FASB decisions on COVID-19 hedge accounting impacts

April 20, 2020 Chatham Financial

Executive summary

The FASB recently issued decisions related to the accounting impacts of COVID-19. The decision regarding hedge accounting created a gray area that will be subject to interpretation and potential manipulation. Therefore, support and documentation related to these decisions will be important. Chatham is prepared to navigate this area and ensure that the accounting treatment applied is consistent and accurate.

Background

The FASB met on April 8, 2020 to discuss certain accounting implications of COVID-19. During the meeting, the Board discussed inquiries they had received related to COVID-19 and its impact on financial statement preparation. A key takeaway from the meeting was that the Board believes COVID-19 to be considered a rare and extenuating circumstance, which may significantly impact hedge accounting results related to shifts in timing of hedged forecasted transactions, as discussed further below.

Hedge accounting takeaways

ASC 815-30-40-4 states that when a cash flow hedging relationship has been de-designated, the amount in Other Comprehensive Income (OCI) is evaluated to determine if the forecasted transactions are still probable of occurring within the originally specified time period or an additional two-month period thereafter.

However, 40-4 also states that in rare and extenuating circumstances beyond the control of the entity, the amounts can be held in OCI if the hedged transactions are probable to occur subsequent to the additional two-month period.

The FASB staff believes that the impacts from the pandemic are considered extenuating circumstances and OCI can be held until the originally forecasted transactions impact earnings, as long as the delay in transactions can be attributed to the pandemic.

Companies will need to determine if delay of OCI release is reasonable given the nature of the business, the nature of the hedged transactions, and the magnitude of the disruption related to the effects of the COVID-19 pandemic. 

Examples of transactions impacted include derivatives designated as cash flow hedges of the following:

  • Foreign currency purchases and sales
  • Commodity purchases and sales
  • Interest payments and receipts

If the transactions are no longer probable to occur, amounts deferred into OCI must be released into earnings immediately.

From the date of de-designation, changes in fair value are no longer deferred into OCI but will flow through current period earnings.

The FASB has not addressed continuation of cash flow hedge accounting if there are concerns about probability of the hedged transactions. So, unless further guidance is issued, companies will likely need to continue with the current practice of de-designating trades if the hedged transactions are not probable to occur within the originally specified time period.

If derivatives are amended in order to adjust the economic hedge of the delayed transactions, the amended derivatives will likely not qualify for simplified effectiveness testing methods. Companies will need to consider more sophisticated effectiveness testing methods, which can also be used to extend the specified time period window and provide greater flexibility for timing delays.

Missed forecasts directly related to the COVID-19 pandemic do not need to be considered when determining whether a company is able to accurately forecast transactions in order to apply cash-flow hedge accounting in the future for similar transactions. 

Example

ABC Company is a manufacturer that purchases raw materials in a foreign currency to fulfill standing orders. In order to hedge their foreign currency risk, ABC Company has entered into FX forwards, which have been designated as cash flow hedges. Due to COVID-19 (delays in ability to purchase raw materials, operations being shut down due to being considered non-essential, etc.), ABC Company doesn’t expect to purchase the raw materials originally designated as being hedged in each of the months March-June. As such, ABC Company de-designates the applicable trades, which were designated under the critical terms match approach and begins marking the change in value of those trades through earnings. ABC Company expects to restart operations and begin purchasing raw materials again in July to fulfill the standing orders.

If ABC’s management determines that the originally hedged transactions are still probable to occur and will be delayed by no more than a reasonable period due to COVID-19, the Company will take advantage of the extenuating circumstances guidance and hold amounts in OCI until the originally hedged transactions impact earnings. If ABC’s management determines the hedged transactions are no longer probable to occur, it will be required to reclassify hedging gains/losses related to those hedged transactions immediately from OCI to earnings.

How can Chatham help?

Chatham's team of accounting consultants, regulatory experts, and hedging advisors can help you navigate the accounting implications of COVID-19 and their impacts to your hedging programs. Please reach out to your Chatham accounting contact or relationship manager if you have any questions or would like to discuss impacts to any of your programs.


Disclosures

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal/notices/.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved. 20-0127

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