ASC Insight Series

ASC 815- Derivatives and hedging

2, June 2025

Purpose

ASC 815 is the source of official guidance in U.S. GAAP on derivatives and hedging. This accounting standard, issued by the Financial Accounting Standards Board (FASB), provides comprehensive guidance on the recognition, measurement, and disclosure of derivative instruments and hedging activities.

Foundation of the guidance in ASC 815 is based on following key principles:

A derivative instrument is either a right or obligation that meets the definition of an asset (expected future cash inflows due from another party) ora liability (expected future cash outflows owed to another party).
Derivatives are recognized at fair value with changes in fair value reported in earnings, unless they are designated in a hedge accounting relationship.
Implicit or explicit terms within a contract that does not in its entirety meet the definition of a derivative instrument (or embedded derivatives) which may or may not require bifurcation from the host instrument subject to certain conditions.
Entities can choose to apply hedge accounting to qualifying transactions if certain criteria are If an entity elects to designate a derivative as thehedging instrument in a highly effective hedge relationship, its change in fair value may be accounted for differently than a non-designated derivative, depending on whether the relationship is a fair value hedge, a cash flow hedge or a hedge of a net investment in a foreign operation.

This publication provides an overview of the key accounting considerations and implementation matters relating to derivatives and hedge accounting. The technical views and accounting positions on the framework continue to improve depending on the results of further technical evaluations.

Background

A. Derivative Accounting

ASC 815 prescribes guidance on instruments and contracts that meet the definition of a derivative. Its nuanced approach is designed to enhancetransparency, reduce complexity, and align financial reporting with the economic substance of derivative transactions. The standard seeks to align financial reporting with the economic substance of these transactions, ensuring that companies accurately represent the impactof derivatives on their financial statements.

Navigating the accounting landscape for derivatives under ASC 815 poses a significant challenge within the realm of U.S. GAAP. This complexity arisesprimarily from the intricate process of determining whether a financial instrument qualifies as a derivative and assessing the availability of scope exceptions. Additionally, the meticulous evaluation of potential embedded derivatives within a host contract adds another layer of intricacy to the process.

Certain instruments and contracts falling within this definition may qualify for a scope exception. On the contrary, those that do not entirely meet thederivative definition still necessitate scrutiny to ascertain the presence of embedded derivatives, subject to the guidelines outlined in ASC 815. The cornerstone of ASC 815 is the recognition of derivatives as either financial asset or financial liability and measurement of derivatives initially andsubsequently at fair value in the statement of financial position.

B. Hedge Accounting

To mitigate certain risks, entities enter into separate contracts that meet the definition of a derivative instrument. Hedging is the practice of usingderivative contracts to offset or minimize the risk of adverse price or interest movements in an underlying asset or liability. Hedge accounting, underASC 815, establishes a formal connection between a derivative (the hedging instrument) and a hedged item. This connection ensures that theaccounting treatment for the derivative is in line with the accounting for the hedged item. The primary goal is to prevent an earnings mismatch that would occur if only the derivative were accounted for at fair value through profit and loss. In essence, hedge accounting harmonizes the accounting treatment of both the derivative and the hedged item to avoid discrepancies in earnings reporting.

ASC 815 aims to align the timing of gains or losses from hedging instruments with changes in the fair value of hedged assets or liabilities, or the earnings impact of forecasted transactions.

Summary of Topic

A. Derivative Accounting- Financial Reporting Considerations

This section summarizes key accounting considerations related to recognition and measurement of derivative accounting:

01 What is derivative?

In simple words, a derivative is an instrument whose value is dependent on the value of an underlying variable or variables, such as stock option,represents a derivative whose value depends on the price of the underlying stock.

02 Commonly used derivatives

Forwards- Agreement to buy or sell an asset on a future date for an agreed-upon price.
Futures- Futures contract is similar to a forward contract in that it is an agreement between two parties to buy or sell an asset on a future date for an agreed-upon price except futures contracts are typically traded on exchanges.
Options- Options grant the holder the choice to buy or sell an underlying asset at an agreed-upon price in the future, without an obligation, unlikeforwards or futures
Swaps- Agreement between two parties to exchange cash flows in the The agreement specifies the dates on which the cash flows are to be paid and theway in which they will be calculated. The most common type of swaps are interest rate swaps (floating interest rate swapped against fixed rate of interest) and currency swaps (principal and interest payment fixed or variable in one currency is exchanged for principal and interest payment in another currency).

03 Scope Exceptions

Key Principle: A contract that qualifies for scope exception does not require classification and measurement as a derivative asset or liability even if it meets the definition of a derivative in ASC 815. Therefore, an entity should firstly evaluate whether a contract meets any of the available scope exceptions before applying the guidance in ASC 815 on classification, recognition, and measurement of derivatives.

ASC 815 relates primarily to whether a contract meets the definition of a derivative instrument. However, some contracts that meet the definition ofderivative instrument are not within the scope of this Subtopic, while other contracts that do not meet the definition of derivative instrument are within the scope of this Subtopic.

ASC 815 scopes out the following contracts from derivative accounting guidance even if it meets all the characteristics of a derivative:

Regular-way security trades
Normal purchases and normal sales
Certain insurance contracts and market risk benefits
Certain financial guarantee contracts
Certain contracts that are not traded on an exchange
Derivative instruments that impede sales accounting
Investments in life insurance
Certain investment contracts
Certain loan commitments
Certain interest-only strips and principal-only strips
Certain contracts involving an entity’s own equity
Leases
Residual value guarantees
Registration payment arrangements
Certain fixed-odds wagering contracts

To read this section in detail, download PDF.

04 Recognition and Measurement Principles for Freestanding Derivatives

Initial Recognition and Measurement

Derivative instruments is recognized in statement of financial position as either assets or liabilities depending on the rights or obligations under the contracts. These are recognized at “Mark-to-Market (MTM)” value and not at notional values.
Derivative instruments shall be measured initially at fair value as per the principles of ASC 820.

Subsequent Measurement

All derivative instruments (other than designated in a qualified hedging relationship) shall be measured subsequently at fair value.
Changes in fair value shall be recognized in earnings.

Reassessment

An entity should re-evaluate its application of ASC 815 as of each reporting period. This assessment should also occur at least quarterly or whenever the company prepares financial statements for an external party.
If a financial instrument or a contract that did not initially meet the definition of a derivative later meets that definition, an entity should recognize the instrument as a derivative asset or a liability at its then current fair value.
Alternatively, if an instrument that was initially recognized as a derivative later ceases to meet that definition, guidance in other U.S. GAAP shall be applied.

05 Embedded Derivatives and its accounting considerations

Embedded derivative is defined as implicit or explicit terms within a contract (that does not, in its entirety meet the definition of a derivative instrument) which affects some or all of the cash flows or the value of other exchanges required by the contract similar to derivative instruments. For example, a debt instrument wherein interest payments fluctuate with the changes in Standard & Poor’s (S&P) 500 index (i.e., an equity-indexed note) would be considered a debt instrument with an embedded derivative.

An instrument that contains embedded derivatives is referred to as a hybrid instrument, which consists of both the host contract and the embedded derivative(s).

To read this section in detail, download PDF.

B. Hedge Accounting- Financial Reporting Considerations

This section summarizes key accounting considerations related to recognition and measurement of hedge accounting:

Types of Hedges

ASC 815 categorizes hedges into the following categories and provides specific accounting guidance for each category:

01. Key Terms

Hedging instrument- A financial instrument used by entities to mitigate risk by offsetting existing financial exposures. These exposures may relate to market prices, interest rates, foreign exchange rates, or other variables.

Hedged item- Specific items that expose the company to the risk of changes in fair value or changes in future cash flows.

Firm commitment- A firm commitment is a (legally) binding agreement between unrelated parties that specifies all significant terms and includes a disincentive for non-performance that is sufficiently large to make performance probable.

Forecasted transaction- A forecasted transaction is essentially a future transaction that is probable and does not meet the definition of a firm commitment.

02. Hedging Criteria

ASC815 requires an entity to meet the following criteria for the combination of the hedging instrument and the hedged item or transaction (‘the hedging relationship’) to qualify for hedge accounting.

03. Hedge Accounting Principles

To read this section in detail, download PDF.

04. Portfolio Hedging

ASC 815 allows a portfolio of similar assets or a portfolio of similar liabilities (or a specific portion thereof), or a group of individual forecasted transactions to be hedged. If similar assets, similar liabilities, firm commitments or forecasted transactions are aggregated and hedged as a portfolio, the individual items that make up the portfolio must share the risk exposure for which they are designated as being hedged i.e. the items that are included in a portfolio all need to share the same risk exposure for which they are being hedged (e.g., assets and liabilities cannot be included in the same hedged portfolio). Portfolio hedging is only available for fair value hedges and cash flow hedges but not for net investment hedges.

05. Portfolio Layer Method

On March 28, 2022, the FASB issued ASU 2022-01, which clarified the guidance in ASC 815 on fair value hedge accounting of interest rate risk for portfolios of financial assets.

Separate from the portfolio hedging guidance discussed above, ASC 815 provides an approach (the portfolio layer method) for hedging financial assets in a closed portfolio or beneficial interests secured by financial instruments. This method alleviates much of the complexity associated with applying fair value hedge accounting to a portfolio of financial instruments by combining the partial-term hedge concept and the ability to measure the hedged item using benchmark cash flows to simplify the determination of whether the individual assets in the portfolio share the risk exposure for which they are designated as being hedged.

This method also allows entities to essentially “ignore” prepayment risk (if applicable) when measuring the change in fair value of the hedged item or items, as long as the designated hedged item(s) (i.e., the hedged layer or layers in aggregate) is expected to be outstanding for the designated hedge period(s).

The portfolio layer method allows entities to (i) hedge multiple layers rather than just a single layer of a closed portfolio of financial assets or one or more beneficial interests secured by a portfolio of financial instruments and (ii) include non-prepayable financial assets in addition to prepayable financial assets in the closed portfolio being hedged.

Comparison with IFRS

ASC 815, Derivative and Hedging under U.S. Generally Accepted Accounting Principles (GAAP), and IFRS 9, Financial Instruments under International Financial Reporting Standards (IFRS), both the standards provide guidance on Derivative and hedge accounting. Both accounting frameworks somewhat share similar requirements related to derivatives and hedging. For example, both sets of standards require derivatives to be accounted for at fair value, and both distinguish between fair value hedges and cash flow hedges. However, there are some key differences in the requirements entities must follow under the two sets of standards to qualify for, document, and apply hedge accounting as summarized in the PDF.

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