For buy-side firms, it is quite complex to account for interest rate swaps in today’s volatile economy. To be able to correctly execute interest rate swaps, buy-side firms must first be aware that this particular contract is treated as a derivative for accounting reasons. Comparable with a derivative, the value of these swaps consistently fluctuates as the amount of a varying asset or liability relatively fluctuates with it. Interest rate swap accounting is facilitated by ASC 815, which is generated by the Financial Accounting Standards Board in the US. This custom used to be named SFAS 133. How an interest rate swap accounting is treated relies upon whether or not it is eligible as a hedge.
If you are new to the buy-side firm, it is first important to know what an interest rate swap is and how it works before you can account for it. An interest rate swap pertains to a contract between two parties; usually one party is always a bank or any other financial institution. In this type of agreement, both parties trade interest premiums in an identical currency within a set time frame, which usually ranges from as short as a year to as long as a decade. One of the parties is responsible of compensating for a fixed interest premium, whereas the other is compensating for a variable amount. The variable interest value is compensated for whenever a new promotional offer is set, usually once every four months. Defined interest is typically compensated at every annual end.
Through partaking in an accounting for this, a buy-side firm can switch from variable premiums to fixed, and vice versa. If a firm utilizes a swap to switch from variable to fixed interest premiums, it can better predict its funding expenses and prevent elevated premiums. However, at the same time, the buy-side firm loses the potential for lowered interest premiums if interest were to be lowered.
To alleviate some stress and difficulty on your part, as a buy-side firm, here are some basics for accounting for this. First, identify if the interest rate swap is eligible as a hedge fund. If the swap was accomplished to conjecture movements on rates of interest, and it isn’t modeled to hedge the particular contingencies of another asset of the firm, then it isn’t treated as a hedge.
Also, measure the swap’s value for every accounting period with the use of present market statistics and charges. Then, emulate any alterations in its fluctuating value in the firm’s financial records.