Financial Instruments: Hedge Accounting

Date recorded:

Application of cash flow hedge accounting mechanics to fair value hedges

The Board considered the application of the Board's September 2009 decision to replace fair value hedge accounting with a mechanism that permitted recognition outside profit or loss of gains and losses on financial instruments designated as hedging instruments - that is, applying the mechanics of cash flow hedge accounting also to fair value hedges. The major implication would be the application of the so-called 'lower-of test' to fair value hedges. The 'lower-of test', currently applied to cash flow hedges only, ensures that only ineffectiveness due to excess cash flows on the hedging instrument (that is, the derivative) is recognised in profit or loss.

The Board members disagreed with the extension of the 'lower-of test' to fair value hedges. The Board was concerned that it was inconsistent with the nature of fair value hedging, could lead to changes in eligibility of portions, could have unintended consequences in the area of deliberately under-hedging, and in effect would lead to a situation that there would be no ineffectiveness in fair value hedges as such. A FASB member clarified that in the FASB approach to hedge accounting (given the recent discussions over the issue) the 'lower of test' would not be applied to fair value hedges.

After a short debate the Board decided by a bare majority (8 votes) to retain the 'lower-of test' for cash flow hedges only. A third of the Board members abstained in this vote.

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