In mid-January 2014, the FASB released Accounting Standard Update 2014-03 Derivatives and Hedging (Topic 815): Accounting for Certain Receive – Variable, Pay – Fixed Interest Rate Swaps (ASU 2014-03). ASU 2014-03 is the second standard issued by the FASB upon endorsement of a consensus of the Private Company Council that is specifically designed to meet the needs of private companies by providing an alternative within US GAAP. Companies that are unable to borrow at fixed rates often rely on variable-rate debt combined with an interest rate swap. In effect, they receive variable rates and pay fixed rates. The net effect is similar to borrowing at fixed rates. But the accounting and disclosure requirements are considerably more complex when an interest rate swap is involved.

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January 2014
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M AY E R H O F F M A N M C C A N N P. C . – A N I N D E P E N D E N T C PA F I R M
A publication of the Professional Standards Group
FASB Releases Simplification for the Accounting for Certain Interest Rate
Swaps for Private Companies
In mid-January 2014, the FASB released Accounting
Standard Update 2014-03 Derivatives and Hedging
(Topic 815): Accounting for Certain Receive – Variable,
Pay – Fixed Interest Rate Swaps (ASU 2014-03). ASU
2014-03 is the second standard issued by the FASB
upon endorsement of a consensus of the Private
Company Council that is specifically designed to
meet the needs of private companies by providing an
alternative within US GAAP.
The Issue
Companies that are unable to borrow at fixed rates
often rely on variable-rate debt combined with an
interest rate swap. In effect, they receive variable
rates and pay fixed rates. The net effect is similar
to borrowing at fixed rates. But the accounting and
disclosure requirements are considerably more
complex when an interest rate swap is involved.
Current accounting standards require companies to
recognize all their derivative instruments (including
interest swaps) on their balance sheets as assets
or liabilities and to measure them at fair value. The
standards allow companies to mitigate the income
statement effect of any swings in fair value attributable
to interest rate risks by applying an accounting
method known as “cash flow hedge” accounting.
This technique has the effect of presenting interest
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expense in the income statement as if the company
had a fixed rate debt. But some entities, especially
private companies, have expressed concerns about
the practical difficulties involved in applying the
current standards.
• Companies often say they lack the accounting
resources and/or expertise to comply with all the
requirements that must be met to use the cash
flow hedge method. These requirements include
formal and timely documentation at the inception
of the hedge, (known as contemporaneous
documentation).
• Additionally, to qualify for hedge accounting, the
hedging relationship must be expected to be highly
effective, both at the inception of the hedge and
on an ongoing basis. As a result, an assessment
of hedge effectiveness is required whenever
financial statements are reported and at least
every three months. If certain other conditions
are met, current accounting standards permit
the reporting entity to use a qualitative method
(known as the shortcut method) to assess hedge
effectiveness. In practice, however, many private
companies find their interest rate swaps do not
qualify for the shortcut method, with the result that
they need to use a technique known as the long
haul method and they often lack the resources or
expertise to use the long haul method.
• The requirement to report interest rate swaps
at fair value can trigger burdensome disclosure
requirements about the fair values of other financial
instruments under current accounting standards.
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Because of the practical difficulties, many private
companies do not use hedge accounting, with the
result that the change in the fair value of an interest
rate swap used by a private company typically flows
through the company’s income statement. Users of
their financial statements have indicated that they do
not find this result useful and some have said they
typically reverse the effects of changes in the fair
value of the swaps in the financial statements.
The Alternative
The simplified hedge accounting approach provides
a practical expedient that enables certain entities
to obtain cash flow hedge accounting for interest
rate swaps that are entered into for the purpose
of economically converting variable rate interest
payments to fixed-rate payments. This practical
expedient is available to private companies other than
financial institutions (e.g., banks, savings and loan
associations, savings banks, credit unions, finance
companies, and insurance entities).
Highlights of the simplified hedge accounting approach
are as follows:
• The simplified hedge accounting approach
assumes no ineffectiveness and it results in an
income statement charge for interest that is similar
to the amount that would result if the private
company had entered into fixed-rate borrowing
instead of variable rate borrowing.
• To qualify for the alternative treatment, interest rate
swaps need to meet certain criteria. For example,
the terms of the swap must be typical (i.e., a
“plain vanilla” swap). In addition, the repricing and
settlement dates for the swap and borrowing must
match or differ by only a few days, the notional
amount of the swap must be equal to or less than
the principal amount of the borrowing, the variable
rates on the swap and borrowing must be based on
the same index and reset period, and the swap’s
fair value at inception must be at or near zero.
• A private company has the option to measure the
designated swap at settlement value instead of
fair value, and it has additional time to prepare the
hedge documentation. This documentation does
not need to be contemporaneous, but it must
be completed by the date on which the annual
financial statements are available to be issued.
• Companies can elect the alternative treatment on
a swap-by-swap basis, provided the swap meets
the appropriate criteria. The policy election does
not need to apply to all swaps. The disclosure
requirements are simplified because use of the
simplified hedge accounting approach will not
trigger fair value disclosure requirements for other
financial instruments.
The effective date is for annual periods beginning
after December 15, 2014 and interim periods within
annual periods beginning after December 15, 2014.
Early adoption is permitted for any period for which
the company’s annual or interim financial statements
have not yet been made available for issuance. Private
companies are permitted to apply either the modified
retrospective approach or the full retrospective
approach upon adoption of the simplified hedge
accounting approach. Existing swaps as of the date
of adoption may qualify for the simplified hedge
accounting approach.
What should companies do now?
While each company’s situation is unique, here are
some general steps that companies may find helpful
now:
• Private companies should consider whether
they qualify for the alternative approach and,
if so, whether and when they wish to adopt the
approach in their financial statements. If you are
considering applying the alternative in your 2013
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financial statements, you may wish to consult with
your accounting firm sooner rather than later.
• All companies that use private company financial
statements should understand the key provisions
for any new alternative accounting treatments,
so they can analyze the financial statements
effectively. This includes lenders, suppliers to
private companies, and public companies that
may need to include private company financial
information in their SEC filings — either now (if
they have already invested in a private company)
or in the near future (if they are considering
acquiring a private company).
For more information
MHM’s Professional Standards Group will continue
to monitor progress on private company standardsetting, and we are prepared to help our private
company clients with any implementation issues that
may arise.
If you have any specific questions, comments or
concerns, please share them with Ernie Baugh or
James Comito of MHM’s Professional Standards
Group or your MHM service professional. You can
reach Ernie at ebaugh@mhm-pc.com or 423.870.0511
and James at jcomito@cbiz.com or 858.795.2029.
The simplified hedge accounting approach was
finalized as ASU 2014-03 and issued early in 2014.
The effective date is for annual periods beginning
after December 15, 2014, and interim periods within
annual periods beginning after December 15, 2014,
with early adoption permitted. Existing swaps as of
the date of adoption may qualify for the simplified
hedge accounting approach.
What to watch for in 2014
The FASB intends to consider whether to permit public
business entities and not-for-profit entities to use this
simplified approach as part of its larger project on
hedge accounting. In addition the PCC is considering
an additional alternative for the accounting for certain
interest rate swaps called the combined instruments
approach that would eliminate the need to apply
hedge accounting in some instances.
The information in this MHM Messenger is a brief summary and may not include all the details relevant to your situation.
Please contact your MHM auditor to further discuss the impact on your audit or audit report.
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