Derivatives, Hedging, and the FASB Accounting Standards Update – What’s Changed?
Articles by: Richey May, Sep 30, 2022
Derivatives and Hedging (Topic 815): Fair Value Hedging—Portfolio Layer Method
In March 2022, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2022-01, clarifying guidance within ASC 815, Derivatives and Hedging. This update expands guidance on fair value hedge accounting, more specifically targeting improvements to the previous update, ASU 2017-12, which provided for the last-of-layer method.
The amendments in update 2022-01 provide answers to questions under the previous update by:
1. Expanding the current last-of-layer method that permits only one hedged layer to allow multiple hedged layers of a single closed portfolio. To reflect that expansion, the last-of-layer method is renamed the portfolio layer method.
2. Expanding the scope of the portfolio layer method to include non-prepayable financial assets.
3. Specifying that eligible hedging instruments in a single-layer hedge may include spot-starting or forward-starting constant-notional swaps, or spot-or forward-starting amortizing-notional swaps and that the number of hedged layers (that is, single or multiple) corresponds with the number of hedges designated.
4. Providing additional guidance on the accounting for and disclosure of hedge basis adjustments that are applicable to the portfolio layer method whether a single hedged layer or multiple hedged layers are designated.
5. Specifying how hedge basis adjustments should be considered when determining credit losses for the assets included in the closed portfolio.
The amendments of ASU 2022-01 apply to all entities utilizing fair value hedge accounting and the portfolio layer method contained within that ASC 815 standard.
Accounting for mortgage lending activities is not impacted by the update. While mortgage lenders commonly utilize certain derivative instruments to mitigate interest rate risks, these instruments are typically accounted for as free-standing derivative instruments and not designated for hedge accounting. Free-standing derivative instruments, such as the To-Be-Announced (TBA) securities, are accounted for at their fair value and recognized as assets or liabilities on the balance sheet. The fair value of free-standing derivative instruments is based on observable market data. Changes in fair value are recognized in current earnings in the period of change.
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