FASB Transition Provisions Use of the Shortcut Method in the Transition Adjustment and Upon Initial Adoption

FASB: Transition Provisions: Use of the Shortcut Method in the Transition Adjustment and Upon Initial Adoption

Derivatives Implementation Group

Statement 133 Implementation Issue No. J9

Title: Transition Provisions: Use of the Shortcut Method in the Transition Adjustment and Upon Initial Adoption
Paragraph references: 48, 52, 68
Date cleared by Board: May 17, 2000

QUESTIONS

  1. For a hedging relationship that existed prior to the initial adoption of Statement 133 and that would have met the requirements for the shortcut method in paragraph 68 at the inception of that pre-existing hedging relationship, may the transition adjustment upon initial adoption be calculated as though the shortcut method had been applied since the inception of that hedging relationship?

  2. In deciding whether the shortcut method can be applied prospectively from the initial adoption of Statement 133 to a designated hedging relationship that is the continuation of a pre-existing hedging relationship, should the requirements of paragraph 68(b) (that the derivative has a zero fair value) be based on the swap's fair value at the inception of the pre-existing hedging relationship rather than at the inception of the hedging relationship newly designated under Statement 133 upon its initial adoption?

RESPONSE

Question 1

Yes. For a hedging relationship that involves an interest rate swap designated as the hedging instrument, that existed prior to the initial adoption of Statement 133, and that would have met the requirements for the shortcut method in paragraph 68 at the inception of that pre-existing hedging relationship, an entity may choose to calculate the transition adjustment upon initial adoption either (a) pursuant to the provisions of paragraph 52, as discussed in Statement 133 Implementation Issue No. J8, "Adjusting the Hedged Item's Carrying Amount for the Transition Adjustment Related to a Fair-Value-Type Hedging Relationship," or (b) as though the shortcut method had been applied since the inception of that hedging relationship, as discussed below. Under either approach, the interest rate swap would be recognized in the statement of financial position as either an asset or liability measured at fair value.

If the previous hedging relationship was a fair-value-type hedge, the difference between the swap's previous carrying amount and its fair value would be included in the transition adjustment and recorded as a cumulative-effect-type adjustment of net income. The hedged item's carrying amount would be adjusted to the amount that it would have been had the shortcut method for a fair value hedge of interest rate risk been applied from the inception of that pre-existing hedging relationship; that adjustment would be recorded as a cumulative-effect-type adjustment of net income.

If the previous hedging relationship was a cash-flow-type hedge, the difference between the swap's previous carrying amount and its fair value would be included in the transition adjustment and allocated between a cumulative-effect-type adjustment of other comprehensive income and a cumulative-effect-type adjustment of net income, as follows. The cumulative-effect-type adjustment of other comprehensive income would be the amount necessary to adjust the balance of other comprehensive income to the amount that it would have been (related to that swap) on the date of initial adoption had the shortcut method been applied from the inception of the pre-existing hedging relationship. The remainder, if any, of the transition adjustment would be recorded as a cumulative-effect-type adjustment of net income.

Question 2

Yes. In deciding whether the shortcut method can be applied prospectively from the initial adoption of Statement 133 to a designated hedging relationship that is the continuation of a pre-existing hedging relationship, the requirements of paragraph 68(b) (requiring that the derivative has a zero fair value) should be based on the swap's fair value at the inception of the pre-existing hedging relationship rather than at the inception of the hedging relationship newly designated under Statement 133 upon its initial adoption. However, if the hedging relationship that is designated upon adoption of Statement 133 is not the continuation of a pre-existing hedging relationship (that is, not the same hedging instrument and same hedged item or transaction), then the decision regarding whether the shortcut method can be applied prospectively from the initial adoption of Statement 133 should be based on the fair value of the swap at the date of initial adoption.

The above response has been authored by the FASB staff and represents the staff's views, although the Board has discussed the above response at a public meeting and chosen not to object to dissemination of that response. Official positions of the FASB are determined only after extensive due process and deliberation.