Derivatives Implementation Group

Statement 133 Implementation Issue No. E9

QUESTION

Would the change in the method of assessing hedge effectiveness by an entity be considered a change in accounting principle as defined in FASB Statement No. 154, Accounting Changes and Error Corrections?

BACKGROUND

Paragraph 62 of Statement 133 requires that an entity define at the time it designates a hedging relationship the method it will use to assess the hedge's effectiveness in achieving offsetting changes in fair value or cash flows attributable to the risk being hedged. The entity should apply this defined method consistently throughout the hedge period to assess at inception of the hedge and on an ongoing basis whether it expects the hedging relationship to be highly effective in achieving offset and to measure the ineffective part of the hedge. (Statement 133 Implementation Issue No. E7, "Methodologies to Assess Effectiveness of Fair Value and Cash Flow Hedges," points out that an entity's consideration of hedge effectiveness has two aspects - in prospective considerations and in retrospective evaluations.) Paragraph 62 further states that when an entity identifies an improved method and wants to apply that method prospectively, it must discontinue the existing hedging relationship and designate the relationship anew using the improved method. Accordingly, the new method of assessing hedge effectiveness must be applied prospectively and must also be applied to similar hedges unless the use of a different method for similar hedges is justified. Examples of changes in the types of methods an entity may use in assessing hedge effectiveness could include the following:

• A change from the dollar-offset method to the use of regression analysis or vice versa

   

• A change between any one of the three methods discussed in Statement 133 Implementation Issue No. G7, "Measuring the Ineffectiveness of a Cash Flow Hedge under Paragraph 30(b) When the Shortcut Method Is Not Applied," (for example, a change from the change in variable cash flows method to either the hypothetical derivative method or change in fair value method)

   

• A change from excluding certain components of a derivative gain or loss to including such components or vice versa (for example, a change from measuring effectiveness based on changes in intrinsic value to the entire change in an option's fair value)

   

• A change from assessing hedge effectiveness on a period-by-period basis to a cumulative basis or vice versa.

Paragraph 2(c) of Statement 154 defines a change in accounting principle as follows:

     A change from one generally accepted accounting principle to another generally accepted accounting principle when there are two or more generally accepted accounting principles that apply or when the accounting principle formerly used is no longer generally accepted. A change in the method of applying an accounting principle also is considered a change in accounting principle.

RESPONSE

No, a change in the method of assessing hedge effectiveness by an entity would not be considered a change in accounting principle as defined in Statement 154. Statement 133 permits a hedging relationship to be dedesignated (that is, discontinued) at any time. If an entity wishes to change any of the critical terms of the hedging relationship (including the method designated for use in assessing hedge effectiveness), as documented at inception, the mechanism provided in Statement 133 to accomplish that change is the dedesignation of the original hedging relationship and the designation of a new hedging relationship that incorporates the desired changes. The dedesignation of an original hedging relationship and the designation of a new hedging relationship represents the application of Statement 133 and is not a change in accounting principle under Statement 154, even though the new relationship may differ from the original relationship only with respect to the method designated for use in assessing the hedge effectiveness of that relationship.

Although paragraph 62 refers to discontinuing an existing hedging relationship and then designating and documenting a new hedging relationship using an improved method for assessing effectiveness, that reference was not meant to imply that the perceived improved method had to be justified as a preferable method of applying an accounting principle under Statement 154. However, any change in the method of assessing hedge effectiveness would need to comply with the requirements of paragraph 62, which also states, "Ordinarily, however, an entity should assess hedge effectiveness for similar hedges in a similar manner; use of different methods for similar hedges should be justified."

The above response has been authored by the FASB staff and represents the staff's views, although the Board has discussed the above response at a public meeting and chosen not to object to dissemination of that response. Official positions of the FASB are determined only after extensive due process and deliberation.