Accounting for Derivative Instruments and Hedging Activities

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FASB Statement 133

• Accounting for Derivative Instruments and Hedging
  Activities

October 12-13, 2000 Chicago, IL
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ACCOUNTING FOR DERIVATIVESFASB Statement No. 133

• Presentation by
• Bavan Holloway
• Robert Jensen
• Ira G. Kawaller

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CASE 1 Cash Flow Hedge of Forecasted Inventory
Sale

• ABC is hedging the risk of changes in cash flows
  related to a forecasted sale of 100,000 bushels
  of Commodity A to be sold at the end of period 1.
  The inventory carrying value is 1 million, and
  current market value is 1.1 million
• On the first day of period 1, ABC enters into
  Derivative Z to sell 100,000 bushels at 1.1
  million at the end of period
• At hedge inception, the derivative is
  at-the-money (fair value is 0)
• All terms of the commodity and the derivative
  match (i.e., no expected ineffectiveness)
• On last day of Period 1, fair value of Derivative
  Z increased by 25,000 and expected sales price
  of 100,000 bushels of Commodity A decreased
  25,000
• From Example 4, Appendix B of Standard

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CASE 1 Cash Flow Hedge of Forecasted Inventory
Sale

• Journal entries at end of period 1
• Derivative Z 25,000
• OCI 25,000
• To record Derivative Z at fair value
• Cash 25,000
• Derivative Z 25,000
• To record settlement of Derivative Z

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CASE 1 Cash Flow Hedge of Forecasted Inventory
Sale

• Journal entries at end of period 1
• Cash 1,075,000
• CGS 1,000,000
• Revenue 1,075,000
• Inventory 1,000,000
• To record inventory sale
• OCI 25,000
• Earnings 25,000
• To reclassify amount in OCI to earnings upon
  inventory sale

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CASE 1 Cash Flow Hedge of Forecasted Inventory
Sale

• Forecasted cash flows 1,100,000
• Actual cash flows
• Derivative 25,000
• Sale of inventory 1,075,000
• Total 1,100,000
• The variability of cash flows related to the
  forecasted inventory sale is offset by change in
  value of derivative.

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CASE 2Fair Value Hedge of Inventory

• ABC has 1,000 bushels of a Commodity with a fair
  value of 1.1 million and a carrying value of
  1.0 million
• ABC wants to hedge overall fair value of the
  Commodity
• On 1/1/X1, ABC enters into an at-the-money
  matching derivative to hedge the changes in
  fair value of the 1,000 bushels of the Commodity

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CASE 2 (Contd)Fair Value Hedge of Inventory

• Effectiveness will be assessed by comparing
  entire change in fair value of derivative to
  change in market price of inventory (time value
  will be ignored for illustration purposes only)
• On 1/31/X1, the fair value of the derivative has
  increased by 25,000 and the fair value of the
  inventory has decreased by 25,000

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CASE 2Fair Value Hedge of Inventory

• Journal entries at end of period
• Derivative 25,000
• Earnings 25,000
• To record derivative at fair value
• Earnings 25,000
• Inventory 25,000
• To record loss on hedged inventory