ASC 848: Successfully maintain hedge accounting beyond LIBOR

February 25, 2020 Yinan Yu

If your organization has London InterBank Offered Rate (LIBOR)-based contracts, the phaseout of LIBOR (i.e., reference rate reform) may impact your existing hedges and hedging relationships. Designed to ease the accounting burden associated with reference rate reform, the Financial Accounting Standards Board (FASB) is expected to issue ASC 848 in March 2020, which provides relief and practical expedients to current GAAP for contracts affected by reference rate reform, including debt contracts, receivables, leases and derivatives.

ASC 848 provides the following relief for hedging relationships that could benefit your organization:

Hedge transaction probability

To qualify for cash flow hedge designation, your organization’s hedged forecasted transactions must be probable of occurring (ASC 815-20-25-15). Due to the phaseout of LIBOR, the hedged forecasted transactions (i.e., LIBOR-based interest payments) may no longer be probable of occurring after 2021. ASC 848 permits the election of a provision that allows you to assert probability of the hedged transactions regardless of any expected modification in terms related to reference rate reform. Prior to ASC 848, entities could rely on an SEC speech from the 2018 AICPA conference to assert probability. However, with the anticipated issuance of ASC 848, you may need to consider electing the specific expedients as prescribed in ASC 848.

Critical terms modifications

For derivatives designated in hedge accounting relationships, a modification to the critical terms of a derivative requires that the hedge accounting relationship be discontinued. For example, a modification of existing ISDA agreement to add fallback language due to reference rate reform could be considered a change to the contractual terms of the existing contract and, therefore, a change to the critical terms of the hedging relationship. Under ASC 848, hedge accounting can continue in this situation if contract modifications are made solely due to reference rate reform.

Effectiveness assessment

Additionally, ASC 848 extends practical expedients to temporarily ease certain effectiveness assessment requirements when there is an economic mismatch between the derivative and the hedged debt agreement. For example, a derivative could transition to a new reference rate prior to the underlying debt agreement. In this situation, you can temporarily elect to ignore the index and payment mismatches when assessing hedge effectiveness until the debt agreement is also modified to the new reference rate.

The FASB expects to issue ASC 848 March 2020. However, its provisions are optional and you must elect them individually to take advantage of their benefits. Chatham recommends reviewing your organization’s individual facts and circumstances to ensure that you elect the relevant expedients in the guidance in a timely manner and appropriately disclose them in your financial statements. Especially for entities with calendar year ends, the issuance of ASC 848 could impact your first quarter financial reporting and disclosures.

How can Chatham help?

Chatham has been following all aspects of reference rate reform from the beginning. Our team of accounting consultants, regulatory experts, and hedging advisors can help companies navigate the contract modifications and accounting analysis that will be key to success in this transition. Chatham can provide sample contract language, draft ASC 848 election memos, and advice to help companies make the right decision at the right time. Please feel free to contact your Hedge Accounting contact or Relationship Manager for more information.

About the Author

Yinan Yu

Yinan is a member of the Corporates Accounting Advisory team. Prior to Chatham, she worked at EY in Assurance. She graduated magna cum laude from Bucknell University, earning her Bachelor of Business Administration in Accounting, and is currently enrolled as an EMBA student at The Wharton School at the University of Pennsylvania.

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