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On the other hand, a 10-year financial asset hedged
for changes in the designated benchmark rate for What ASU 2022-01 improves
a five-year partial term is considered to exhibit the
interest rate risk profile of a five-year financial asset The most significant improvements over prior GAAP guidance are that it:
hedged for changes in the designated benchmark ■ Expanded the number of hedged layers from only one layer to multiple
rate. layers in a single closed portfolio. Accordingly, it uses the term portfolio
layer method rather than last-of-layer method.
Expanding types of assets eligible for hedging ■ Expanded the hedged-item scope from only including prepayable
Prior to ASU 2022-01, accounting guidance financial assets to including nonprepayable financial assets.
permitted only prepayable financial assets to be in-
■ Provided additional guidance for fair-value hedge basis adjustments,
cluded in the closed portfolio, which was less than
including determining a credit loss impact.
ideal because it excluded nonprepayable financial
assets. Although nonprepayable financial assets do
not have prepayment cash flow risk, they may still
incur uncertain cash flows due to default risk and
interest rate changes. Thus, the company could create more than one
Now, under ASU 2022-01, both prepayable and hedged layer. For example, the company could:
nonprepayable financial assets qualify for the same ■ Designate two layers and enter into:
hedge accounting method. This better reflects the y One hedge for a $5 million layer ($7.5 mil-
impact of company asset value risk management lion − $2.5 million) with five years expected
activities on the financial statement because it al- until maturity, and
lows financial asset value risks managed in the same y A second hedge for a $2.5 million layer
way to qualify for the same hedge accounting. This expected to remain outstanding for 10 years;
reduces complexity for both financial statement or
users and preparers. ■ Designate two layers and enter into:
y One hedge for a $7.5 million layer with five
COMPARING THE EXISTING AND NEW years expected until maturity, and
GUIDANCE y A second hedge for a $2.5 million layer with
The following example illustrates the difference expected maturity during years six through
between the existing guidance following the 10.
last-layer method under ASU 2017-12 and the As part of the initial hedge documentation and
portfolio-layer method under ASU 2022-01: at each subsequent hedge effectiveness assess-
A company forms a $10 million closed portfolio ment date, document the analysis supporting the
of financial assets and hedges interest rate risk fol- expectation that the hedged layers and aggregated
lowing its risk management strategy. In this closed closed portfolio is anticipated to be outstanding for
portfolio, the company expects $7.5 million to the designated layer period and for the designated
remain outstanding for five years and $2.5 million hedge periods. The analysis incorporates expecta-
to remain outstanding for 10 years. The company tions about prepayments, defaults, and other factors
expects that the financial assets in the closed port- impacting the cash flow amounts and timing of the
folio will not be affected by prepayments, defaults, financial assets in the closed-portfolio layers.
or other factors affecting the timing or amount of
cash flows for the hedge periods. NEW GUIDANCE FOR BASIS ADJUSTMENTS
Under the last-layer method in ASU 2017-12, Additionally, ASU 2022-01 provides accounting
the company could only hedge either $7.5 million guidance for closed-portfolio basis adjustments
for five years or $2.5 million for 10 years, as long or for dedesignating a portfolio layer. The update
as the company expected the portfolio assets would prohibits including closed-portfolio asset basis
remain outstanding for these periods. adjustments when measuring expected credit losses
After adopting ASU 2022-01 using the or when determining available-for-sale (AFS)
new portfolio-layer method, the company gains security impairment. The hedged-item fair-value
significant flexibility in how it manages risk. The change attributed to the hedge risk remains
company is no longer restricted to only one hedge within the closed portfolio and does not adjust the
layer because ASU 2022-01 allows the creation of individual asset carrying value in (or removed from)
multiple hedged layers in a single closed portfolio. the closed portfolio.

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