United States

Staff interpretations of ASU 2017-12: Prepayable financial instruments

FINANCIAL REPORTING INSIGHTS  | 

At its February 14, 2018 meeting, the Financial Accounting Standards Board (FASB) met to discuss certain questions raised related to Accounting Standards Update (ASU) 2017-12, Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities. In part, discussions focused around the definition of prepayable, given that this definition impacts (a) the financial assets that are eligible to be designated as the hedged item under a “last-of-layer” method, and therefore, (b) the held-to-maturity securities that are eligible to be transferred to available-for-sale upon the adoption of ASU 2017-12, without penalty. (Note that an entity is not required to elect hedge accounting for a transferred security; the security just needs to qualify for the “last-of-layer” method). The definition of prepayable also is relevant in that when hedging interest rate risk associated with a prepayable debt instrument, an entity can consider only how changes in the benchmark interest rate affect the decision to settle the instrument before its scheduled maturity when calculating its change in fair value attributable to interest rate risk.

During the February meeting, the FASB expressed agreement with the Staff Interpretations of Update 2017-12 for Prepayable Financial Instruments, which was recently posted on the FASB’s website. This document states that the following financial instruments meet the definition of prepayable for the above-mentioned purposes:  

  • Instruments that are currently exercisable and prepayable at any time
  • Instruments with certain contingent prepayment features (that is, based on the passage of time, the occurrence of a specified event other than the passage of time, and the movement in a specified interest rate)
  • Callable convertible and non-callable convertible instruments

Contingent acceleration clauses that permit an acceleration of contractual maturity due to credit should not be considered prepayment features. Therefore, instruments for which the contractual maturity can only be accelerated due to credit do not meet the definition of prepayable.