The ASU adds the following definitions to the glossary of ASU 815, Derivatives and Hedging:
Nonperformance Risk
Nonperformance risk is the risk that an entity will not fulfill an obligation. Nonperform-ance risk includes, but may not be limited to, the reporting entity’s own credit risk.
Financial Statements Are Available to Be Issued
Financial statements are considered available to be issued when they are complete in a form and format that complies with GAAP and all approvals necessary for issuance have been obtained, for example, from management, the board of directors, and/or signifi-cant shareholders. The process involved in creating and distributing the financial statements will vary depending on an entity’s management and corporate governance structure as well as statutory and regulatory requirements.
Not-for-Profit Entity
A not-for-profit entity is an entity that possesses the following characteristics, in varying degrees, that distinguish it from a business entity:
• Contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return
• Operating purposes other than to provide goods or services at a profit
• Absence of ownership interests like those of business entities Entities that clearly fall outside this definition include the following:
• All investor-owned entities
• Entities that provide dividends, lower costs, or other economic benefits directly and proportionately to their owners, members, or participants, such as mutual insurance entities, credit unions, farm and rural electric cooperatives, and employee benefit plans.
Private Company
A private company is an entity, other than a public business entity, a not-for-profit entity, or an employee benefit plan on plan accounting. (Such benefit plans are covered by ASC 960 and ASC 965.)
Public Business Entity
A public business entity is a public business entity meeting any one of the criteria below. Neither a not-for-profit entity nor an employee benefit plan is a business entity.
• It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or does file or furnish financial statements
(includ-ing voluntary filers), with the SEC (includ(includ-ing other entities whose financial statements or financial information are required to be or are included in a filing).
• It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency other than the SEC.
• It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of, or for purposes of, issuing securities that are not subject to contractual restrictions on transfer.
• It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
• It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U.S. GAAP financial statements (including footnotes) and make them publicly available on a periodic basis (e.g., interim or annual periods). An entity must meet both of these conditions to meet this criterion.
An entity may meet the definition of a public business entity solely because its financial statements or financial information is included in another entity’s filing with the SEC. In that case, the entity is only a public business entity for purposes of financial statements that are filed or furnished with the SEC.
¶ 207 SCOPE
The simplified hedge accounting approach may be used only for an eligible entity. An eligible entity is one that is a private company. It is not available for any of the following entities:
• A public business entity
• Not-for-profit entity
• Employee benefit plan
• Financial institutions, including banks, savings and loan associations, savings banks, credit unions, finance companies, and insurance entities
The PCC decided not to include financial institutions because those entities usually use many derivative instruments recorded at fair value. Therefore, introducing the concept of settlement value for certain types of swaps could be confusing to users. Also, financial institutions generally have sufficient resources to comply with the current ASC 815 GAAP requirements. Additionally, the PCC noted that application of the scope exception to swaps accounted for under the simplified accounting approach may not be appropri-ate for financial institutions, considering their greappropri-ater exposure to financial instruments and the relevance of fair value accounting for those instruments. The FASB and the PCC recognize that decisions about whether an entity may apply alternatives within U.S.
GAAP for private companies may ultimately be decided by regulators, lenders, and other creditors or other financial statement users that require U.S. GAAP financial statements.
STUDY QUESTIONS
1. Which of the following is defined as a private company under ASU 2014-03?
a. Nonpublic entity b. Not-for-profit entity c. Public business entity d. Employee benefit plan
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2. Under ASU 2014-03, financial statements are considered
when they are complete in a form and format that complies with GAAP and all approvals for issuance have been obtained.
a. Ready to distribute b. Issued
c. Available to be issued d. Finalized
¶ 208 RULES
The general rule is that all derivative instruments shall be measured at fair value.
The simplified hedge accounting approach may be applied by an eligible entity (private company) to a cash-flow hedge of a variable-rate borrowing with a receive-variable, pay-fixed interest-rate swap.
A receive-variable, pay-fixed interest-rate swap for which the simplified hedge accounting approach is applied may be measured subsequently at settlement value instead of fair value. The primary difference between settlement value and fair value is that nonperformance risk is not considered in determining settlement value. One approach for estimating the receive-variable, pay-fixed interest-rate swap’s settlement value is to perform a present value calculation of the swap’s remaining estimated cash flows using a valuation technique that is not adjusted for nonperformance risk.
Interest expense is recorded as though the entity had fixed-rate borrowing as opposed to a variable-interest rate borrowing.
In order to use the simplified hedge accounting approach, a private entity must satisfy all of the following additional conditions:
• Both the variable rate on the swap and the borrowing must be based on the same index and reset period. In complying with this condition, an entity is not limited to benchmark interest rates described in ASC 815, Derivatives and Hedging, Subtopic 815-20-25-6A.
NOTE: ASC 815-20-25-6A defines benchmark interest rates to include rates on direct U.S. Treasury obligations and the London Interbank Offered Rate (LIBOR) swap rate.
EXAMPLE: Both the swap and borrowing are based on one-month LIBOR, or both the swap and borrowing are based on the three-month LIBOR.
• The swap must be a typical, “plain-vanilla swap, and there must be no floor or cap on the variable interest rate of the swap unless the borrowing has a comparable floor or cap.
NOTE: In complying with this condition, the term “comparable does not necessarily mean equal.
EXAMPLE: If the swap’s variable rate is the LIBOR and the borrowing’s variable rate is LIBOR plus two percent, a 10 percent cap on the swap would be comparable to a 12 percent cap on the borrowing.
• The re-pricing and settlement dates for the swap and the borrowing must match or differ by no more than a few days.
• The swap’s fair value at inception (i.e., at the time the derivative was executed to hedge the interest rate risk of the borrowing) must be at or near zero.
• The notional amount of the swap must match the principal amount of the borrowing being hedged. In complying with this condition, the amount of the borrowing being hedged may be less than the total principal amount of the borrowing.
NOTE: For a forward-starting swap, only the effective term of the receive-variable, pay-fixed interest-rate swap (i.e., from its effective date through its expiration date) shall be considered in complying with this condition. The period from the swap’s inception to the date the swap is effective shall not be considered in complying with this condition because the effective date of a forward-starting swap occurs after the swap’s inception.
EXAMPLE: A forward-starting receive-variable, pay-fixed, interest-rate swap with a five-year effective term and an effective date commencing one year after the swap’s inception would meet this condition if designated as a hedge of a five-year, variable-rate borrowing forecasted to be entered into one year after the swap’s inception.
• All interest payments occurring on the borrowing during the term of the swap (or the effective term of the swap underlying the forward starting swap) must be designated as hedged whether in total or in proportion to the principal amount of the borrowing being hedged.
NOTE: A cash-flow hedge established through the use of a forward-starting receive-variable, pay-fixed interest-rate swap may be permitted in applying the simplified hedge accounting approach only if the occurrence of forecasted interest payments to be swapped is probable. When forecasted interest pay-ments are no longer probable of occurring, a cash-flow hedging relationship will no longer qualify for the simplified hedge accounting approach and the General Subsections of ASC 815, Derivatives and Hedging, shall apply at the date of change and on a prospective basis.
Assumption That There is No Ineffectiveness in the Cash Flow Hedging Relationship
If all of the conditions to use a simplified hedging accounting approach are met, an entity may assume that there is no ineffectiveness in a cash-flow hedging relationship involving a variable-rate borrowing and a receive-variable, pay-fixed interest-rate swap.
Subsequent Change in Required Conditions
If any of the conditions for applying the simplified hedge accounting approach subse-quently cease to be met or the relationship otherwise ceases to qualify for hedge accounting, the General Subsections of ASC 815, Derivatives and Hedging, shall apply at the date of change and on a prospective basis.
EXAMPLES: If the related variable-rate borrowing is prepaid without termi-nating the receive-variable, pay-fixed interest-rate swap, the gain or loss on the swap in accumulated other comprehensive income shall be reclassified to earnings with the swap measured at fair value on the date of change and subsequent changes in fair value reported in earnings.
If the receive-variable, pay-fixed interest-rate swap is terminated early without the related variable-rate borrowing being prepaid, the gain or loss on the swap in accumulated other comprehensive income shall be reclassified to earnings.
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Documentation Requirements
In applying the simplified hedge accounting approach, the documentation required by ASC 815, Derivatives and Hedging, paragraph 815-20-25-3 to qualify for hedge account-ing must be completed by the date on which the first annual financial statements are available to be issued after hedge inception rather than concurrently at hedge inception.
NOTE: ASC 815-20-25-3 requires an entity to document certain items to qualify for hedge accounting including the hedging relationship, and the entity’s risk management objective and strategy for undertaking the hedge, among others.
Disclosures
If the simplified hedge accounting approach is applied in accounting for a qualifying receive-variable, pay-fixed interest-rate swap, the settlement value of that swap may be used in place of fair value when disclosing the information required by this ASU or in providing other fair value disclosures, such as those required under ASC 820, Fair Value Measurements and Disclosures, on fair value. For the purposes of complying with these disclosure requirements, amounts disclosed at settlement value will be subject to all of the same disclosure requirements as amounts disclosed at fair value. Any amounts disclosed at settlement value shall be clearly stated as such and disclosed separately from amounts disclosed at fair value.
Private Company Exemption
Private companies that elect to use the simplified hedge accounting approach are exempt from most of the fair disclosures. Private companies electing to use the simplified hedge accounting approach are exempt from the fair value disclosures found in ASC 825, Financial Instruments, paragraphs 825-10-50-10 through 50-16.
The ASU clarifies that for purposes of determining whether an entity is exempt from fair value disclosures under ASC 825, Financial Instruments, an interest-rate swap recorded using the simplified hedge accounting approach is not considered a derivative instrument under ASC 815.
NOTE: ASC paragraph 825-10-50-3 states that certain entities are exempt from fair value disclosures only if all of the following conditions are met:
• The entity is a nonpublic entity.
• The entity’s total assets are less than $100 million on the date of the financial statements.
• The entity has no instrument that, in whole or in part, is accounted for as a derivative instrument under ASC 815 other than commitments related to the origination of mortgage loans to be held for sale during the reporting period.
ASU 2014-03 confirms that an interest-rate swap is not considered a derivative if the simplified method is elected.