FASB ASC 815 – Derivatives and Hedging
The Financial Accounting Standards Board (FASB) released Accounting Standards Codification 815 (ASC 815) to address derivatives and hedging.
Some of the main items included are:
- Weather Derivatives
- Contracts in Entity’s own Equity
- Net Investment Hedges
- Cash Flow Hedges
- Fair Value Hedges
- General Hedging
- Embedded Derivatives
For the most part, there are four underlying principles which drive these various different types of derivatives.
- Derivatives are considered to be assets or liabilities
- Reporting the fair value of these derivative instruments is key
- Gains and losses on derivatives are not separately reported, but as part of the value of the instrument
- Hedge accounting can only be used for those items designated as qualifying items, effectively offset by either changes in fair value or cash flows
Embedded derivatives must be reported according to the standard, if they would otherwise be included in the scope of the standard. These should be separated from the host contract and treated as if it were a separate instrument, if all of the requirements on a list are met. Generally this is if the risks are not closely related to the host contract, the instrument is not required to be measured at fair value under GAAP, as well as if separate instruments with the same terms are required to be accounted for as derivative instruments.
Hedging Activities under FASB ASC 815
The three types of hedging activities designated by the accounting standard are:
- Fair Value Hedges
- Cash Flow Hedges
- Foreign Currency Exposure
Each type of derivative has its own specific caveats which is addressed in this FASB ASC. As more companies are purchasing these and because they can be very complex instruments, as they are most famously known to be, it is important that they are accounted for correctly. When this is done, risks due to the volatility of hedged items reported in the financial statements are effectively offset. Utilizing hedge accounting is a more complex area in the profession, as there are many requirements, however the benefits of utilizing hedges for some companies can be tremendous in removing volatility of items such as commodity prices or interest rates.
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