Impact of Upcoming FASB Changes on Commodity Hedgers

An upcoming Exposure Draft, which the FASB is expected to issue before the end of Q3, will contain sweeping changes for commodity hedgers.

This is Part 1 in a series of posts highlighting the changes expected to be included in the exposure draft. Part 2 focuses on FX hedging; Part 3 focuses on cash flow interest rate hedging. This post is all about commodities.

Commodity Hedges & FASB Changes: What You Need to Know

The FASB is expected to include bifurcation of risk in the upcoming Exposure Draft. This is particularly exciting for commodity hedgers because it will allow them to get “perfect” hedge accounting treatment once an expectation of highly effective is met. At the same time, even more hedge relationships will be highly effective because hedgers will be allowed to evaluate effectiveness against any contractually identified component, whereas current guidance mandates that hedgers evaluate the risk of all changes (e.g., location, grade, etc.).

Corporates will be able to hedge the copper component of bronze, the price of gas delivered to a specific hub or delivery surcharges if these components are individually identified in the hedged item contract or purchase agreement. This change to hedge accounting is expected to modify how commodity contracts are written to ensure that hedge-able components are separately identified.

Not only are commodity hedgers finally being invited to the derivative accounting table, hedge accounting rules are being simplified and made easier to implement. Effectiveness measurement is expected to be eliminated, which means that once an expectation of offset is met the mismatches in timing, grade and location between derivative and the hedged item will no longer be measured and accelerated into income. Instead, all changes in the derivative will be recorded in equity in other comprehensive income until the hedged item is recorded. The P&L will be impacted (in the line item where the hedged item is recorded and in the period the hedged item is recorded) to the extent that there is not a perfect offset between the derivative and the hedged item.

Other expected highlights in the coming Exposure Draft:

  • The elimination of retrospective and ongoing prospective effectiveness testing unless critical terms of the hedged item change
  • Initial quantitative effectiveness testing no longer required “contemporaneously,” but by quarter end after the designation date
  • The documentation of a “back-up test” in the event matched terms are no longer applicable

With the elimination of the concept of ineffective amounts, ineffectiveness disclosures will disappear and current disclosures will be rearranged and augmented as follows:

  • A table showing the P&L impact by line item
  • A discussion of the quantitative goals

Those companies currently hedging commodities without the benefit of hedge accounting will definitely want to show their support of the proposed changes to GAAP by writing comment letters backing those aspects of the Exposure Draft that are beneficial. We expect that the comment period will be between 30 and 60 days long, so start sharpening your pencils now.

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