The new guidance will allow companies to perform more qualitative effectiveness assessments, thereby eliminating some of the challenges with performing quantitative effectiveness assessments. For hedges that do not qualify for either the shortcut or critical terms match methods, a quantitative effectiveness assessment will still be required at the inception of each hedging relationship to demonstrate that it is “highly effective.” However, for ongoing effectiveness testing, the updated guidance will allow a company to qualitatively assess that hedges will continue to be highly effective as long as there have been no changes in the hedging relationship.
If a hedging relationship has changed, a company will be required to perform quantitative testing to demonstrate that the hedge will be highly effective going forward. In addition, if changes to the hedging relationship are expected to occur, quantitative effectiveness assessments will be required to validate that the hedging relationship continues to be highly effective.
The updated guidance will also allow companies additional time to complete the quantitative inception testing when the shortcut method or critical terms match method are not used. Companies will have until the end of the reporting period in which the transaction is executed to complete the inception effectiveness assessments. All other documentation requirements will continue to be required “contemporaneous” with trade execution.
Today, companies are required to perform quantitative effectiveness testing both at inception and on an ongoing basis when the shortcut method or critical terms match method are not used. These quantitative effectiveness tests are required on a regular basis—at least quarterly—throughout the life of the hedge. Most companies perform a statistical regression analysis, although the accounting guidance doesn’t specify a required method for performing these effectiveness assessments.
The updated guidance does not specify how effectiveness assessments will be applied in every situation. For hedging relationships where no mismatches exist, the ongoing quantitative effectiveness assessments will likely be replaced by qualitative assessments. However, in situations where mismatches exist or could arise in the future, quantitative effectiveness assessments will likely continue to be required. Also, we expect many companies to determine that the incremental work of performing quantitative testing on an ongoing basis is insignificant and worth the effort to safely maintain hedge accounting – particularly when quantitative inception testing has already been performed and the effort to roll forward those calculations is minimal. We expect that practice will develop in this area as companies and their auditors interpret the proposed guidance.
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Contact us today to learn more. CorpAcctgTeam@chathamfinancial.com