Understanding ASC 848
- February 25, 2020
Global Head of Hedge Accounting
Kennett Square, PA
Answers to key questions about the FASB's new update, ASC 848 Reference Rate Reform, and what you need to know about the optional relief it can provide.
- The FASB issued an update (ASC 848) that provides temporary optional guidance to ease the potential burden in accounting for reference rate reform.
- If companies elect to apply ASC 848, they can ignore certain economic mismatches that arise as a result of reference rate reform.
- ASC 848 is designed to provide relief while companies are exposed to reference rate form, with a set expiration date of December 31, 2022.
On July 27, 2017, the Financial Conduct Authority (FCA), tasked with overseeing the London Interbank Offered Rate (LIBOR), announced the benchmark interest rate will be phased out by the end of 2021. Existing and future contracts indexed to LIBOR will need to be renegotiated to reference another rate. The proposed replacement for USD-LIBOR is the Secured Overnight Financing Rate (SOFR); other alternative risk-free rates (RFRs) have been identified in the UK, Europe, Japan, and Switzerland. Reference rate reform will impact millions of contracts with trillions of aggregate notional value throughout the world. Companies find exposure to LIBOR not only in debt, leases, and derivatives, but also in the default provisions of purchase and sale contracts and other contracts. Chatham has published an FAQ about the economic effects of reference rate reform.
In March 2020 the Financial Accounting Standards Board (FASB) issued a set of optional relief in ASC 848 Reference Rate Reform. The guidance contains optional expedients that can be applied to debt contracts, receivables, leases, derivatives, and other contracts impacted by reference rate reform.
Due to the number of complexities involved in this transition, it is imperative that companies assess their current and potential future exposure to LIBOR and actively plan for the transition. In addition to the economic and operational impact, this includes having discussions with auditors to ensure that the timing and content of documentation is sufficient.
In addition, tax relief has been proposed by the U.S. Treasury for reference-rate-reform-related contract modifications. Companies should consult with tax counsel and advisors to evaluate the impacts.
What is ASC 848 Intended to Address?
ASC 848 provides optional relief for contract modifications that are related to reference rate reform. When you modify a contract, current GAAP requires analysis to determine the ongoing treatment of the contract and the P&L impact associated with the modification. And, unless they are renegotiated concurrently, derivatives and the contracts that they hedge could be renegotiated with different critical terms. In that scenario, application of ASC 848 would allow companies to ignore certain economic mismatches arising due to reference rate reform in a hedging relationship where current GAAP requires those mismatches be modeled into the assessment of effectiveness. This can all be done without changing the accounting treatment for the affected instruments and contracts if you elect certain optional expedients within ASC 848.
When will Topic 848 go into effect?
The FASB issued ASC 848 in March 2020, and it became effective upon issuance. However, the provisions in ASC 848 are optional and must be elected individually for relief to be applied. Chatham recommends that companies review their individual facts and circumstances to ensure that election of relevant portions of the guidance is done in a timely manner and that you make appropriate disclosures in financial statements. While ASC 848 does not impose any new disclosure requirements, the SEC staff has requested additional disclosure regarding reference-rate-reform activities.
What elections might I need to make now or in the near-term?
Companies that have cash flow hedging relationships should consider the optional expedients related to probability and effectiveness assessments. These expedients will allow companies to ignore the impact of reference rate reform in these forward-looking analyses until both the derivative and hedged transactions have completed the transition. Once companies begin to modify contracts, such as through adherence to the ISDA fallback protocol, these expedients will be necessary to preserve hedge accounting.
What elections will I need to make in the future?
As you begin to modify contracts, consider applying the optional expedients in ASC 848 that allow companies to avoid the quantitative modifications test in ASC 310, ASC 470, ASC 842, and the embedded derivative analysis in ASC 815. Note that the optional expedients in ASC 848 are only available for terms modified due to reference rate reform. You will need to analyze each contract amendment to determine whether it is in scope for the exceptions provided in ASC 848. Additionally, you should consider the expedients that allow hedge accounting to continue even though the terms of the derivative have been modified, as well as the need to update valuation models as the risk-free discount rates migrate to RFRs over the course of reference rate reform.
What happens when companies no longer have exposure to reference rate reform?
ASC 848 is designed to provide relief while companies are exposed to reference rate form, with a set expiration date of December 31, 2022. Exposure to reference rate reform is considered on a contract-by-contract, or relationship-by-relationship basis. For example, once an individual debt or lease contract transitions to a risk-free rate, that specific contract is no longer exposed to reference rate reform and thus no longer eligible for relief under ASC 848. For contracts in hedging relationships, exposure ends when both the hedge (or hedges) and the hedged item have been modified to reference a new rate. Companies will have access to the relief in ASC 848 until the earlier of the 2022 sunset date or the end of their exposure.
How can Chatham help?
Chatham has been following all aspects of reference rate reform from the beginning. Our team of accounting consultants, regulatory experts, and hedging advisors can help you navigate the contract modifications and accounting analysis that will be key to success in this transition. Chatham can provide sample contract language, draft ASC 848 election memos and advice to help companies make the right decision at the right time. Please contact your Hedge Accounting representative or Relationship Manager for more information.
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