Changes Proposed by FASB in Accounting For Derivatives
There are two accounting standards updates relating to hedging and derivatives that have been proposed for release by the Financial Accounting Standards Board. The first proposal entails the effect of derivatives novations contract on prevailing relationships on hedge accounting. Proposal two pertains to the ‘put and pull’ contingent options of debt instruments.
The recommended update on novations of derivative contracts comes from the task force of Emerging Issues of FASB. Novation is a term referring to the replacement of one party to a derivative contract in a new party. Practically, FASB noted that novations of derivatives may occur due to a number of reasons. This includes mergers or financial institutions, intercompany novations, an organization exiting certain business or relationship derivatives, entities managing credit limits internally and in response to regulatory and law requirements.
FASB noted that the instrument of derivative which is subject to novation could be the hedging instrument in a relationship of hedge accounting that is designated under the 815 Topic.
According to FASB, the point of concern is if a change in derivative instrument counterparty is designated as an instrument for hedging, it results in a requirement for designating the relationship of hedge accounting, therefore discontinuing the hedge accounting application.
The limited existing guidance is also inconsistently applied and interpreted in practice. The changes proposed would apply for all reporting bodies where there is a counterpart change to a derivative instrument that is designated as a hedging instrument in the Topic 815.
In this proposed update, an organization would take into account these amendments prospectively to all new and existing accounting relationships where a change to a derivative’s counterparty occurs after the effective date of guidance proposed. FASB is seeking for feedback on this proposal.
Put and Call Options
The next proposal regarding the debt instrument put and call option also arises from the EITF. The accounting rules prevailing offer particular guidance in assessing if call (put) options which may accelerate the principal repayment on debt instrument meet the close and clear related criteria. According to the guidance, put options have to be considered closely ad clearly and only indexed to credit risk or interest rate.