In response to concerns raised by companies about accounting issues relating to contract modifications and hedge accounting related to reference rate reform, on September 5, 2019, the FASB issued an Exposure Draft – Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.
The FASB’s proposed ASU seeks to provide relief for companies that have contracts impacted by reference rate reform. The proposals would provide companies with optional guidance for a limited time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform. Comments are due from constituents on October 7, 2019 with the final standard issued thereafter.
- Companies would be permitted to elect optional expedients and exceptions for applying US GAAP to contracts, hedging relationships and other transactions when they:
- reference LIBOR or another reference rate expected to be discontinued due to reference rate reform; and
- have modifications that change, or have the potential to change, the amount and timing of contractual cash flows related to the replacement of the reference rate.
- The expedients and exceptions would not apply to contract modifications made, and hedging relationships entered into or evaluated after, December 31, 2022.
Optional expedients for contract modifications
The proposed ASU provides optional expedients for modifications of the following contracts that meet certain scope criteria, including that the modification is related to reference rate reform:
- Modifications of contracts within the scope of Topic 310, Receivables, or Topic 470, Debt, may be accounted for as the continuation of existing contracts without the need for detailed analysis.
- Modifications of contracts within the scope of Topic 842, Leases, may be accounted for as a continuation of the existing contract with no reassessments or remeasurement required.
- Modifications of contracts can be elected to not be reassessed under Subtopic 815-15, Derivatives and Hedging – Embedded Derivatives, for embedded derivatives previously determined to be clearly and closely related to the host contract.
The optional expedients for contract modification must be applied consistently for all contracts or transactions within the relevant section of the codification.
Optional expedients for changes in the critical terms of a hedging relationship
The proposed ASU provides companies the option to elect to continue hedge accounting for the following changes which are due to reference rate reform:
- Change in the contractual terms of a designated hedging instrument in a fair value, cash flow or net investment hedge.
- Change in the proportion of a designated hedged item, a derivative hedging instrument, or both, in a fair value hedge.
- Change in the designated hedging instrument to add one or more derivatives in a fair value or cash flow hedge.
- Change in the method used to assess hedge effectiveness when initially applying an optional expedient method and when reverting to the requirements of ASC 815 for cash flow hedges.
Optional expedients for fair value hedges
For existing fair value hedging relationships for which there is a change in the original benchmark rate to a different eligible benchmark rate due to a reference rate reform, a company may elect to:
- Continue the hedge relationship without dedesignation and following the proposed methodology to account for the change; and/or
- Continue to apply the shortcut method for existing relationships notwithstanding certain qualifying conditions that would not have been met due to reference rate reform.
Optional expedients for cash flow hedges
- For existing cash flow hedging relationships, the proposed ASU provides the following optional expedients a company may elect:
- Disregard the potential change in the designated hedged risk when assessing whether the hedged forecasted transaction is probable.
- Continue hedge accounting upon a change in the hedged risk as long as the hedge is still highly effective.
- Continue to apply the shortcut method (or another method that assumes perfect hedge effectiveness) for existing relationships notwithstanding certain qualifying criteria that would not have been met.
- Change the method to initially assess whether hedge accounting may be applied for new cash flow hedges for which the hedging instrument or hedged forecasted transactions reference a rate that is affected by the reference rate reform and disregard the mismatch in variable rate indexes.
- For new cash flow hedges of portfolios of forecasted transactions that reference a rate that is expected to be affected by reference rate reform, disregard the requirement that individual transactions must share the same risk exposure for which they are being hedged.