives that do not use hedge accounting should be presented in the statement of activities, fair value changes generally would be shown in a single line item. Splitting gains and losses into more than one line item or "recycling" the gains and losses by recognizing them in multiple line items in different periods is generally not appropriate. We believe that an NFP may make a policy election regarding the income statement classification of derivatives that are economic hedges. An NFP may either report the fair value fluctuations associated with the derivative (1) in the same line as the hedged item or (2) in another reasonable income statement line item. For additional information, see FSP 19.4.4. AAG-NFP 4.29 through AAG-NFP 4.37 discuss the classification and presentation of the gains and losses on swaps, as well as considerations for investments in derivative instruments.
EXAMPLE NP 11-2
Income statement presentation of interest rate swap
Income statement presentation of interest rate swap
In September 20X1, ABC University, through its state educational financing authority, issued $200 million of variable rate debt. At the same time, ABC University entered into an interest rate swap for a notional amount of $200 million in order to fix the interest rate over the term of the debt. Because ABC University does not have an earnings measure that meets the definition of a performance indicator, it cannot use cash flow hedge accounting. For the year ended June 30, 20X2, ABC University paid $6.3 million in interest to the bondholders, and received $0.4 million (net) from the interest rate swap counterparty. As of June 30, 20X2, the interest rate swap from ABC University’s perspective had a fair value of negative $1.2 million (i.e., a liability).
How should the amounts related to the interest rate swap be presented in ABC University’s statement of activities?
Analysis
The interest rate swap has two components: unrealized gains and losses due to changes in fair value and realized gains and losses that are the net payments associated with the swap. For the year ended June 30, 20X2, the total impact of the derivative on changes in net assets is a loss of $0.8 million (the loss due to the change in fair value of $1.2 million offset by the net realized gain of $0.4 million from the net settlement of the swap to date).
ASC 815 does not provide specific guidance on the income statement presentation of gains and losses on derivatives that are not designated to be part of a hedging relationship. We believe the presentation in the statement of activities of derivatives that are not designated as hedges is a policy election, although splitting gains and losses into more than one income statement line item is generally not appropriate. As such, ABC University could present the net $0.8 million loss within interest expense, other income/expense, or another appropriate line item of their choice.
11.8.3 Presentation of derivative gains and losses—NFP HCOs
NFP HCOs report changes in fair value of derivatives in the same manner as business entities, as required by ASC 954-815-25-2. That is, derivative gains and losses are included in or excluded from the performance indicator in the same manner as a business entity would include or exclude them from net income (i.e., report them in other comprehensive income).
Except as provided in paragraph 954-815-50-1, not-for-profit health care entities shall apply the provisions of Topic 815 (including the provisions pertaining to cash flow hedge accounting) in the same manner as for-profit entities. That is, the gain or loss items that affect a for-profit entity's income from continuing operations similarly shall affect the not-for-profit health care entity's performance indicator, and the gain or loss items that are excluded from a for-profit entity's income from continuing operations (such as items reported in other comprehensive income) similarly shall be excluded from the performance indicator by the not-for-profit health care entity.
For fair value hedges, the changes in the fair value of the derivative are reported in the same line item as the changes in the fair value of the hedged item and reported within the performance indicator.
Unlike other NFPs, NFP HCOs are permitted to use cash flow hedge accounting. NFP HCOs can initially present a derivative’s change in fair value outside of an earnings measure (the performance indicator), and subsequently reclassify it into earnings in the period that the hedged transaction affects earnings. See also ASC 954-220-45-8(e). As discussed in ASC 954-815-45-1, the fact that NFP HCOs are not required to report accumulated other comprehensive income (or changes therein) as a separate component of equity in the balance sheet pursuant to ASC 220 is not a barrier to their use of cash flow hedge accounting.
The absence of a requirement to report a separate component of equity in the balance sheet of a not-for-profit, business-oriented health care entity shall not preclude those entities from using comprehensive income reporting for qualifying gains and losses on cash flow hedges. Although accumulated other comprehensive income will inherently be carried forward in a not-for-profit health care entity's net assets, there is no compelling need for it to be reported separately in the balance sheet.
However, ASC 954-815-50 requires NFP HCOs to provide cash flow hedging disclosures that are analogous to those required for business entities, including disclosure of amounts that have been excluded from the performance indicator.
If the NFP HCO does not qualify for or does not elect to use hedge accounting, or if it enters into a nonhedging derivative for purposes other than risk management, the changes in fair value are included within the performance indicator unless they pertain to donor-restricted activity.
AAG-HCO Chapter 5, Derivatives, provides additional discussion on these matters.
11.8.4 NFP tabular disclosure requirements of derivatives
ASC 815 requires that certain derivative disclosures be provided in a tabular format, with specific considerations for NFPs discussed at ASC 815-10-50-4G.
For purposes of the disclosure requirements beginning in paragraph 815-10-50-4A, not-for-profit entities within the scope of Topic 954 should present a similarly formatted table. Those entities shall refer to amounts within their performance indicator, instead of in income, and amounts outside their performance indicator, instead of in other comprehensive income. Not-for-profit entities not within the scope of Topic 954 shall disclose the gain or loss recognized in changes in net assets using a similar format. All not-for-profit entities also would indicate which class or classes of net assets (without donor restrictions or with donor restrictions) are affected.
NFPs must include the location and amounts of gains and losses reported in the statement of activities (or for NFP HCOs, in the statement of operations, identifying the amount of gains and losses recognized in the performance indicator and, where applicable, outside the performance indicator). This disclosure requires separate categories for derivatives designated and qualifying as fair value hedges, those designated and qualifying as cash flow hedges, those not designated or not qualifying as hedging instruments, and other categories, if applicable. Within each category, separate line items should further categorize derivatives by purpose (i.e., the item being hedged, or the exposure created). NFPs also must disclose which class or classes of net assets (without donor restrictions or with donor restrictions) are affected.
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.
Link copied
