FAS
133 As Amended and DIGed:
Introduction to FAS 138 Amendments and Some Key DIG Issues
Accounting for Derivative Financial Instruments and Hedging Activities
This
document was prepared for my
KPMG Workshops on
October 12 (Chicago), November 1 (NYC), and November 30 (Las Vegas)
Bob Jensen at Trinity University
Table of Contents
Interest
Rate Hedges as Amended and DIGed
Cross-Currency
Compound Hedges as Amended and DIGed
Two Board
Members Dissent from Issuance of FAS 138
Intercompany
FX Hedges as Amended and DIGed
DIG Issues
Incorporated Into FAS 138
What the
FASB Refused to Amend in FAS 138
Issues of
Booking Out and Normal Purchases Normal Sales (NPNS)
Bob
Jensen’s Introduction to FAS 133 and FAS 39 (with audio clips of leading
experts)
Bob Jensen's Online FAS 133 and IAS 39 Glossary
Bob Jensen's free online
cases are at http://www.trinity.edu/rjensen/caseans/000index.htm
In 1998, the Financial
Accounting Standards Board (FASB)
issued Financial Accounting Standard 133 (FAS 133) on Accounting for Derivative
Financial Instruments and Hedging Activities. The standard was so confusing and costly to implement that the
FASB later extended the implementation deadline to January 1, 2001 for
calendar-year companies.
In the meantime, the FASB formed
the FAS 133 Derivatives Implementation Group (DIG) to help resolve particular
implementation questions, especially in areas where the standard is not clear
or allegedly onerous. The FASB's DIG
website (that contains its mission and pronouncements) is at http://www.rutgers.edu/Accounting/raw/fasb/derivatives/digmain.html.
DIG issues are also summarized (in red borders) at http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#0000Begin.
A number of important issues
that surfaced in the DIG have resulted in a new standard FAS 138, Accounting
for Certain Derivative Instruments and Certain Hedging Activities an
amendment of FASB Statement No. 133, Released June 15, 2000 --- http://www.rutgers.edu/Accounting/raw/fasb/public/index.html
A nice
summary of FAS 138 and its impact on FAS 133 implementation is provided by
CFO.com on July 1, 2000 at http://www.cfo.com/printarticle/1,4580,3|17|AD|880,00.html
The FASB provides some new
examples illustrating the FAS 138 Amendments to FAS 133 at http://www.rutgers.edu/Accounting/raw/fasb/derivatives/examplespg.html
The purpose of this document is
to highlight some of the more important FAS 138 amendments and to comment on
some of the DIG issues that were not amended.
FAS 133 as “amended and DIGed” remains the most confusing and arguably
the most controversial accounting standard ever issued in the history of U.S.
accounting rules and regulations.
FAS 133 requires that all
derivative financial instruments (with only a few defined exceptions) be booked
and adjusted to fair value at least quarterly.
This is a huge departure from earlier standards and accounting traditions. Financial instruments, except in a few
defined exceptions, are accounted for at historical (amortized) cost. Hence there is now a distinction between
derivative financial instruments (at fair value) versus financial instruments
(amortized cost).
Complications arise in
particular when a derivative financial instrument (the hedge) is used to hedge
a financial instrument (the hedged item).
If the hedge does not meet the FAS 133 requirements for special hedge
accounting of cash flow, fair value, or foreign exchange (FX) hedges. Firms complained to the FASB and the DIG
that some common and “natural” hedges had to be adjusted repeatedly to fair
value but did not qualify for FAS 133 hedge accounting to mitigate the impact
of the fair value adjustments on current earnings and balance sheet items.
Interest Rate Hedges as Amended and DIGed
FAS 138 Introduces
Benchmarking
FAS 138 Amendments expand the
eligibility of many derivative instrument hedges to qualify FAS 133/138 hedge. Such
qualifications in accounting treatment that reduces earnings volatility when
the derivatives are adjusted for fair value.
It is very popular in practice
to have a hedging instrument and the hedged item be based upon two different
indices. In particular, the hedged item
may be impacted by credit factors. For
example, interest rates commonly viewed as having three components noted below:
·
Risk-free
risk that the level of interest rates in risk-free financial instruments such
as U.S. treasury T-bill rates will vary system-side over time.
·
Credit
sector spread risk that interest rates for particular economic sectors will
vary over and above the risk-free interest rate movements. For example, when automobiles replaced
horses as the primary means of open road transportation, the horse industry’s
credit worthiness suffered independently of other sectors of the economy. In more recent times, the dot.com sector’s
sector spread has suffered some setbacks.
·
Unsystematic
spread risk of a particular borrower that varies over and above risk-free and
credit sector spreads. The credit of a
particular firm may move independently of more system-wide (systematic)
risk-free rates and sector spreads.
Suppose that a hedge only pays
at the T-Bill rate for hedged item based on some variable index having credit
components. FAS 133 prohibited
“treasury locks” that hedged only the risk-free rates but not credit-sector
spreads or unsystematic risk. This was
upsetting many firms that commonly hedge with treasury locks. There is a market for treasury lock
derivatives that is available, whereas hedges for entire interest rate risk are
more difficult to obtain in practice.
It is also common to hedge with London’s LIBOR that has a spread apart
from a risk-free component.
The DIG confused the issue by
allowing both risk-free and credit sector spread to receive hedge accounting in
its DIG Issue E1 ruling. Paragraph 14
of FAS 138 states the following:
Comments received by the Board on
Implementation Issue E1 indicated (a) that the concept of market interest rate
risk as set forth in Statement 133 differed from the common understanding of
interest rate risk by market participants, (b) that the guidance in the
Implementation Issue was inconsistent with present hedging activities, and (c)
that measuring the change in fair value of the hedged item attributable to
changes in credit sector spreads would be difficult because consistent sector
spread data are not readily available in the market.
In FAS 138, the board sought to
reduce confusion by reducing all components risk into just two components
called “interest rate risk” and “credit risk.”
Credit risk includes all risk other than the “benchmarked” component in
a hedged item’s index. A benchmark
index can include somewhat more than movements in risk-free rates. FAS 138 allows the popular LIBOR hedging
rate that is not viewed as being entirely a risk-free rate. Paragraph 16 introduces the concept of
“benchmark interest rate” as follows:
Because the Board decided to permit a rate that is not
fully risk-free to be the designated risk in a hedge of interest rate risk, it
developed the general notion of benchmark
interest rate to encompass both risk-free rates and rates based on the
LIBOR swap curve in the United States.
FAS 133 thus allows benchmarking
on LIBOR. It is not possible to
benchmark on such rates as commercial paper rates, Fed Fund rates, or FNMA par
mortgage rates.
Readers might then ask what the
big deal is since some of the FAS 133 examples (e.g., Example 5 beginning in
Paragraph 133) hedged on the basis of LIBOR.
It is important to note that in those original examples, the hedging
instrument (e.g., a swap) and the hedged item (e.g., a bond) both used LIBOR in
defining a variable rate? If the
hedging instrument used LIBOR and the hedged item interest rate was based upon
an index poorly correlated with LIBOR, the hedge would not qualify (prior to
FAS 138) for FAS 133 hedge accounting treatment even though the derivative
itself would have to be adjusted for fair value each quarter. Recall that LIBOR is a short-term European
rate that may not correlate with various interest indices in the U.S. FAS 133 now allows a properly benchmarked
hedge (e.g., a swap rate based on LIBOR or T-bills) to hedge an item having
non-benchmarked components.
The short-cut method of
relieving hedge ineffectiveness testing may no longer be available. Paragraph 23 of FAS 138 states the
following:
For cash flow hedges of an existing
variable-rate financial asset or liability, the designated risk being hedged
cannot be the risk of changes in its cash flows attributable to changes in the
benchmark interest rate if the cash flows of the hedged item are explicitly
based on a different index. In those
situations, because the risk of changes in the benchmark interest rate (that
is, interest rate risk) cannot be the designated risk being hedged, the
shortcut method cannot be applied. The
Board’s decision to require that the index on which the variable leg of the
swap is based match the benchmark interest rate designated as the interest rate
risk being hedged for the hedging relationship also ensures that the shortcut
method is applied only to interest rate risk hedges. The Board’s decision precludes use of the shortcut method in
situations in which the cash flows of the hedged item and the hedging
instrument are based on the same index but that index is not the designated
benchmark interest rate. The Board
noted, however, that in some of those situations, an entity easily could
determine that the hedge is perfectly effective. The shortcut method would be permitted for cash flow hedges in
situations in which the cash flows of the hedged item and the hedging
instrument are based on the same index and that index is the designated
benchmark interest rate.
In other words, any hedge item
that is not based upon only a benchmarked component will force hedge
effectiveness testing at least quarterly.
Thus FAS 138 broadened the scope of qualifying hedges, but it made the
accounting more difficult by forcing more frequent effectiveness testing.
FAS 138 also permits the hedge
derivative to have more risk than the hedged item. For example, a LIBOR-based interest rate swap might be used to
hedge an AAA corporate bond or even a note rate based upon T-Bills.
There are restrictions noted in
Paragraph 24 of FAS 138:
This Statement provides limited guidance
on how the change in a hedged item’s fair value attributable to changes in the
designated benchmark interest rate should be determined. The Board decided that in calculating the
change in the hedged item’s fair value attributable to changes in the
designated benchmark interest rate, the estimated cash flows used must be based
on all of the contractual cash flows of the entire hedged item. That guidance does not mandate the use of
any one method, but it precludes the use of a method that excludes some of the
hedged item’s contractual cash flows (such as the portion of interest payments
attributable to the obligor’s credit risk above the benchmark rate) from the
calculation. The Board concluded that
excluding some of the hedged item’s contractual cash flows would introduce a
new approach to bifurcation of a hedged item that does not currently exist in
the Statement 133 hedging model.
The FASB provides some new
examples illustrating the FAS 138 Amendments to FAS 133 at http://www.rutgers.edu/Accounting/raw/fasb/derivatives/examplespg.html
Example 1 on interest rate benchmarking begins as follows:
Example: Fair Value Hedge of the LIBOR Swap Rate
in a $100 Million A1-Quality 5-Year Fixed-Rate Noncallable Debt On April 3,
20X0, Global Tech issues at par a $100 million A1-quality 5-year fixed-rate
noncallable debt instrument with an annual 8 percent interest coupon payable
semiannually. On that date, Global Tech enters into a 5-year interest rate swap
based on the LIBOR swap rate and designates it as the hedging instrument in a
fair value hedge of the $100 million liability. Under the terms of the swap,
Global Tech will receive a fixed interest rate at 8 percent and pay variable
interest at LIBOR plus 78.5 basis points (current LIBOR 6.29%) on a notional
amount of $101,970,000 (semiannual settlement and interest reset dates). A
duration-weighted hedge ratio was used to calculate the notional amount of the
swap necessary to offset the debt's fair value changes attributable to changes
in the LIBOR swap rate.
An extensive analysis of the
above illustration is provided at http://www.cs.trinity.edu/~rjensen/000overview/138bench.htm
Some DIG Issues Affecting
Interest Rate Hedging
Issue
E1—Hedging the Risk-Free Interest Rate
http://www.rutgers.edu/Accounting/raw/fasb/derivatives/issuee1.html
(Cleared 02/17/99)
Issue E1 heavily influenced FAS 138 as noted above.
*Issue
G6—Impact of Implementation Issue E1 on Cash Flow Hedges of Market Interest
Rate Risk
(Cleared 5/17/00)
With
regard to a cash flow hedge of the variability in interest payments on an
existing floating-rate financial asset or liability, the distinction in Issue
E1 between the risk-free interest rate and credit sector spreads over the base
Treasury rate is not necessarily directly relevant to assessing whether the
cash flow hedging relationship is effective in achieving offsetting cash flows
attributable to the hedged risk. The effectiveness of a cash flow hedge of the
variability in interest payments on an existing floating-rate financial asset
or liability is affected by the interest rate index on which that variability
is based and the extent to which the hedging instrument provides offsetting
cash flows.
If
the variability of the hedged cash flows of the existing floating-rate
financial asset or liability is based solely on changes in a
floating interest rate index (for example, LIBOR, Fed Funds, Treasury Bill
rates), any changes in credit sector spreads over that interest rate index for
the issuer's particular credit sector should not be considered in the
assessment and measurement of hedge effectiveness. In addition, any changes in
credit sector spreads inherent in the interest rate index itself do not impact
the assessment and measurement of hedge effectiveness if the cash flows on both
the hedging instrument and the hedged cash flows of the existing floating-rate
financial asset or liability are based on the same index. However, if the cash
flows on the hedging instrument and the hedged cash flows of the existing
floating-rate financial asset or liability are based on different indices, the
basis difference between those indices would impact the assessment and
measurement of hedge effectiveness.
*Issue
E6—The Shortcut Method and the Provisions That Permit the Debtor or Creditor to
Require Prepayment
http://www.rutgers.edu/Accounting/raw/fasb/derivatives/issueg6.html
(Cleared 5/17/00)
An
interest-bearing asset or liability should be considered prepayable
under the provisions of paragraph 68(d) when one party to the contract has the
right to cause the payment of principal prior to the scheduled payment dates
unless (1) the debtor has the right to cause settlement of the entire contract
before its stated maturity at an amount that is always greater than the then
fair value of the contract absent that right or (2) the creditor has the right
to cause settlement of the entire contract before its stated maturity at an
amount that is always less than the then fair value of the contract absent that
right. A right to cause a contract to be prepaid at its then fair value would
not cause the interest-bearing asset or liability to be considered prepayable
under paragraph 68(d) since that right would have a fair value of zero at all
times and essentially would provide only liquidity to the holder.
Notwithstanding the above, any term, clause, or other provision in a debt
instrument that gives the debtor or creditor the right to cause prepayment of
the debt contingent upon the occurrence of a specific event related to the
debtor's credit deterioration or other change in the debtor's credit risk (for
example, the debtor's failure to make timely payment, thus making it
delinquent; its failure to meet specific covenant ratios; its disposition of
specific significant assets (such as a factory); a declaration of
cross-default; or a restructuring by the debtor) should not be considered a
prepayment provision under the provisions of paragraph 68(d). Application of
this guidance to specific debt instruments is provided below.
Issue
E10—Application of the Shortcut Method to Hedges of a Portion of an
Interest-Bearing Asset or Liability (or its Related Interest) or a Portfolio of
Similar Interest-Bearing Assets or Liabilities http://www.rutgers.edu/Accounting/raw/fasb/derivatives/issuee10.html
(Released 4/00)
1. May the shortcut method be applied to fair value hedges of a proportion of the principal amount of the interest-bearing asset or liability if the notional amount of the interest rate swap designated as the hedging instrument matches the portion of the asset or liability being hedged, and all other criteria for applying the shortcut method are satisfied? May the shortcut method similarly be applied to cash flow hedges of the interest payments on only a portion of the principal amount of the interest-bearing asset or liability if the notional amount of the interest rate swap designated as the hedging instrument matches the principal amount of the portion of the asset or liability on which the hedged interest payments are based? [Generally yes was the DIG’s answer.}
2. May the shortcut method be applied to fair value hedges of portfolios (or proportions thereof) of similar interest-bearing assets or liabilities if the notional amount of the interest rate swap designated as the hedging instrument matches the notional amount of the aggregate portfolio? May the shortcut method be applied to a cash flow hedge in which the hedged forecasted transaction is a group of individual transactions if the notional amount of the interest rate swap designated as the hedging instrument matches the notional amount of the aggregate group that comprises the hedged transaction? [Generally no was the DIG’s answer.}
*Issue
F2—Partial-Term Hedging http://www.rutgers.edu/Accounting/raw/fasb/derivatives/issuef2.html
(Cleared 07/28/99)
A
company may not designate a 3-year interest rate swap with a notional amount
equal to the principal amount of its nonamortizing debt as the hedging
instrument in a hedge of the exposure to changes in fair value, attributable to
changes in market interest rates, of the company’s obligation to make interest
payments during the first 3 years of its 10-year fixed-rate debt instrument.
There would be no basis for expecting that the change in that swap’s fair value
would be highly effective in offsetting the change in fair value of the
liability for only the interest payments to be made during the first three
years. Even though under certain circumstances a partial-term fair value hedge
can qualify for hedge accounting under Statement 133, the provisions of that
Statement do not result in reporting a fixed-rate 10-year borrowing as having
been effectively converted into a 3-year floating-rate and 7-year fixed-rate
borrowing as was previously accomplished under synthetic instrument accounting
prior to Statement 133. Synthetic instrument accounting is no longer acceptable
under Statement 133, as discussed in paragraphs 349 and 350.
*Issue
G7—Measuring the Ineffectiveness of a Cash Flow Hedge under Paragraph 30(b)
When the Shortcut Method is Not Applied
http://www.rutgers.edu/Accounting/raw/fasb/derivatives/issueg7.html
(Cleared 5/17/00)
Three
methods for calculating the ineffectiveness of a cash flow hedge that involves
either (a) a receive-floating, pay-fixed interest rate swap designated as a
hedge of the variable interest payments on an existing floating-rate liability
or (b) a receive-fixed, pay-floating interest rate swap designated as a hedge
of the variable interest receipts on an existing floating-rate asset are
discussed below. As noted in the last section of the response, Method 1 (Change
in Variable Cash Flows Method) may not be used in certain circumstances. Under
all three methods, an entity must consider the risk of default by
counterparties that are obligors with respect to the hedging instrument (the
swap) or hedged transaction, pursuant to the guidance in Statement 133 Implementation
Issue No. G10, "Need to Consider Possibility of Default by the
Counterparty to the Hedging Derivative." An underlying assumption in this
Response is that the likelihood of the obligor not defaulting is assessed as
being probable.
Other DIG issues can be viewed
at http://www.rutgers.edu/Accounting/raw/fasb/derivatives/issuindex.html
Cross-Currency
Compound Hedges as Amended and DIGed
FAS 138 Makes Compound Hedging
Possible
Prior to FAS 138, the scope of
foreign currency hedging that qualified for hedge accounting under FAS 133
(even though the hedges themselves probably had to be accounted for at current
fair value) was limited to the following for foreign currency denominated (FCD)
items:
·
Fair Value
Hedge of Unrecognized FCD Firm Commitments
·
Cash Flow
Hedge of Forecasted FCD Transactions
·
Net
Investment in FCD Foreign Operations
FAS 138 widened the net of
qualified FX hedges as follows:
·
Foreign-currency-denominated
(FCD) assets or liabilities can be hedged in fair value or cash flow
hedgings. However, cash flow hedging of
a recognized FCD asset or liability is permitted only when all the variability
in the hedged item's functional currency equivalent cash flows is reduced to
zero.
·
Unrecognized
FCD firm commitments also can be hedged in fair value or cash flow hedge.
Much of FAS 52 remains in
effect. For example, marking-to-spot
the asset or liability under SFAS 52 is still in effect while marking-to-market
the derivative under SFAS 133 rules.
One of the more important
concessions granted by the FASB in FAS 138 is to allow joint hedging of
interest rate risk and FX risk in one compound hedge --- the so-called
cross-currency hedge (CCH) of fair value.
A CCH hedge of fair value was not allowed in FAS 133 prior to the FAS
138 Amendments. However, it was
possible with more cost and trouble to hedge each risk separately. Paragraph 29 of FAS 138 reads as follows:
The Board’s decision to permit fair value
hedge accounting for assets and liabilities denominated in a foreign currency
relates to the ability of an entity to designate a compound derivative as a
hedging instrument in a hedge of both interest rate risk and foreign exchange
rate risk. An entity’s ability to use a
compound derivative would achieve the same result that would be achieved prior
to this amendment with the use of an interest rate derivative as a qualifying
hedging instrument to hedge interest rate risk and an undesignated foreign
currency derivative to hedge exchange rate risk. Permitting use of a compound derivative in a fair value hedge of
interest rate risk and foreign exchange risk would result in the value of the
foreign currency asset or liability being adjusted for changes in fair value
attributable to changes in foreign interest rates before remeasurement at the
spot exchange rate. The ability to adjust the foreign currency asset or
liability for changes in foreign interest rates effectively eliminates any
difference recognized currently in earnings related to the use of different
measurement criteria for the hedged item and the hedging instrument. The Board concluded that in the situations
in which fair value hedges would be used, remeasurement of the foreign-currency-denominated
asset or liability based on the spot exchange rate would result in the same
functional currency value that would result if the instrument was remeasured
based on the forward exchange rate.
For example, FCD items (e.g., a
fixed-rate bond in German marks) is subject to fair value risk both in terms of
changes in interest rates (that change the bond prices in German marks) and
changes in the FX rates (that change the U.S. dollars needed to pay make
interest coupon payments in German marks).
Before being amended, the debtor would first have to hedge interest
rates in some way such as with a vanilla swap in which FCD variable interest is
received and FCD fixed interest is paid, thereby locking in the combined value
(bond + swap value) at a fixed amount in German marks. Then another derivative contract would have
to be entered into to hedge the combined FCD value for FX risk. For example, a forward contract could be
entered into to hedge a downward spiral of the German mark’s value against the
dollar.
After being amended by FAS 138,
it is now possible to acquire a single compound derivative to hedge the joint
fair value risk of interest rate and FX movements. One such derivative is a cross currency interest swap (receive
fixed interest rate in German marks, pay variable interest rate in US$). The combined value (bond + swap) will,
thereby, remain locked in at a fixed rate.
Of course locking in value must result in creation of cash flow
risk. The amount of US$ needed for each
swap payment varies jointly with interest rate and FX movements.
Of course a reverse process can
be used to hedge cash flow risk of variable-rate FCD items. For example, if a variable rate bond is
denominated in German marks, it is possible to jointly hedge interest rate and
FX cash flow risk by entering into a cross currency interest swap (receive
variable interest rate in German marks, pay fixed interest rate in US$). This will lock in the cash flow in US$, but
the combined value (bond + swap) will vary with both interest rate and FX
movements.
The FASB provides two FX hedging
examples illustrating the FAS 138 Amendments to FAS 133 at http://www.rutgers.edu/Accounting/raw/fasb/derivatives/examplespg.html
Some DIG Issues Affecting
Foreign Currency Hedging
Issue
G8—Hedging Interest Rate Risk of Foreign-Currency-Denominated Floating-Rate
Debt
http://www.rutgers.edu/Accounting/raw/fasb/derivatives/issueg8.html
(Cleared 5/17/00)
After
entering into a currency swap to "hedge" the foreign exchange risk of
the foreign-currency-denominated debt instrument (that is, without designating
the currency swap as a hedge under Statement 133), an entity may not designate
a cash flow hedging relationship in which the hedging instrument is a
receive-floating, pay-fixed interest rate swap denominated in the entity's
functional currency. That hedging relationship would involve designation of a
hedged transaction that is not permitted under Statement 133. Specifically, the
hedged transaction may not be expressed as the net flows after consideration of
the effect of the currency swap that is economically hedging the foreign
currency risk of the floating-rate foreign-currency-denominated debt because
that would be applying the notion of synthetic instrument accounting, which is
not permitted by Statement 133. The floating-rate cash flow exposure from the
interest payments on the debt exists only with respect to interest
payments actually made in the currency in which the debt is denominated—not
with respect to the synthetic interest payments in the entity's functional
currency. Therefore, an interest rate swap denominated in the entity's
functional currency could not be expected to be highly effective in mitigating
the variability of the floating interest payments denominated in a foreign currency.
Similarly, the floating-rate interest flows that represent the leg of the
currency swap matching the functional currency of the entity may not be
designated as the hedged transaction. Statement 133 does not permit variable
cash flows from a derivative to be the hedged transaction in a cash flow hedge
because the currency swap is a derivative that is measured at fair value with
changes in fair value reported currently in earnings.
Paragraph
425 of Statement 133 contemplated that only an interest rate derivative that is
denominated in the same currency as the interest rate exposure would qualify
for hedge accounting treatment. Therefore, if an entity employs a strategy of
first entering into a foreign-currency-denominated interest rate swap to hedge
the interest rate risk inherent in the foreign-currency-denominated
floating-rate debt, the entity may designate that interest rate swap as a cash
flow hedge of the variability of the foreign-currency-denominated floating-rate
interest payments. Under that strategy, the entity could then enter into a
currency swap if it desired to economically hedge the foreign exchange risk of
the foreign-currency-denominated fixed-rate interest flows (the net cash
flows arising from the debt and the interest rate swap). The currency swap may
not be designated as a cash flow hedge of the synthetic
foreign-currency-denominated fixed-rate interest payments; however, the
currency swap could function as an economic hedge of the foreign currency risk
because some income statement offset would be achieved by recognizing both the
change in fair value of the undesignated currency swap and the remeasurement of
the debt into the entity's functional currency concurrently in earnings. That
strategy achieves the objective of simultaneously hedging foreign currency and
interest rate risk but utilizes derivative products different from those
described in the strategy presented in the question section.
All DIG Section
H issues and several Section J issues deal with FX matters. There are too many issues to discuss
here. The issues can be viewed at http://www.rutgers.edu/Accounting/raw/fasb/derivatives/issuindex.html
Two Board Members Dissent from Issuance of FAS
138
Two of the seven FASB members
dissented from issuing FAS 138 primarily due to the above amendments to partial
hedging of interest rate risk and compound hedging of joint interest rate and
FX risks. You can read the following
beginning on Page 25 of FAS 138 regarding the dissents of Messr.s Foster and
Leisenring:
While Statement 133 gave wide latitude to
management in determining the method for measuring effectiveness, it is clear
that the hedged risk is limited to (a) the risk of changes in the entire hedged
item, (b) the risk attributable to changes in market interest rates, (c) the
risk attributable to changes in foreign currency exchange rates, and (d) the
risk attributable to changes in the obligor’s creditworthiness. Those limitations were designed to limit an
entity’s ability to define the risk being hedged in such a manner as to
eliminate or minimize ineffectiveness for accounting purposes. The effect of the provisions in this
amendment relating to (1) the interest rate that is permitted to be designated
as the hedged risk and (2) permitting the foreign currency risk of
foreign-currency-denominated assets and liabilities to be designated as hedges
will be to substantially reduce or, in some circumstances, eliminate the amount
of hedge ineffectiveness that would otherwise be reflected in earnings. For example, permitting an entity to
designate the risk of changes in the LIBOR swap rate curve as the risk being
hedged in a fair value hedge when the interest rate of the instrument being
hedged is not based on the LIBOR swap rate curve ignores certain effects of
basis risk, which, prior to this amendment, would have been appropriately
required to be recognized in earnings.
Messrs. Foster and Leisenring believe that retreat from Statement 133 is
a modification to the basic model of Statement 133, which requires that
ineffectiveness of hedging relationships be measured and reported in
earnings.
Intercompany FX Hedges as Amended and DIGed
The Confusing Intercompany FX
Amendments
In this particular section of
FAS 138, a whole lot of words are spent to give away very little in real
benefits. The added accounting
difficulties of the central treasury of the consolidated group of companies
might discourage making use of these intercompany FX amendments (see Paragraphs
30-36) of FAS 138. Paragraph 30 sets
the stage:
Paragraph 36 of Statement 133 permits a
derivative instrument entered into with another member of the consolidated
group to qualify as a foreign currency hedging instrument in the consolidated
financial statements only if the member of the consolidated group has entered
into an individual offsetting derivative contract with an unrelated third
party. Constituents requested that
Statement 133 be amended to permit derivative instruments entered into with a
member of the consolidated group to qualify as hedging instruments in the
consolidated financial statements if those internal derivatives are offset by
unrelated third-party contracts on a net basis.
The constituents essentially got
their wish, but this is an illustration of the old warning “watch what you ask
for before you ask.” Consider the
accounting (and auditing) requirements imposed by FAS 138:
·
Central
treasury must act as a pass-through entity by entering into third-party
contracts to offset, on a net basis, for each foreign currency. The foreign exchange risk arising from
multiple internal derivatives AND the derivative contract with the unrelated
third party must general equal or closely approximating gains and losses when
compared with the aggregate or net losses and gains generated by the
intercompany derivative contracts.
·
Due to
concerns regarding macro-hedging, accountants must track exposures and document
linkage of all derivatives. Central
treasury cannot alter or terminate third-party contracts unless the hedging
affiliate initiates action. Accountants
must reassess compliance with all requirements if the internal derivative is
modified or de-designated as a hedge.
·
Offsetting
net third-party contract must offset the aggregate or net exposure to that
currency. Exposures from internal
contracts must mature within the same 31-day period and be entered into within
3 business days after the designation of internal contracts as hedging
instruments
All I can say on this one is
that the cost of accounting and auditing may far outweigh the benefits unless
the notional amounts involved are enormous.
The FASB provides a complicated
example illustrating internal derivatives FAS 138 Amendments to FAS 133 at http://www.rutgers.edu/Accounting/raw/fasb/derivatives/examplespg.html
A DIG Issue on Intercompany
Derivatives
*Issue
E3—Hedging with Intercompany Derivatives http://www.rutgers.edu/Accounting/raw/fasb/derivatives/issuee3.html
(Cleared 03/31/99)
Whether
an intercompany derivative can be designated as a hedging instrument in
consolidated financial statements depends on the risk being hedged. If the
hedged risk is either the risk of changes in fair value or cash flows
attributable to changes in a foreign currency exchange rate or the foreign
exchange risk for a net investment in a foreign operation, then an intercompany
derivative can be designated as the hedging instrument provided that the
counterparty (that is, the other member of the consolidated group) has entered
into a contract with an unrelated third party that offsets the intercompany
derivative completely, thereby hedging the exposure it acquired from issuing
the intercompany derivative instrument to the affiliate that designated the
hedge. For example, if a parent company’s central treasury function enters into
an intercompany derivative with a subsidiary for the subsidiary’s use in
hedging its foreign currency risk, the central treasury function must also
enter into an offsetting matched foreign currency derivative contract with a
third party (or an offsetting contract of at least the same magnitude). In
contrast, if the central treasury function chooses to enter into a contract
with a third party for only its net foreign currency exposure from all
intercompany derivatives, that action would be insufficient to enable all of
the related counterparties (such as subsidiaries) to designate those
intercompany derivatives as qualifying hedging instruments in consolidated
financial statements. The Board decided to permit the designation of
intercompany derivatives as hedging instruments for hedges of foreign exchange
risk to enable companies to continue using a central treasury function for
derivative contracts with third parties and still comply with the requirement
in paragraph 40(a) that the operating unit with the foreign currency exposure
be a party to the hedging instrument. (As used in this response, the term subsidiary
refers only to a consolidated subsidiary. The response should not be applied
directly or by analogy to an equity-method investee.)
In
contrast, an intercompany derivative cannot be designated as the hedging
instrument if the hedged risk is (1) the risk of changes in the overall fair
value or cash flows of the entire hedged item or transaction, (2) the risk of
changes in its fair value or cash flows attributable to changes in market
interest rates, or (3) the risk of changes in its fair value or cash flows
attributable to changes in the obligor’s creditworthiness or nonperformance.
Similarly, an intracompany derivative (that is, a derivative instrument
contract between operating units within a single legal entity) cannot be
designated as the hedging instrument in a hedge of those risks. Only a
derivative instrument with an unrelated third party can be designated as the
hedging instrument in a hedge of those risks in consolidated financial
statements.
There
is no requirement in Statement 133 that the operating unit with the interest
rate, market price, or credit risk exposure be a party to the hedging
instrument. Thus, for example, a parent company’s central treasury function can
enter into a derivative contract with a third party and designate it as the
hedging instrument in a hedge of a subsidiary’s interest rate risk for purposes
of the consolidated financial statements. However, if the subsidiary wishes to
qualify for hedge accounting of the interest rate exposure in its
separate-company financial statements, the subsidiary (as the reporting entity)
must be a party to the hedging instrument, which can be an intercompany
derivative obtained from the central treasury function. Thus, an intercompany
derivative for interest rate risk can qualify for designation as the hedging
instrument in separate company financial statements but not in consolidated
financial statements.
Other DIG issues in Sections H
and J will not be reviewed here. These
can be viewed at http://www.rutgers.edu/Accounting/raw/fasb/derivatives/issuindex.html
The other amendments are not so
controversial. I will list them without
further comment:
·
Amendment
Related to Normal Purchases and Normal Sales (NPNS)
For a message from an industry expert who says NPNS is
important, click here.
·
Amendments
for Certain Interpretations of Statement 133 Cleared by the Board Relating to
the Derivatives Implementation Group Process
·
Amendments to
Implement Guidance in Implementation Issue No. G3, “Discontinuation of a Cash
Flow Hedge”
·
Amendments
to Implement Guidance in Implementation Issue No. H1, “Hedging at the Operating
Unit Level”
·
Amendments
to Implement Guidance in Implementation Issue No. H2, “Requirement That the
Unit with the Exposure Must Be a Party to the Hedge”
·
Amendments
to the Transition Guidance, the Implementation Guidance in Appendix A of
Statement 133, and the Examples in Appendix B of Statement 133
·
Amendments
to the Glossary of Statement 133
DIG Issues Incorporated Into FAS 138
DIG Issue G3,
"Discontinuation of a Cash Flow Hedge": Gain or loss continues to be reported in OCI unless it is
probable that the forecasted transaction will not occur by the
originally specified time period or within an additional two month period. Extenuating circumstances resulting in the
continued reporting in OCI beyond that two-month period must be rare and beyond
control of the reporting entity.
DIG Issue H2, "Requirements That the Unit With the Exposure Must Be Party to the Hedge": For consolidated financial statements, either:
- Operating unit that has the FX exposure must be
party to the hedging instrument, or
- Another member of the consolidated group is party to the hedge and: that other member has the same functional currency as the operating unit. There are no intervening subsidiaries with a different functional currency
DIG Issue H5, "Hedging a
Firm Commitment or a Fixed-Price Agreement Denominated in a Foreign
Currency": Unrecognized foreign-currency-denominated
firm commitment can be designated in either a fair value or a cash flow
hedge. The DIG’s earlier position
reaching the same conclusion for payments due under an available-for-sale (AFS
under FAS 115) debt security is explicitly permitted by SFAS 138.
What the FASB Refused to Amend in FAS 138
Except
for the confusing and highly limited amendments on intercompany intercompany
derivative contracts, FAS 138 does not change the FASB’s stand against
portfolio (macro) hedging. In order to
qualify as a FAS 133/138 hedge, the hedge must, except in unrealistic
circumstances, relate to a particular hedged item in a portfolio rather than a
subset of items. The only exception is
where subsets of items having identical terms and are virtually fungible. Drilling down to matches of individual
hedges against individual hedged items (see Paragraph 21 in FAS 133) not only
magnifies the accounting costs, it runs contrary to the way many firms view
economic hedges. As a result, FAS 133
allegedly forces companies to change hedging strategies and risk management
practices.
The
FASB did not replace FAS 52 and, thereby, left a great deal of confusion when
applying both standards simultaneously.
FAS 138 did a great deal to reduce differences between spot versus
forward rate adjustments, but in the end we are still left with a certain
amount of confusion in reconciling the two standards.
The FASB requires fair value adjustments but provides very little guidance on how to measure fair value of custom derivatives such as swaps and forwards that are not traded in markets or are not traded in sufficiently deep and wide markets. Example 5 in Appendix B of FAS 133 that begins in Paragraph 131 contains some errors and confusions that were not cleaned up by FAS 138 or any other FASB announcements. In particular, there is no FASB guidance on how swap values were derived in Examples 2 or 5. Corrections and derivation discussions are discussed in the following two documents:
·
”The
Receive Fixed/Pay Variable Interest-Rate Swap in SFAS 133, Example 2, Needs An
Explanation: Here It Is,” by Carl M.
Hubbard and Robert E. Jensen, Derivatives Report, November 1999, pp.
6-11.
http://www.trinity.edu/rjensen/caseans/294wp.doc
The Excel workbook is at http://www.cs.trinity.edu/~rjensen/133ex02a.xls
·
”An
Explanation of Example 5, Cash Flow Hedge of Variable-Rate Interest Bearing
Asset in SFAS 133,” by Carl M. Hubbard and Robert E. Jensen, Derivatives
Report, Aprils 2000, pp. 8-13.
http://www.trinity.edu/rjensen/caseans/133ex05.htm
The Excel workbook is at http://www.cs.trinity.edu/~rjensen/133ex05a.xls
Derivative
instruments cannot be designated as held-to-maturity items that are not subject
to fair value adjustment. For certain derivatives,
this can cause income volatility that is entirely artificial and will
ultimately, at maturity, have all previously recognized fair value gains wash
out against fair value losses. Economic
hedges of hedged items (e.g., bond investments) designated as held-to-maturity
cannot receive hedge accounting under FAS 133 even though the hedges must be
booked at fair value. The reason, as
given in Paragraph 29e, is that this hedge is a credit hedge. Fair value hedging of fixed-rate debt makes
little sense since the item will be held to maturity. Cash flow hedging of variable interest payments will wash out
each other unless the interest payments cease in contract default. The reasons for not allowing such hedges to
receive FAS 133 hedge accounting treatment are clear. However, what is not clear is why the hedges have to be booked to
market value if they also will be held to maturity.
FAS
138 did very little to reduce the complexity of FAS 133 and the enormous
confusions that exist among financial managers, accountants, and auditors. Effectiveness testing remains a
nightmare. It is virtually impossible
to write general software packages that can deal with the thousands of unique
types of derivative instruments contracts used worldwide.
Some
of the issues considered by the FASB that were either included or excluded in
FAS 133 are summarized with thumbs-up and thumbs-down symbols in a Deloitte and
Touche document http://www.us.deloitte.com/PUB/HEADSUP/7-1/feb07-01.htm. The thumbs down topics that were considered
and rejected by the FASB were as follows:
|
|
Topic |
Perceived Problem |
FASB Leaning |
|
|
Accounting for Time Value in Purchased Options |
Under today’s accounting, the time value of purchased options that qualify as hedges are recognized in expense ratably. Under FAS 133, the time value is recognized based on changes in fair value, leading to volatility in earnings. |
The FASB will not consider the issue for a possible amendment. |
|
|
Partial-Term Fair Value Hedges |
Today, hedge accounting permits a hedger to swap to
floating the first two years of interest on fixed-rate, ten-year debt
(other conditions need to be met). FAS 133 precludes fair value hedging for
this strategy because the changes in fair value of the debt and the
derivative won’t closely offset. |
The FASB will not consider the issue for a possible
amendment. |
Hopefully, readers will give me feedback on both
typos and issues of substance. My email
address is shown below:
Bob Jensen at email address rjensen@trinity.edu
A message concerning Normal Purchases and Normal Sales (NPNS)
I
received a very long message and received permission to quote the message below
regarding the Normal Purchases and Normal Sales (NPNS) amendment in FAS 138::
Hello Professor Jensen,
Great website! However, I
have to disagree with your comment regarding the issue of NPNS.
I work for the
Bonneville Power Administration (Bonneville), a federal based Electric
Wholesale Power Marketer, we sell the output from the 29 federally owned dams
on the Columbia and Snake River system in the Pacific Northwest. I am the project manager for Bonneville
responsible for implementing FAS 133.
More on Bonneville at the end of this email - postscript.
Regarding the NPNS issue: This issue is of big concern to the Energy
industry as it relates to our normal sales and purchases activities. I am most familiar with the Electric Utility industry and the sales and delivery practices
that are prevalent throughout the industry.
I would argue that Bonneville was much
better off under the original statement para 10 (b) because the statement was
silent on the practice I describe below referred to as "Bookouts".
Specifically, in
the electric utility industry it is necessary and is considered best utility
and business practice to perform a type of transaction called a
"Bookout" whereby several transactions with the same Counterparty in
the same month - a purchase and a sale - are
offset and not scheduled for physical delivery. For example, Bonneville may sell forward 200
MWs for the month of August 2000 in January 2000 based on our most current
hydro forecasts and subsequently in May 2000 our most current forecasts now
show a deficit and we have to purchase 200 MWs for the same month to cover our
obligations. We may from time to time
find ourselves with both purchases and sales with the same counterparty in the
same month at the same delivery location.
Just prior to delivery, we look at our schedule and try and match up
transactions --- the "Bookout" procedure.
This
"Bookout" procedure is common in the electric utility industry as a
scheduling convenience when two utilities happen to have offsetting
transactions. If this procedure is not used, both counterparties incur transmission costs in order to make
deliveries to each other. The Bookout procedure avoids the energy scheduling
process (an administrative burden as well) which would trigger payment of
transmission costs. We do not plan for
this event or know in advance what we will bookout and we do not
"Bookout" to capture a margin.
Rather, we find ourselves in this situation because of our inventory
management constraints, maintenance schedules, and dependency on factors
outside our control such as the weather and streamflows or environmental
constraints placed upon us by other federal agencies or federal courts.
We lobbied the FASB and the DIG to clarify and revise the NPNS
language to allow for this practice, but the FASB position was very restrictive
-- if you do not deliver then it is considered net settled. It seems to me and other
industry participants that bookouts do not fit into the net settlement
definition as it was described and intended in FAS 133. Rather it is a utility
best practice that results in no physical delivery. In addition, when we bookout the cash settling is done at the
agreed upon contract prices - not at the market pricing. We would argue that the Board's original
intent was to capture net settlement mechanisms that require "market"
settlement. Unfortunately, the
FASB made their decision about a practice without doing more homework on the
nature of the transaction. I understand the pressures the FASB was
under to get the statement amended and implemented. Unfortunately, the industry participants and practitioners are
left to deal with the Board's end product. The final 138 was not clear in its guidance either as it relates
to these types of transactions and what this meant to our "similar"
contracts that we want to qualify for NPNS.
I continue, along with our auditors, to hold discussions with FASB
staff.
What I am afraid
may happen is that because of the "One size fits all approach by the
FASB", Bonneville and other
regulated utilities will be forced into adopting a FV accounting approach on
transactions that are simple sales and purchases. Applying mark to market treatment to these transactions is more
misleading to the financial statement reader not clearer - the original intent
of 133. I believe the interpretation of
the final written words by individuals unfamiliar with the Energy industry is
driving us into misleading and confusing presentation.
Any
advice or encouragement you can provide would be appreciated. We adopt October 1 and I have a deadline to
meet and I still do not have final clear and convincing guidance. I am ahead of most folks on this issue since
we do have an earlier adoption date than most utilities. Thanks for your time. This is a complex issue and I apologize for
the length of this email and I imagine I still have not described the issues in
the most succinct and clear fashion.
Regards,
Sanford Menashe
Project Manager,
FAS 133
Bonneville Power
Administration
phone: 503-230-3570
email: smmenashe@bpa.gov
Postscript:
About Bonneville
Power Administration:
Bonneville is a federal agency under the Department of Energy, which was established over 60 years ago to market power from 29 federal dams and one non-federal nuclear plant in the Pacific Northwest. BPA’s energy sales are governed by federal legislation (e.g. the Northwest Power Act) and other regional mandates to maintain the benefits of power sales for the Pacific Northwest region and to manage its environmental and safety obligations relative to operating the federal hydroelectric system. Its primary objective is to provide low-cost electricity to the region by offering cost-based rates for its power and transmission services to eligible publicly owned and investor-owned utilities in the Pacific Northwest (including Oregon, Washington, Idaho, western Montana and small parts of Wyoming, Nevada, Utah, California and eastern Montana).
Sanford Menashe, Manager, FAS 133 Project.
Project Manager, FAS 133
Bonneville Power Administration
phone: 503-230-3570
email: smmenashe@bpa.gov
Email: smmenashe@bpa.gov
Update in
September 2001:
The DIG addressed Mr. Menasche's concerns, especially in Dig Issue C16.
See the term "Net Settlement" at http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
----Original Message-----
From: sajjad [mailto:lima@flash.net]
Sent: Monday, July 24, 2000 9:39 AM To: Jensen, Robert Subject: Re:
Correction.noted
I had been busy, will
look at your over(underhedging) case for swaps. Like I said before that
situation should also exist on forwards also? What do you think? . I do want to
respond to one of your readers addressing the issue of "Bookouts".
That phenomenon is common in the commodity biz, specifically in the Gas and
Commodity business and it has been addressed by DIG, Firstly 138 has expanded
the Normal Purchase and Sales exceptions in a way that on the 9(a) and 9(b)
criteria have been relaxed. Secondly in applying the interpretation language to
the case of Bookouts, the issue is the existence of a market mechanism that
facilitates Net settlement. And settlement process in turn requires a process
that extinguishes the existence of rights and obligations that have otherwise been
created by the contract. If there exists a series of transactions whereby
offsetting contracts are created that tend to offset each other, but DO NOT
actually eliminate the rights and obligations of each party under contract,
then they DONOT meet the definition, since the rights and obligation DO EXIST
under each contract. They are merely offsetting not eliminating. This is
exactly the case in most Bookouts.
The only exception will
be, if the offsetting contract ends up with the counterparty that was the
originating party. In that case the terminating contract will have the
cancellation characteristics of the original contract's rights and obligations.
You can share my response
with the reader who asked you the question. Also if you can elaborate his question,
or provide me complete excerpt, I might be able to address it better.
Sajjad Rizvi
Energy Risk Consulting
YES you can post my
message as follows:
We were hoping in the
industry that the question addressing both "Back to Back" contracts
and "Bookouts arrangements" will be addressed under 138 and the
industry practice be recongized as NPNS (normal purchase normal sales).
However, it appears that such contractual arrangement go against one of the key
cornerstone concepts of the 133 pronouncement, that recognizes the derivatives
as rights and obligation that meet the definition of assets and liabilities. In
case of net settlement process in the bookouts and Back to back contracts, the
orignal rights and obligations of multiple counterparties within the loop
remain in tact. They are merely offsetting not actually eliminating or
releiving the orignating counterparty of its asset or liability. Thus DIG
clearly came out and has explicity stated for the BOOKOUTS to be excluded from
NPNS scope.
However the attempt to
expand the scope of the 10-b provision to include certain contracts affected by
9-a and 9-c net settlement requirements has failed to make a clear
determination for NPNS (normal purchase normal sales). In the sense they have
failed to address the contracts that fall under 9-c (large amount of power
generators and commodity producers have contracts that fall into that
category.One thing that is interesting is the expansion of the scope by
including the word "probable" in its language of defining the intent
of the parties not to Net settle, even though the 9a, 9b criteria of Net
settlement is being met. The recent meeting by EITF on Energy related contracts
could have provided more guidance on some of these issues, but I am not aware
of any major "breakthroughs".
Secondly, an issue might
be a major one for the commodity industry to consider, in view of the scrutiny
that will follow the 133 implementation process starting next year. That is the
issue of dislosure of hidden physical optionality embedded in the commodity
contracts. Having been exposed to the trading market place as a Risk manager, I
see a very big chunk of hidden "embedded optionality" sitting on the
books of major Gas and power companies. Take or pay contracts, Requirements
contracts, Swing contracts, Keep Whole Arrangements etc. Historically comanies
with less sophistication and resources have always looked at them as NPNS, and
primarily hedged them without hedging the optionality component (OC). Since the
contracts were on the books without OC, the hedge was also a straight swap or a
forward based on the face value of the hedged item, and hence no apparent
discrepancies. Would that be a disclosable item effective Jan 2000? Would the
non disclosure of the embedded optionality be OK, as it could qualify for
"clearly and closely related" definition? If the answer is yes, then
it can lead to a further question of what will be the structure of the
derivative that will be required to hedge it, leading to a whole new valuation
scope. Might create scope for more OTC structuring. Thus IF there is ANY
optionality language in a GAS or OIL or POWER purchase or sales contracts, SFAS
133 implementation can force the industry to PRICE it.
Sajjad Rizvi
Energy/Financial Risk Consulting lima@flash.net
Note from Bob Jensen (as suggested to me by Roy Monarch:
|
From the Emerging Issues Task Force
EITF 98-10 |
|
Booking Out (or Netting
Out)--Booking out is a procedure for financially settling a contract for the physical
delivery of energy. Booking out occurs when one party appears more than once
in a contract path for the sale and purchase of energy. In that instance, the
intervening counterparties may agree that they will not schedule or deliver
physical energy that originates and ends with the same counterparty, but
rather will settle in cash the amounts due to or from each intervening
counterparty, thus booking out the transaction. Example: In March, Utility X sells
electricity for delivery in June to Marketer A. Marketer A sells June
electricity to B, B sells to C, C sells to D, D sells back to A and A sells
to Utility Z. Marketer A appears twice in the contract path. Prior to June,
Marketers A, B, C, and D agree to settle the amounts due to/from each other in
cash and agree not to schedule the flow of physical electricity between them.
Rather, Utility X schedules the flow of electricity to Marketer A, who in
turn schedules delivery of the electricity to Utility Z. Flash Title--Flash title is an
instantaneous flow-through of title caused by purchases and sales of energy
for delivery at the same time and location, resulting in no physical movement
by the purchaser or seller of the energy (also known as physical bookout). Capacity Contract--A capacity
contract is an agreement by an owner of capacity to sell theright to that
capacity to another party to satisfy its obligations. For example, in the
electric industry, capacity (sometimes referred to as installed capacity) is
the capability to deliver electric power to the electric transmission system
of an operating control area. A control area is a portion of the electric
grid that schedules, dispatches, and controls generating resources to serve
area load (ultimate users of electricity) and coordinates scheduling of the
flow of electric power over the transmission system to neighboring control
areas. A control area requires entities that serve load within the control
area to demonstrate ownership or contractual rights to capacity sufficient to
serve that load at time of peak demand (usually annual) and to provide a
reserve margin to protect the integrity of the system against potential
generating unit outages in the control area. Requirements Contract--A
requirements contract is a contract to serve the full needs of an end user of
energy. For example, in the electric industry, an end user's electricity
requirements consist of several components including: o Installed capacity--the need
to have generation owned or under contract which, if available, is sufficient
to serve the expected peak demand of the customer plus reserves o Load-following
energy--energy provided when and as demanded by the end user, including
adjusting the level of energy provided to reflect instantaneous changes in
demand o Transmission and ancillary services--those services necessary to deliver power from the generation source to the end user as well as the other services necessary to maintain the operational security and the integrity of the electric grid. |
Some Resource
Links
·
FASB's FAS 138 Amendments to FAS 133 I have created a summary document called "FAS 133 As
Amended and DIGed: · One of the best documents the FASB generated for FAS 133 implementation is called "summary of Derivative Types." This document also explains how to value certain types. It can be downloaded free from at http://www.rutgers.edu/Accounting/raw/fasb/derivsum.exe
For a FAS 133 flow chart, go to http://www.trinity.edu/rjensen/acct5341/speakers/133flow.htm FASB's Exposure Draft for Fair
Value Adjustments to all Financial Instruments If an item is viewed as a financial instrument rather than inventory, the accounting becomes more complicated under SFAS 115. Traders in financial instruments adjust such instruments to fair value with all changes in value passing through current earnings. Business firms who are not deemed to be traders must designate the instrument as either available-for-sale (AFS) or hold-to-maturity (HTM). A HTM instrument is maintained at original cost. An AFS financial instrument must be marked-to-market, but the changes in value pass through OCI rather than current earnings until the instrument is actually sold or otherwise expires. Under international standards, the IASC requires fair value adjustments for most financial instruments. This has led to strong reaction from businesses around the world, especially banks. There are now two major working group debates. In 1999 the Joint Working Group of the Banking Associations sharply rebuffed the IAS 39 fair value accounting in two white papers that can be downloaded from http://www.iasc.org.uk/frame/cen3_112.htm. ·
Financial Instruments: Issues Relating to
Banks (strongly argues for required fair value adjustments of financial
instruments). The issue date is August 31, 1999. ·
Accounting for financial Instruments for Banks (concludes
that a modified form of historical cost is optimal for bank accounting).
The issue date is October 4, 1999 Recommended Tutorials on Derivative Financial Instruments (but not about FAS 133 or IAS 39) · You might start at http://www.finpipe.com/derivatives.htm. · Then you can try Financial Derivatives in Plain English --- http://www.iol.ie/~aibtreas/derivs-pe/ · For details on products and how they work in practice, I like the following tutorial/education websites: CBOE --- http://www.cboe.com/education/ Recommended Tutorials on FAS 133 ·
One of the best documents the FASB generated for FAS
133 implementation is called "summary of Derivative Types." This
document also explains how to value certain types. It can be downloaded
free from at http://www.rutgers.edu/Accounting/raw/fasb/derivsum.exe ·
The Appendix B examples in FAS 133. You can
also download Excel worksheet tutorials on the first 10 examples in files
133ex01a.xls through 133ex10.xls at http://www.cs.trinity.edu/~rjensen/ · Bob Jensen's cases indexed at http://www.trinity.edu/rjensen/caseans/000index.htm · The FASB's CD-ROM Self-Study CPE Training Course and Research Tool http://www.rutgers.edu/Accounting/raw/fasb/CDROM133.html ·
The FASB
provides some new examples illustrating the FAS 138 Amendments to FAS 133 at http://www.rutgers.edu/Accounting/raw/fasb/derivatives/examplespg.html · Implementation Guidelines on IAS 39 --- http://www.iasc.org.uk/frame/cen2_139.htm · The excellent tutorials entitled Introductory Cases on Accounting for Derivative Instruments and Hedging Activities by Walter R. Teets and Robert Uhl available free from http://www.gonzaga.edu/faculty/teets/index0.html.
Recommended Glossaries Bob Jensen's FAS 133 Glossary on Derivative Financial Instruments and Hedging Activities Also see comprehensive risk and trading glossaries such as the ones listed below that provide broader coverage of derivatives instruments terminology but almost nothing in terms of FAS 133, FAS 138, and IAS39: ·
http://risk.ifci.ch/SiteMap.htm · http://www.margrabe.com/Dictionary.html ·
http://www.adtrading.com/glossary/glossary.htm · Related glossaries are listed at http://www.trinity.edu/rjensen/bookbus.htm
|