Successfully reported this slideshow.
We use your LinkedIn profile and activity data to personalize ads and to show you more relevant ads. You can change your ad preferences anytime.

Derivative Accounting Convergence: The path from Where We Are (US GAAP) to Where We Are Headed (IFRS)

2,419 views

Published on

Derivative Accounting rules are constantly changing. With the expectation of worldwide accounting standards on the horizon, US GAAP and IAS (International Accounting Standards) are both moving towards a similar framework. This presentation provides an overview of the path corporate hedge programs might need to follow starting with the current interpretation of FAS 133 (ASC 815) through the recently issued exposure draft and then on to IAS 39 and what the worldwide standard could look like. For more information visit www.hedgetrackers.com.

Published in: Economy & Finance
  • Be the first to comment

Derivative Accounting Convergence: The path from Where We Are (US GAAP) to Where We Are Headed (IFRS)

  1. 1. Derivative Accounting Convergence: The path from Where We Are to Where We Are Headed Presented by: Helen Kane, President www.hedgetrackers.com February 17, 2011
  2. 2. International Financial Reporting Standard <ul><li>IAS were issued 1973 - 2001 by the International Accounting Standards Committee (IASC). </li></ul><ul><li>In 2001, the new IASB took over from the IASC the responsibility for setting International Accounting Standards and adopted existing IAS </li></ul><ul><li>Subsequent standards IASB issued are called IFRS </li></ul><ul><li>110 countries have either adopted or in the process of adopting IFRS </li></ul>
  3. 3. Background <ul><li>August 2008, the SEC proposed that IFRS replace U.S. GAAP with a complete phase-in by 2014 </li></ul><ul><ul><li>2009 Obama administration put plan under review </li></ul></ul><ul><li>February 2010, the SEC Commissioner Walter approved a new IFRS timeline </li></ul><ul><ul><li>June 2011: scheduled completion date for IASB/FASB convergence projects </li></ul></ul><ul><ul><li>Later 2011: SEC will vote on IFRS mandate </li></ul></ul><ul><ul><li>Implementation probable 2015 or 2016 if adopted </li></ul></ul>
  4. 4. Current Events <ul><li>Project exists to replace IAS 39 with IFRS 9 by 6/2011 </li></ul><ul><ul><li>Phase 1-- Classification and Measurement of Financial Assets </li></ul></ul><ul><ul><li>Phase 2-- Amortized Cost and Impairment, expected issuance 12/10 </li></ul></ul><ul><ul><li>Phase 3-- 12/10 Issued Hedge Accounting Exposure Draft , 6/11 </li></ul></ul><ul><ul><ul><li>To be applied prospectively for annual periods beginning on or after 1/1/13 with early application permitted (for all of IFRS 9) </li></ul></ul></ul>
  5. 5. Current Events <ul><li>The IASB published an exposure draft of proposed amendments on 12/9/2010 </li></ul><ul><ul><li>Comments due by 3/9/2011 </li></ul></ul><ul><li>The FASB published an invitation to comment on IASB’s exposure draft 2/9/11 </li></ul><ul><ul><ul><li>Comments due by 4/25/2011 </li></ul></ul></ul><ul><ul><li>FASB to participate in IASB discussion of comments in Q2/11 </li></ul></ul>
  6. 6. Exposure Draft Objectives <ul><li>IFRS: </li></ul><ul><ul><li>To represent in the financial statements the effect of an entity’s risk management activities that use financial instruments to manage exposures that could affect profit or loss </li></ul></ul><ul><ul><li>Establish objective-based approach </li></ul></ul><ul><li>FASB: </li></ul><ul><ul><li>Simplify hedge accounting to improve compliance </li></ul></ul><ul><ul><li>Make financial reporting of hedge activities useful and transparent </li></ul></ul>
  7. 7. IAS 39 Background <ul><li>Treatment for all Financial Instruments </li></ul><ul><li>Principles for recognizing/measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items. </li></ul><ul><li>Derivative accounting is subset </li></ul><ul><ul><ul><li>Cash Flow </li></ul></ul></ul><ul><ul><ul><li>Fair Value </li></ul></ul></ul><ul><ul><ul><li>Net Investment Hedging </li></ul></ul></ul><ul><ul><li>Virtual and Embedded Derivatives remain an issue </li></ul></ul><ul><li>Disclosure separately handled under IFRS 7 </li></ul>
  8. 8. Comparison Flow <ul><li>ASC 815 </li></ul><ul><li>ASC 815 </li></ul><ul><li>Current Guidance </li></ul>ASC- ED ASC-Proposed Update Exposure Draft May 26, 2010 IAS 39 IAS 39 Current Guidance IASB-ED IASB Exposure Draft Exposure Draft December 9, 2010
  9. 9. Derivative Defined <ul><li>ASC 815 </li></ul><ul><li>Financial instrument or contract with </li></ul><ul><li>Underlying(s), </li></ul><ul><li>Notional or payment provisions </li></ul><ul><li>Little or no initial net investment </li></ul><ul><li>Net settle-able </li></ul>ASC- ED No significant change <ul><li>IAS 39 </li></ul><ul><li>Financial instrument whose value changes in response to changes in underlying variables </li></ul><ul><li>Little or no initial net investment </li></ul><ul><li>Settled at a future date </li></ul>IASB-ED No significant change
  10. 10. Virtual Derivatives <ul><li>ASC 815 </li></ul><ul><li>Documentation required to scope out normal purchase/normal sale contracts from Derivative Accounting requirements </li></ul><ul><li>Climatic/geological contracts scoped out </li></ul>ASC- ED No significant change IAS 39 No documentation requirements surrounding “Own Use” contracts (assumption of normal purchase/normal sale) Election of either insurance or derivative accounting required IASB-ED “ Own Use” contracts may elect treatment as derivatives
  11. 11. Embedded FX Derivatives <ul><li>ASC 815 </li></ul><ul><li>3 rd Currency contracts = derivatives </li></ul><ul><li>if not local or functional currency of either counterparty, </li></ul><ul><li>if not denominated in 3 rd currency around the world, </li></ul><ul><li>ASC- ED </li></ul><ul><li>No longer bifurcate derivatives embedded in financial instruments </li></ul><ul><ul><li>If not clearly and closely related, fair value the hybrid contract in earnings </li></ul></ul><ul><li>IAS 39 </li></ul><ul><li>Similar to ASC with additional caveat </li></ul><ul><li>If not the currency used in such contracts in the economic environment in which it takes place </li></ul>IASB-ED No significant change
  12. 12. Hedging AFS Securities <ul><li>ASC 815 </li></ul><ul><li>Gain or loss on AFS Security recorded in OCI without special hedge accounting. Cash flow or fair value accounting aligns currency related earnings effect of hedge and security </li></ul>ASC- ED No significant change IAS 39 Currency gain or loss on AFS Security recorded in P&L, therefore special hedge accounting not required to align currency earnings effect of hedge with security IASB-ED No significant change
  13. 13. Fair Value <ul><li>ASC 815 </li></ul><ul><li>Amount that would be received to sell an asset or paid to transfer a liability in orderly transaction </li></ul><ul><li>Mid-market pricing as practical expedient </li></ul>ASC- ED No significant change IAS 39 Amount an asset could be exchanged or a liability settled between knowledgeable willing parties No “own credit” effect Bid/Ask pricing unless offsetting Elect and disclose use of trade-date or settlement-date accounting IASB-ED Own credit effects recorded in OCI
  14. 14. Qualifying Hedging Instrument <ul><li>ASC 815 </li></ul><ul><li>Non derivative financial instruments are not permitted to be a hedging instrument (except as FX hedges of Net Investment or Fair Value) </li></ul>ASC- ED No significant change <ul><li>IAS 39 </li></ul><ul><li>Derivative instruments with 3rd parties </li></ul><ul><li>All changes in derivative except time value in options & forward points in forwards must be designated </li></ul><ul><ul><li>Designate proportion of notional </li></ul></ul><ul><ul><li>Must include credit </li></ul></ul>IASB-ED Nonderivative financial assets and liabilities measured at fair value in P&L eligible as hedging instrument (not net written options) Interco balances can only be designated for FX risk May designate layers
  15. 15. Qualifying Hedged Risks <ul><li>ASC 815 </li></ul><ul><li>Benchmark interest rates </li></ul><ul><li>Foreign Exchange </li></ul><ul><li>Credit </li></ul><ul><li>Overall </li></ul>ASC- ED IAS 39 Separately identifiable and reliably measured financial risk Foreign Exchange Credit Overall <ul><li>IASB-ED </li></ul><ul><li>May designate all changes or “something other than the entire fair value change or cash flow variability of an item, i.e. a component . </li></ul><ul><ul><li>Provided component is separately identifiable and reliably measured </li></ul></ul>
  16. 16. Qualifying Hedged Items <ul><li>ASC 815 </li></ul><ul><li>FX risk on firm or anticipated acquisition of business not a qualifying hedged item </li></ul>ASC- ED No significant change <ul><li>IAS 39 </li></ul><ul><li>FX risk on firmly committed acquisition of business qualifies for special hedge accounting </li></ul><ul><ul><li>Gain/loss reclassed to income with impairment or disposal of entity </li></ul></ul>IASB-ED No significant change
  17. 17. Qualifying Interco Hedged Items <ul><li>ASC 815 </li></ul><ul><ul><li>FX risk of a highly probable forecast intragroup transaction may qualify in a cash flow hedge provided currency risk will affect consolidate profit or loss </li></ul></ul>ASC- ED Royalty payments , interest payments or management charges between members of the same group cannot qualify as hedged item IAS 39 Intragroup transaction may qualify in a cash flow hedge provided currency risk will affect consolidate profit or loss Usually royalty payments, interest payments or management charges cannot qualify IASB-ED No significant change
  18. 18. Qualifying Hedged Items <ul><li>ASC 815 </li></ul><ul><li>Groups of similar items can be hedged together </li></ul><ul><li>Back to back hedging allows centralized treasury to hedge netted exposures from different entities </li></ul><ul><li>Layers of cash flows can be hedged, % of Fair Value and Entities </li></ul>ASC- ED No significant change IAS 39 Portfolio of interest rate items permitted. All other groups must be similar No centralized netting permitted IASB-ED Items in group must individually qualify for hedge accounting treatment May represent offsetting positions , can net to zero Offsetting positions are grossed up , gain/loss apportioned to P&L
  19. 19. Hedge Effectiveness Testing <ul><li>ASC 815 </li></ul><ul><ul><li>Whenever financial statements are prepared but at least quarterly </li></ul></ul><ul><li>ASC- ED </li></ul><ul><ul><ul><ul><li>No significant change </li></ul></ul></ul></ul><ul><li>IAS 39 </li></ul><ul><ul><li>Whenever financial statements are prepared (could just be annually) </li></ul></ul>IASB-ED No significant change
  20. 20. Hedge Effectiveness Testing <ul><li>ASC 815 </li></ul><ul><ul><li>Prospective and retrospective testing required at inception and each reporting date </li></ul></ul><ul><li>“ Highly Effective” Expectation </li></ul><ul><li>Short-Cut, Matched Terms, critical term comparison, dollar-offset analysis, regression </li></ul><ul><li>ASC- ED </li></ul><ul><ul><ul><li> Reasonably Effective </li></ul></ul></ul><ul><ul><ul><ul><li>Qualitative Evaluation </li></ul></ul></ul></ul><ul><ul><li> No Short-Cut or Matched Terms </li></ul></ul><ul><ul><ul><li>Inception test with limited additional testing </li></ul></ul></ul><ul><li>IAS 39 </li></ul><ul><ul><li>Prospective and retrospective testing required at inception and each reporting date </li></ul></ul><ul><li>“ Highly Effective” Expectation </li></ul><ul><li>No assumption of perfect offset </li></ul><ul><li>Critical term comparison, dollar-offset analysis, regression </li></ul>IASB-ED No more retrospective testing Expectation of other than accidental offset and meets “objective” of strategy No “bright lines”
  21. 21. Credit in Hedge Effectiveness Testing <ul><li>ASC 815 </li></ul><ul><li>Credit risk from derivative is applied to hedged item as well </li></ul><ul><li>ASC- ED </li></ul><ul><li>No significant change </li></ul>IAS 39 Derivative credit adjusted for counterparty, underlying not IASB-ED No significant changes
  22. 22. Hedge Effectiveness Testing <ul><li>ASC 815 </li></ul><ul><li>No prohibition against deliberate mismatch of hedge item and derivative to create over or under hedging </li></ul><ul><li>ASC- ED </li></ul><ul><li>No significant change </li></ul>IAS 39 No prohibition against deliberate mismatch of hedge item and derivative to create over or under hedging IASB-ED Ensure that hedge relationship does not produce and unbiased result: reduce ineffectiveness
  23. 23. Hedge Effectiveness Measurement <ul><li>ASC 815 </li></ul><ul><li>Change in variable cash flow for zero fair value designations </li></ul><ul><li>Hypothetical derivative </li></ul><ul><li>Change in fair value method </li></ul><ul><li>ASC- ED </li></ul><ul><li>No significant change </li></ul>IAS 39 Present value guiding concept Hypothetical derivative Change in fair value method IASB-ED No significant change
  24. 24. Hedge Accounting <ul><li>ASC 815 </li></ul><ul><li>Special Hedge Accounting for </li></ul><ul><li>Cash Flow </li></ul><ul><li>Fair Value </li></ul><ul><li>Net Investment: direct subsidiary </li></ul>ASC- ED No significant change <ul><li>IAS 39 </li></ul><ul><li>Special Hedge Accounting for </li></ul><ul><li>Cash Flow </li></ul><ul><li>Fair Value </li></ul><ul><li>Net Investment: direct or indirect subsidiary </li></ul>IASB-ED No significant change
  25. 25. Hedge Accounting for Options <ul><li>ASC 815 </li></ul><ul><li>For hedges of intrinsic value record option time value changes in P&L as they occur </li></ul><ul><li>For hedges of total changes under G20 concepts effective time value is reclassified to P&L with hedged item </li></ul>ASC- ED Option premium expense to be amortized to income in “rational way ” IAS 39 Special Hedge Accounting for Intrinsic Value of Options only: time value changes recorded in P&L as they occur <ul><li>IASB-ED </li></ul><ul><li>Underlying defines if premium </li></ul><ul><li>amortizes over life when hedging or </li></ul><ul><li>Premium impacts earnings together with hedged item </li></ul>
  26. 26. Hedge Accounting <ul><li>ASC 815 </li></ul><ul><li>Cash Flow ineffectiveness limited to over performance of derivative </li></ul><ul><li>Changes in Fair Value of hedged item recognized in underlying asset/liability in BS and P&L </li></ul>ASC- ED Both over and under- performance of cash flow hedges in income IAS 39 Cash Flow ineffectiveness limited to over performance of derivatives Changes in Fair Value item recognized in underlying asset/liability in BS and P&L IASB-ED No change to cash flow ineffectiveness calculation: addressed by no bias requirement Changes in Fair Value item in BS (separate) and OCI, not P&L
  27. 27. Hedge Accounting for Cash Flow Exposures <ul><li>ASC 815 </li></ul><ul><li>Effective gains/losses remain in OCI until hedged item recognized in income </li></ul>ASC- ED No significant change IAS 39 Effective gains/losses may remain in OCI until hedged item recognized in income or may adjust the basis of hedged items recorded in balance sheet IASB-ED Must adjust the basis of hedged items recorded in balance sheet
  28. 28. Hedge Accounting for Cash Flow Exposures <ul><li>ASC 815 </li></ul><ul><li>Gains/losses on anticipated transactions possible but not probable of occurring stay in OCI until probable not to occur </li></ul><ul><li>2 additional months for hedged item to occur </li></ul>ASC- ED No significant change IAS 39 Gains/losses on anticipated transactions stay in OCI until no longer expected to occur No specified 2-month extension of hedge period IASB-ED No significant change
  29. 29. Hedge Accounting for Net Investment <ul><li>ASC 815 </li></ul><ul><li>Gains/losses on Net Investments remain in OCI/CTA until substantial liquidation of subsidiary </li></ul>ASC- ED No significant change IAS 39 Gains/losses on Net Investments in OCI/CTA reclassified upon disposal or partial disposal of foreign operation IASB-ED No significant change
  30. 30. Termination of Hedge Relationship <ul><li>ASC 815 </li></ul><ul><ul><li>Qualifying criteria for designation no longer met </li></ul></ul><ul><ul><li>Hedging instrument expires, sold, terminated or exercised </li></ul></ul><ul><ul><li>Company dedesignates relationship </li></ul></ul>ASC- ED No voluntary dedesignation Compensating contract relationship must be documented <ul><li>IAS 39 </li></ul><ul><ul><li>Qualifying criteria for designation no longer met </li></ul></ul><ul><ul><li>Hedging instrument expires, sold, terminated or exercised </li></ul></ul><ul><ul><li>Company dedesignates relationship </li></ul></ul>IASB-ED No voluntary dedesignation Change in hedge objective can terminate relationship
  31. 31. Dedesignation/Redesignation Events <ul><li>ASC 815 </li></ul><ul><li>Changes in any of the critical terms of the instrument or hedged item would require dedesignation </li></ul>ASC- ED Adjustments to derivative notional only requires amendment of inception documentation, not dedesignation <ul><li>IAS 39 </li></ul><ul><li>Changes in any of the critical terms of the instrument or hedged item would require dedesignation </li></ul>IASB-ED Proactive “rebalancing of hedge relationship” requires update to documentation The replacement or rollover of a hedge instrument is not an expiration (dedesignation) if contemplated in documentation
  32. 32. Corporate Status
  33. 33. Status on adoption for US companies Source: PricewaterhouseCoopers
  34. 34. Status on adoption for US companies Source: PricewaterhouseCoopers
  35. 35. Resources
  36. 36. ASC Update Reference Paragraphs <ul><li>ASC- Proposed Update Derivative & Hedging Guidance buried throughout the standard: </li></ul><ul><li>Questions from FASB on hedging </li></ul><ul><ul><li>Questions 56-58 and 61-64 </li></ul></ul><ul><li>Proposed guidance: 110-128 </li></ul><ul><li>Implementation guide: IG172-180 </li></ul><ul><li>Background/conclusions: BC216-235 </li></ul><ul><li>http:// www.fasb.org/cs/ContentServer?c = Document_C&pagename =FASB%2FDocument_C%2FDocumentPage&cid=1176156904144 </li></ul>
  37. 37. IASB Exposure Draft <ul><li>FASB Invitation to Comment: </li></ul><ul><li>Background </li></ul><ul><li>Questions (from FASB) for Respondents </li></ul><ul><li>High Level Comparison </li></ul><ul><li>Copy of entire IASB Exposure Draft </li></ul><ul><li>http:// www.fasb.org/cs/ContentServer?site = FASB&c = Document_C&pagename =FASB%2FDocument_C%2FDocumentPage&cid=1176158233827 </li></ul><ul><li>IASB Exposure draft direct: </li></ul><ul><li> Guidance, Basis for Conclusions, Illustrations </li></ul><ul><li>http://www.ifrs.org/Current+Projects/IASB+Projects/Financial+Instruments+A+Replacement+of+IAS+39+Financial+Instruments+Recognitio/Phase+III+-+Hedge+accounting/edcl/ed.htm </li></ul>
  38. 38. Additional resources <ul><li>IASB ( www.iasb.org ) </li></ul><ul><li>FASB ( www.fasb.org ) </li></ul><ul><li>AICPA IFRS resources site ( www.ifrs.com ) </li></ul><ul><li>Securities and Exchange Commission ( www.sec.gov ) </li></ul><ul><ul><li>SEC Roadmap to IFRS ( www.sec.gov/spotlight/ifrsroadmap.htm ) </li></ul></ul><ul><li>Deloitte ( http:// www.iasplus.com ) </li></ul><ul><li>PricewaterhouseCoopers </li></ul><ul><li>( http://www.pwc.com/gx/en/ifrs-reporting/index.jhtml ) </li></ul><ul><li>EY ( http:// www.ey.com /IFRS ) </li></ul><ul><li>KPMG ( http://www.kpmginstitutes.com/ifrs-institute/index.aspx ) </li></ul>
  39. 39. Answers [email_address]

×