PwC reports it's been getting some questions lately on whether it would be appropriate to use the bookkeeping-friendly shortcut method of hedge accounting for certain late hedges. Maybe, but cautiously, PwC says in an alert to clients.

Hedge accounting, often described as one of the most complex area of an already complex system of accounting rules in the United States, is on deck for an overhaul at the Financial Accounting Standards Board. Contained in a comprehensive proposal to rewrite rules for financial instruments, FASB has proposed some nip-and-tuck changes to existing hedge accounting rules, but it's also sought feedback on a more radical overhaul that is being developed by the International Accounting Standards Board.

In the meantime, says PwC, companies that are issuing debt or investing in assets have been asking a lot of questions lately about hedging the change in fair value of an instrument because of changes in interest rates, after the instrument has been issued. Such late hedges may be appealing because interest rate swap rates are looking attractive or because the company wants to gain more floating rate exposure. The questions focus on whether such late hedges would still qualify for the highly prescriptive requirements for using the shortcut method to account for such hedges, PwC says.

FASB began looking at the issue, the firm said, but set the project aside as it pursued a more comprehensive rewrite of hedge accounting rules. PwC says companies considering such an approach should first analyze the transaction to assure that the terms of the late hedge do not tread on any underlying assumption that the hedge is highly effective otherwise, which is required to meet the criteria for using the shortcut method. The firm recommends a few different approaches for how to complete the analysis, both beginning with a side-by-side comparison of the hedge that's being considered along with a hypothetical hedge that would meet the shortcut criteria perfectly.

In one approach, the company would look to the terms of the interest rate swap and the coupon on the fixed rate leg of the interest rate swap. Alternatively, a company could also refer to the fair value of the hedged instrument. If effectiveness of the hedge is no different under either approach, the company may be able to use the shortcut method.

PwC advises caution with both analyses, and it points out that the analysis focuses only on hedging after an instrument is issued, not after the swap is executed. “The fair value of an interest rate swap designated in a hedging relationship under the shortcut method must always be zero at inception,” the firm says in its alert to clients. “Therefore it is highly unlikely that a hedging relationship could qualify for the shortcut method unless the designation is made at inception of the swap.”

Topics