Financial Accounting Standards Board

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Financial Accounting Standards Board
IASB MEETING JUNE 2008 OBSERVER NOTE 5

• Hedging Project
• IASB Education Session
• June 18, 2008
• Kevin Stoklosa

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Hedging Project

• Project Objectives
• Simplify accounting for hedging activities
• Improve the financial reporting of hedging
  activities to make the accounting model and the
  associated disclosures easier to understand for
  financial statement users
• Resolve hedge accounting practice issues that
  have arisen under Statement No. 133
• Address differences in the accounting for
  derivative instruments and hedged items or
  transactions

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Hedging Project

• The hedge accounting approach would establish a
  fair value methodology to hedge accounting. The
  approach would eliminate many elements that exist
  under the current hedge accounting model,
  including bifurcation-by-risk, the shortcut
  method, critical terms match, and the requirement
  to quantitatively assess effectiveness in order
  to qualify for hedge accounting
• The items and transactions currently eligible for
  hedge accounting would continue to be eligible
  under this approach.

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Hedging ProjectMajor Changes

• Hedge Effectiveness
• Qualitative instead of Quantitative
• Reasonably effective
• No ongoing effectiveness testing unless
  circumstances suggest no longer reasonably
  effective
• No effectiveness testing at all was considered

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Hedging ProjectMajor Changes

• Dedesignation
• Discontinuation of hedge accounting only if
  hedging relationship is terminated
• Discontinuation of hedging relationship by merely
  dedesignating is not permitted

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Hedging ProjectMajor Changes

• Hedged Risk
• General model is that the designated hedged risk
  must be all changes in fair value or variability
  in cash flows (bifurcation-by-risk not permitted)
• Two exceptions
• Foreign exchange rate risk can be designated as
  the hedged risk
• Interest rate risk can be designated as the
  headed risk in a hedge of an entitys own debt at
  inception of the debt

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Hedging ProjectMajor Changes

• Measurement of Hedged Item in Fair Value Hedges
• Hedged item and derivative hedging instrument
  must be independently measured for changes in
  fair value
• Not permitted to take the change in fair value of
  the derivative, change the sign and apply it to
  the hedged item
• All of contractual cash flows of the entire
  hedged item must be included in calculating the
  fair value
• Adjust the carrying value of hedged item for
  changes in fair value during the hedge period

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Hedging ProjectMajor Changes

• Measuring and Reporting Ineffectiveness in Cash
  Flow Hedges
• Compare change in fair value of the actual
  derivative and the present value of the
  cumulative change in expected future cash flows
  on the hedged transaction
• For example, an entity could compare the change
  in fair value of the actual derivative with the
  change in fair value of a derivative that would
  mature on the date of the forecasted transaction,
  be priced at market, and provide cash flows that
  would exactly offset the hedged cash flows
• The difference would be reported in earnings as
  ineffectiveness
• Nonperformance risk must be considered when
  calculating the fair value of the derivative
  hedging instrument
• Permitted to use the same credit adjustment in
  the derivative that would exactly offset the
  hedged cash flows as used in the actual derivative

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Hedging ProjectMajor Changes

• Measuring and Reporting Ineffectiveness in Cash
  Flow Hedges
• Hedging with purchased options
• When a purchased option contract is used as the
  hedging instrument to provide only one-sided
  protection, a purchased option derivative that
  would mature on the date of the forecasted
  transaction and provide cash flows that would
  exactly offset the one-sided change in the hedged
  cash flows could be used for calculating
  ineffectiveness.
• Ineffectiveness can be measured using all changes
  in the options cash flows

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Hedging ProjectMajor Changes

• Measuring and Reporting Ineffectiveness in Cash
  Flow Hedges
• Hedging groups of transactions first 100M in
  sales for January
• Compare actual derivative to derivative that
  settles within a reasonable period of time of
  cash flows on forecasted transactions
• Reasonable if the difference in forward rates
  between that derivative and derivative(s) that
  would exactly offset cash flows is minimal

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Hedging ProjectMajor Changes

• Disclosures
• For hedged items in fair value hedges - table
  showing amount reported in balance sheet,
  Statement 133 adjustment, Other fair value
  adjustments, amount excluding those adjustments
• Hedging interest rate risk in issued debt how
  hedging derivative(s) changes maturity and
  interest rate on debt