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FASB Proposes End to Shortcut Many Treasurers Use to Reduce Earnings Volatility

  • By Salome J. Tinker
  • Published: March 17, 2010

At a meeting last week FASB reaffirmed its position to move toward a "bifurcation by risk" model to evaluate hedge effectiveness.  Key features of the possible hedge accounting model to be included in the forthcoming Exposure Draft are as follows:

The shortcut method and critical terms match method would be eliminated. An entity would no longer have the ability to assume a hedging relationship is reasonably effective and recognize no ineffectiveness in net income during the term of the hedge. 

Entities would be able to designate particular risks as the risks being hedged in a hedging relationship. Only the effects of the risks hedged would be reflected net income.

Entities would be required to perform a qualitative (rather than quantitative) test at inception to demonstrate that an economic relationship exists between the hedging instrument and the hedged item or forecasted transaction. However, in certain situations a quantitative test may be necessary at inception. 

As part of the hedge effectiveness assessment, entities would be required to demonstrate that changes in fair value of the hedging instrument would be reasonably effective in offsetting the changes in the hedged item's fair value or the variability in the hedged cash flows for the risk or risks hedged by the entity in that hedging relationship. 

After inception of the hedging relationship, an entity would need to qualitatively (or quantitatively, if necessary) reassess effectiveness only if circumstances suggest that the hedging relationship may no longer be reasonably effective.

An entity would not be permitted to discontinue hedge accounting by simply removing the designation of a hedging relationship. Hedge accounting can be discontinued only if the criteria for hedge accounting are no longer met or the hedging instrument expires, is sold, terminated, or exercised.

AFP staff in conjunction with AFP's Finanical Accounting and Investor Relations (FAIR) Task Force is currently evaluating the proposed guidance to determine the impact the proposed rules may have on Treasury Professionals.  The complete discussion summary can be viewed at FASB's website.  Your views on this issue is also welcome.  If you have any comments on the proposal please feel free to contact Salome J. Tinker, AFP's Director of Accounting at sjtinker@afponline.org.

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