The Financial Accounting Standards Board’s Emerging Issues Task Force has issued an accounting standards update on the effect of derivative contract novations on existing hedge accounting relationships.

In a novation, one of the parties to a derivative instrument is replaced with a new party. FASB noted that derivative instrument novations can occur for various reasons, including mergers of financial institutions and intercompany transactions. The novation may involve a hedging instrument in a hedging relationship that has been designated under Topic 815 of the FASB Accounting Standards Codification, Derivatives and Hedging.

“The issue is whether a change in the counterparty to a derivative instrument that has been designated as a hedging instrument under Topic 815, in and of itself, results in a requirement to dedesignate that hedging relationship and therefore discontinue the application of hedge accounting,” said FASB. “The guidance in Topic 815 is not explicitly clear about the effect on an existing hedging relationship, if any, of a change in the counterparty to a derivative instrument that has been designated as a hedging instrument. Furthermore, the existing guidance, which is limited, is interpreted and applied inconsistently in practice.”

FASB is updating the standard to clarify that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met.

For public companies, the changes are effective for financial statements issued for fiscal years beginning after Dec. 15, 2016, and interim periods within those fiscal years. For all other entities, the amendments are effective for financial statements issued for fiscal years beginning after Dec. 15, 2017, and interim periods within fiscal years beginning after Dec. 15, 2018.