In order to properly account for interest rate swaps, it is important to understand that they are considered to be derivatives for accounting purposes. As a derivative, their value moves up and down as the value of a different asset or liability moves up and down. The accounting treatment for interest rate swaps is governed by ASC 815, which is produced by the Financial Accounting Standards Board in the United States. This standard used to be SFAS 133. The accounting treatment for an interest rate swap depends upon whether or not it qualifies as a hedge.
Account for a Swap
Determine if the interest rate swap qualifies as a hedge. If the swap was executed to speculate on movements in interest rates, and it is not structured to hedge the specific risk of another asset or liability of the company, then it does not qualify.
Value the swap each accounting period using current market data and pricing, and reflect any changes in its value up or down in the company’s financial statements.
Test the changes in the value of the swap as compared to the changes in the value of an asset or liability that the swap was executed to hedge. If the correlation is very high, such as 0.75 or higher, then the swap should qualify as a cash flow hedge. For example, the swap might provide cash flows to the company that increase if interest rates increase. This can be used to hedge the risk of higher interest rate charges on debt that the company might have with floating, or adjustable interest rates.
Recognize changes in the value of the swap in the “Other Comprehensive Income” section on the company’s balance sheet each and every accounting period.
Recognize the cash flows from the swap as they are earned when interest payments are made for the debt instrument that has been hedged.
Reduce the value of the swap on the company’s balance sheet each period as it gets closer to maturity. Its value will be zero when it matures.