Until January 2018, the hedge accounting guidance under U.S. GAAP and IFRS was fairly aligned. However, the new International Financial Reporting Standard for financial instruments, IFRS 9, diverges in several key elements and introduces concepts that don't exist under U.S. GAAP.
While the Securities and Exchange Commission expects the two standards to coexist, challenges remain for U.S. companies that have international subsidiaries that will need to report under IFRS 9 for statutory purposes and for U.S. subsidiaries of international companies.
What are turning out to be the most disruptive changes? The areas of divergence that will likely have the largest impact are twofold: the new time value election, and the related requirement to calculate “aligned time value.”
A new election for time value
IFRS 9 introduces a new accounting election for time value: excluding currency basis. “Exclude currency basis” represents the difference between the traded market rate and the forward price implied using interest rate differentials only. Therefore, the time value elections under IFRS 9 are:
- Include time value;
- Exclude currency basis; and,
- Exclude all of time value.
Treasury departments will need to reassess their time value election and update the related documentation, specifically assessing hedge effectiveness. The new time value election requires hedgers to rethink their strategies and consider how to become compliant.
New calculations and reporting
If a company chooses to exclude currency basis or exclude all of time value, they will need to measure what is being termed “aligned time value,” a new concept that will likely be the biggest shift for companies. Never before, under any accounting guidance, have companies that excluded time value had to look at the time value of the derivative and compare it to the time value of the exposure — historically, that analysis was limited to the include time value hedge relationships.
Hedgers now have to calculate the aligned time value for large portfolios in short accounting close time frames. This could be a complex and time-consuming undertaking. Many companies are struggling to prepare their existing accounting systems to handle the new calculations and record results in the general ledger accurately.
Rather than using complicated workarounds to make legacy systems work, companies can implement technology that is already IFRS 9-compliant.
Not only will companies need to calculate aligned time value, they also have to report on it. For U.S. companies reporting foreign results under "local" jurisdiction guidance and foreign companies with U.S. subsidiaries, this may mean reporting under both U.S. GAAP and IFRS 9. Knowing which elections align most effectively and working with a system that is compliant under both,may significantly reduce the complexity and burdens of hedge accounting.
Companies both large and small are finding the implementation of IFRS 9 more challenging than anticipated, requiring everything from patching legacy accounting software (or even going back to spreadsheets for some elements) to a wholesale revaluation of hedging strategies. Being aware of these changes and how they impact all aspects of a foreign exchange hedge program is crucial.