Hedging handbook as amended by ASU 20170-12

931 Pages·2017·6.81 MB·English

Hedging
As amended by ASU 2017-12
Handbook

US GAAP

September 2018
kpmg.com/us/frv
Contents
Foreword ...................................................................................................... 1
About this publication .................................................................................. 2
1. Executive summary ........................................................................... 4
2. General hedging requirements .......................................................... 14
3. Qualifying criteria for fair value hedges ............................................. 155
4. Accounting for fair value hedges ....................................................... 211
5. Qualifying criteria for cash flow hedges ............................................ 293
6. Accounting for cash flow hedges ...................................................... 379
7. Hedging foreign currency exposures ................................................ 479
8. Net investment hedges ..................................................................... 595
9. Hedge effectiveness ......................................................................... 642
10. Private companies ............................................................................. 843
11. Effective dates and transition ............................................................ 865
Appendices .................................................................................................. 897
Index of Q&As ................................................................................... 897
Index of examples ............................................................................. 919
KPMG Financial Reporting View .................................................................. 927
Acknowledgments ....................................................................................... 928
© 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
Hedging 1
Foreword

Perspectives on a complex
area
When the first comprehensive hedge accounting guidance was issued in 1998,
the accounting requirements in this area were widely acknowledged as the
most detailed and complex in US GAAP.
Since then, we have seen ongoing changes made to the requirements. For a
long time, the changes added to the rules and complexity. But more recently,
the changes have been focused on reducing operational burden, expanding the
use of hedge accounting and better reflecting risk management practices.
Throughout all of these changes, one constant has been that hedge accounting
itself has remained optional. Even after electing to apply hedge accounting,
optionality has been a hallmark of the underlying accounting requirements. The
guidance in this area has always included various alternatives for different
strategies and methods for aspects such as measuring and assessing hedging
relationships – and now those options have expanded.
Our objective with this publication is to help you focus effectively and efficiently
on the hedge accounting alternatives and requirements. We provide you with
insights, examples and perspectives based on our years of experience in this
area – so you can understand your options and decide which alternatives are
right for you.

Kimber Bascom and Mark Northan
Department of Professional Practice, KPMG LLP

© 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
Hedging 2
About this publication

About this publication
The purpose of this Handbook is to assist you in understanding the new
hedging standard following the targeting improvements issued in August 2017.
Accounting literature and scope
This Handbook focuses on hedge accounting under ASC 815, Derivatives and
Hedging, as amended by Accounting Standards Update No. 2017-12, Targeted
Improvements to Accounting for Hedging Activities, which was issued in
August 2017 and first becomes effective in 2019.
The scope of ASC 815 (including the definition of a derivative) and embedded
derivatives will be addressed in future updates to this Handbook. In the
meantime, guidance on these topics is included in KPMG’s publication,
Derivatives and hedging (pre-ASU 2017-02), which provides guidance for
entities that have not yet adopted 2017-12.
In addition, KPMG’s publication on the targeted improvements to hedge
accounting under ASU 2017-12 provides a focused discussion of the specific
amendments in the ASU.
Organization of the text
Each chapter of this Handbook includes excerpts from FASB’s Accounting
Standards Codification® and overviews of the relevant requirements. Our in-
depth guidance is explained through Q&As that reflect the questions we are
encountering in practice. We include observations and examples to explain key
concepts.
Our commentary is referenced to the Codification and to other literature, where
applicable. The following are examples.
— 815-20-25-3 is paragraph 25-3 of ASC Subtopic 815-20.
— ASU 2017-12.BC148 is paragraph 148 of the basis for conclusions to
ASU 2017-12.
— FAS 133.BC423 is paragraph 423 of the basis for conclusions to
FASB’s Statements of Financial Accounting Standards No. 133, Accounting
for Derivative Instruments and Hedging Activities.
— DIG Issue is in relation to the Derivative Implementation Group
— 2006 AICPA Conf is the 2006 AICPA National Conference on Current SEC
and PCAOB Developments. These references are hyperlinked to the source
material on the SEC’s website.

© 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
Hedging 3
About this publication

Pending content
In some cases, the Codification is subject to content that becomes effective
after ASU 2017-12. For example, ASU 2016-13, Financial Instruments—Credit
Losses (Topic 326), includes consequential amendments to Topic 815.
When an excerpt from the Codification is affected by pending content:
— the specific sentences that have been superseded are struck out and the
added text is underlined; and
— the amended sentences are marked as pending content.
Future developments
As more people turn their attention to the application of the new hedging
standard, more questions are arising and the interpretations of the principles in
the standard continue to evolve. This means that some positions may change,
and positions on new issues will emerge, as we get closer to implementation.
For the Questions in this Handbook where we are aware of ongoing
discussions and the potential for a position to change, we have indicated that in
our interpretive response.
In addition, the FASB is currently working on a project to provide further
guidance on when an entity would be able to change the hedged risk and/or the
hedged forecasted transaction when the guidance on cash flows hedging is
applied. This project has the potential to significantly impact our guidance for
cash flow hedges. Currently the FASB is collecting external feedback related to
this project. Summaries of the potential Codification improvements discussed
at the March 2018 Board meeting are included in chapters 2, 5 and 6 (see
Future Developments).
Abbreviations
We use the following abbreviations in this Handbook.
AFS Available-for-sale
AOCI Accumulated other comprehensive income
CTA Cumulative translation adjustment
DIG Derivatives Implementation Group
FCD Foreign currency denominated
HTM Held-to-maturity
LIBOR London Interbank Offered Rate
NYMEX New York Mercantile Exchange
OCI Other comprehensive income
PEH Perfectively effective hypothetical (derivative)
SIFMA Securities Industry and Financial Markets Association
© 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
Hedging 4
1.Executive summary
1. Executive summary
Topic 815 provides guidance on accounting for derivative instruments and
hedging activities.
Derivative instruments are assets or liabilities that are recorded on the balance
sheet at fair value. If the derivative instrument does not qualify for hedge
accounting, changes in fair value are recorded in earnings.
Hedge accounting is designed to allow an entity to hedge risks inherent in
certain transactions by using derivative instruments. It is elective and subject to
several criteria. If a hedging relationship meets these criteria, the accounting
varies based on the type of risk(s) being hedged and the type of hedge.
Topic 815 provides for three different types of hedges.
 Fair value hedge. A hedge of the exposure to changes in the fair value of a
recognized asset or liability, or of an unrecognized firm commitment, that is
attributable to a particular risk.
 Cash flow hedge. A hedge of the exposure to variability in the future cash
flows of a recognized asset or liability, or of a forecasted transaction, that is
attributable to a particular risk.
 Net investment hedge. A hedge of the exposure to foreign currency risk
of a net investment in a foreign operation.
General qualifying criteria
Hedge accounting is permitted only if all applicable criteria are met. There are
five general criteria that apply to fair value hedges and cash flow hedges, some
of which also apply to net investment hedges.
Criterion 1 Criterion 2 Criterion 3 Criterion 4
Eligibility of Eligibility of
Eligibility of Hedge
hedged items hedging
hedged risk(s) effectiveness
or transactions instruments
Criterion 5: Formal documentation
There are also specific qualifying criteria based on the type of hedge and the
type of risk(s) being hedged. Topic 815 also specifically prohibits certain items
and transactions from hedge accounting.
If any eligibility criteria cease to be met, the hedging relationship must be
discontinued – i.e. hedge dedesignation.
Read more: chapter 2
© 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
Hedging 5
1. Executive summary

Qualifying criteria for fair value hedges
In addition to the general qualifying criteria, Topic 815 specifies certain items,
risks and hedging instruments that are eligible to be designated in a fair value
hedge.
Criterion 1: Items eligible for fair value hedges
Only recognized assets or liabilities, or unrecognized firm commitments, are
eligible to be designated as the hedged item in a fair value hedge. Topic 815
allows different strategies when hedging certain risks.
Individual recognized assets and
Firm commitments
liabilities

Portfolios of similar assets and liabilities

Portion (or percentage) of hedged item

Hedging only Partial-term
Residual
benchmark hedge of Embedded put Last-of-layer
value in a
interest rate interest rate or call option method
lease
component risk

Criterion 2: Risks eligible for fair value hedges
The risks eligible to be designated in a fair value hedge are different for financial
and nonfinancial items.

Financial items Nonfinancial items
Interest  Changes in the Not applicable.
rate risk benchmark interest rate
for recognized fixed-

rate financial
instruments.

Credit Includes: Not applicable.
risk — changes in the obligor’s
creditworthiness; and
— changes in the credit

spread over the
benchmark interest
rate.

Foreign — Changes in the related — Changes in the related
currency foreign currency foreign currency
risk exchange rates. exchange rates if the firm
commitment is
denominated in a foreign
currency.

© 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
Hedging 6
1.Executive summary
Financial items Nonfinancial items
Price risk — Total change in the fair — Total change in the fair
value. value.
Criterion 3: Hedging instruments eligible for fair value hedges
There are no additional eligibility criteria or limitations specific to fair value
hedges, other than fair value hedges involving foreign currency risk.
Read more: chapter 3
Accounting for fair value hedges
The fair value hedge accounting model can change how the hedged item is
measured on the balance sheet.
Hedged items are subject to other applicable US GAAP – e.g. an asset or
liability measured at amortized cost. However, the hedging instrument is
measured at fair value with changes in fair value reported in earnings. This
creates a mismatch between the measurement of the hedged item and
hedging instrument. Fair value hedge accounting allows an entity to measure
the hedged item at fair value based on changes in the hedged risk.
In general, the fair value hedge accounting model has two main elements.
Hedging instrument Hedged item
A derivative hedging instrument is Changes in the fair value of the hedged
recognized at fair value on the balance item that are attributable to the hedged
sheet with changes in fair value risk are recognized as an adjustment to
recognized in earnings, other than the amortized cost basis of the hedged
amounts related to excluded item. The offsetting entry is a gain or
components that are recognized through loss that is recognized in earnings.
an amortization approach.
The following diagram shows the general accounting and presentation for a
highly effective fair value hedge (assuming there are no excluded components).
Hedging instrument Hedged item
Changes in fair value
Gain or loss recognized Change in value attributable to
in earnings hedged risk recognized in earnings
Income statement presentation
Recorded in the same income statement line item where the
earnings effect of the hedged item is presented
© 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
Hedging 7
1. Executive summary

The effect is to offset gains or losses on the hedging instrument with gains or
losses on the hedged item that are attributable to the hedged risk within one
line item of the income statement.
The adjustment to the amortized cost basis of the hedged item from applying
fair value hedge accounting is referred to as a basis adjustment. Basis
adjustments are accounted for in the same manner as other components of the
amortized cost basis of the hedged item.
Read more: chapter 4
Qualifying criteria for cash flow hedges
In addition to the general qualifying criteria, Topic 815 specifies certain
transactions, risks and hedging instruments that are eligible to be designated in
a cash flow hedge.
Criterion 1: Transactions eligible for cash flow hedges
Cash flows from existing recognized assets or liabilities or forecasted
transactions are eligble to be designated as the hedged transaction in a cash
flow hedge.
Cash flows from existing recognized Forecasted transactions – e.g. forecasted

assets and liabilities purchases or sales

Group of similar forecasted
All-in-one hedge
transactions

Criterion 2: Risks eligible for cash flow hedges
The risks eligible to be designated in a cash flow hedge are different for
financial and nonfinancial assets and liabilities.

Financial assets and Nonfinancial assets and

liabilities liabilities

Inter est Eithe r: Not applicable.
ra te risk — chan ges in a
contractually specified
interest rate for

variable-rate financial
instruments or
forecasted issuances or
purchases of variable-
rate financial
instruments; or
— changes in the
benchmark interest
rate for forecasted
issuances or purchases
of fixed-rate financial
instruments.
© 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.
Hedging 8
1. Executive summary

Financial assets and Nonfinancial assets and

liabilities liabilities

Cred it Inclu des : Not applicable.
ri sk — risk of de fault;
— changes in the obligor’s
creditworthiness; and

— changes in the credit
spread over the
contractually specified
interest rate or the
benchmark interest
rate.

Foreign — Changes in the related — Changes in the related
currency foreign currency foreign currency
risk exchange rates. exchange rates of foreign
currency denominated

forecasted transactions or
firm commitments.

Price risk  Total change in the Either:
cash flows related to  all changes in the
the asset or liability –
purchase price or sales

e.g. all changes in the price of the asset – i.e.
purchase price or sales
price risk; or
price.
 changes in a contractually
specified component – i.e.
a component of price risk.

Criterion 3: Hedging instruments eligible for cash flow hedges
In addition to the general qualifying criteria and limitations of hedging
instruments, there are eligibility criteria specific to cash flow hedges. This
includes additional requirements that must be met in order to designate a basis
swap as the hedging instrument in a cash flow hedge.
Read more: chapter 5
Cash flow hedge accounting
The cash flow accounting model allows changes in the fair value of the
derivative instrument to be recorded in OCI instead of earnings.
Hedged transactions are probable future transactions that are not yet
recognized on the balance sheet or in earnings. Instead of recognizing the
forecasted transaction in advance, cash flow hedge accounting defers the
recognition of changes in the fair value of the derivative instrument.
In general, the cash flow hedge accounting model works as follows.
— A derivative hedging instrument is recorded at fair value in the balance
sheet. Changes in its fair value that are included in the assessment of
hedge effectiveness are reported in OCI.
© 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member
firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.