Companies often find it difficult to obtain a fixed-rate loan because lenders are reluctant to lock in the interest rates they charge. Forced to accept floating interest rates, some borrowers enter into a “receive-variable, pay-fixed” interest rate swap, which in essence, converts their floating-rate loan into a fixed-rate loan. Here’s how it works: the borrower pays interest on the loan at the floating rate, then, under the swap, receives interest at the floating rate. Those payments essentially cancel each other out. Then, the borrower pays interest under the swap at the fixed rate. The combination of the floating-rate loan and the swap work to convert the initial floating-rate loan into a fixed-rate loan.
Interest-rate swaps are derivatives, and historically have been required to be recognized and reported at fair value unless the reporting entity qualifies for, and elects to apply complex hedge accounting rules. Because of limited resources and the fact that hedge accounting is difficult to understand and apply, many organizations lack the expertise to comply with the requirements. Some also question the relevance and cost associated with determining and presenting the fair value of a swap entered into solely for the purpose of converting a floating-rate loan into a fixed-rate loan.
Well, FASB listened, and recently issued Accounting Standards update No. 2014-03 Accounting for Certain Receive-Variable, Pay-Fixed Interest Rate Swaps–Simplified Hedge Accounting Approach, which provides a simplified hedge accounting alternative—a so-called “practical expedient”—that permits the swap to be measured at settlement value instead of fair value.
Unfortunately, as in many other cases, the simplified approach is available only to certain private companies—thus, it is not available to nonprofit entities. Nonprofits, for now, will have to continue to fair value their swaps as before under Topic 815 of the Codification.