Impact of Exposure Draft on Derivative Accounting for  Currency Risk Presented by  Helen Kane June 8, 2010
<ul><li>Exposure Draft Status </li></ul><ul><li>What is the Same </li></ul><ul><li>Effectiveness  </li></ul><ul><li>Option...
Codification Revision Status  <ul><li>On May 26th two Exposure Drafts Issued </li></ul><ul><li>Accounting for Financial In...
Outline of Exposure Draft  <ul><li>Summary </li></ul><ul><li>Questions </li></ul><ul><li>For  all respondents </li></ul><u...
Objective of Revision (BC212) <ul><li>Simplify hedge accounting to improve compliance </li></ul><ul><li>Make financial rep...
What Hasn’t Changed (BC213) <ul><li>Types of items and transactions currently eligible for hedge accounting under Topic 81...
What is Different
Effectiveness Testing  (BC 218-220) <ul><li>Old </li></ul><ul><li>Emphasis on Quarterly Testing </li></ul><ul><li>Hedge ac...
Effectiveness Testing  (BC 218-220) <ul><li>Old </li></ul><ul><li>Focus on sophisticated quantitative statistical modeling...
Effectiveness Documentation  (116) <ul><li>Old </li></ul><ul><li>Document effectiveness test so that 3 rd  party can re-pe...
Effectiveness Testing  (BC 218-220) <ul><li>Old </li></ul><ul><li>Matched terms:  FX & Commodity  assumption that hedge is...
Effectiveness Measurement  (BC 224-229) <ul><li>Old </li></ul><ul><li>Over-performance of the derivative only source of in...
Debit/Credit Example <ul><li>DR   Derivative Asset  Pre-Credit Deriv FV </li></ul><ul><li>CR   OCI   Pre-Credit PEHD FV </...
Effectiveness Measurement  (BC 116-118) <ul><li>Old </li></ul><ul><li>Precision in measuring ineffectiveness due to timing...
Option Amortization
G20 Concept Plus…. <ul><li>“Include time value” concept on options remains with variations  </li></ul><ul><li>Update requi...
G20 Updated <ul><li>Our guess on entries assuming $100 premium for 4-month option, PEHD inception $92: </li></ul><ul><ul><...
G20 Updated <ul><ul><li>Month End 1, Option Fair Value = 50, PEHD =55 </li></ul></ul><ul><ul><ul><li>Dr OCI (PEHD change a...
G20 Updated <ul><li>Balances </li></ul><ul><ul><li>Deriv Asset  Dr 49 </li></ul></ul><ul><ul><li>P&L Effective  Dr 23 </li...
De-designation
No Election to Dedesignate <ul><li>Once hedge relationship designated, only terminated if </li></ul><ul><ul><li>Qualifying...
Why No Dedesignation? <ul><li>No longer able to remove the designation </li></ul><ul><ul><li>Board notes “the economics of...
Ineffectiveness Conclusion <ul><li>“The Board believes that ineffectiveness should be recognized in net income if an entit...
Foreign Denominated  Financial Instruments
Financial Instruments Fundamental Change <ul><li>Initial measurement principle </li></ul><ul><ul><li>Financial instruments...
Foreign Denominated Debt (92) <ul><li>Change in non-functional currency denominated debt is composed of two pieces: </li><...
Disclosure
Additional Disclosure Requirements (127) <ul><li>Disclose the following for assets and liabilities reported within a singl...
Reference Paragraphs <ul><li>Derivative & Hedging Guidance buried throughout the standard: </li></ul><ul><li>Questions fro...
<ul><li>Answers </li></ul>Contact: hkane@hedgetrackers.com
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Hedge Trackers reviews how FASB Exposure Draft on Financial Instruments - Derivative Instruments & Hedging Activities - will impact Foreign Currency Hedge Programs

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Hedge Trackers highlights how the new exposure draft, "Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities: Financial Instruments (Topic 825) and Derivatives and Hedging (Topic 815)" will impact your foreign currency hedge program. We are seeing many opportunities to lighten the hedge accounting load, but it doesn’t come without a price. Learn if your program will benefit or lose under the proposed changes. For more information visit www.hedgetrackers.com.

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  • Likely delay in Effective Date (2013 or 2014) Could derivative accounting changes come early?
  • Note the Fannie Mae problem for inconsistency Defacto FV option on tire inventory if no controls
  • Note the Fannie Mae problem for inconsistency Defacto FV option on tire inventory if no controls
  • Note the Fannie Mae problem for inconsistency Defacto FV option on tire inventory if no controls
  • Now like FV and NI hedging (OCI = change in PEHD)(
  • OCI is catch-all for change in PEHD and amortization of Option
  • OCI is catch-all for change in PEHD and amortization of Option
  • OCI is catch-all for change in PEHD and amortization of Option
  • Put in the detail from the theoretical preso and see what slides here can be removed or made as a handout.
  • Added to KC
  • Put in the detail from the theoretical preso and see what slides here can be removed or made as a handout.
  • Hedge Trackers reviews how FASB Exposure Draft on Financial Instruments - Derivative Instruments & Hedging Activities - will impact Foreign Currency Hedge Programs

    1. 1. Impact of Exposure Draft on Derivative Accounting for Currency Risk Presented by Helen Kane June 8, 2010
    2. 2. <ul><li>Exposure Draft Status </li></ul><ul><li>What is the Same </li></ul><ul><li>Effectiveness </li></ul><ul><li>Option “Amortization” </li></ul><ul><li>Dedesignation </li></ul><ul><li>Foreign Denominated Debt </li></ul><ul><li>Disclosure </li></ul>Agenda
    3. 3. Codification Revision Status <ul><li>On May 26th two Exposure Drafts Issued </li></ul><ul><li>Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities (Topics 825 & 815 ) </li></ul><ul><ul><ul><li>Redline version to 815 not available until “late July” </li></ul></ul></ul><ul><ul><ul><li>Comment period ends Sept. 30, 2010 </li></ul></ul></ul><ul><ul><ul><li>Early adoption prohibited </li></ul></ul></ul><ul><ul><li>Other Comprehensive Income </li></ul></ul><ul><li>IASB has been working on similar standards in 3 pieces </li></ul><ul><ul><ul><li>Derivative accounting related standard not yet released </li></ul></ul></ul>
    4. 4. Outline of Exposure Draft <ul><li>Summary </li></ul><ul><li>Questions </li></ul><ul><li>For all respondents </li></ul><ul><li>For users of financial statements </li></ul><ul><li>For preparers and auditors </li></ul><ul><li>Proposed guidance: ¶1-137 </li></ul><ul><li>Proposed implementation guidance ¶ IG1-IG178 </li></ul><ul><li>Background , Basis for Conclusions ¶ BC1-BC252 </li></ul><ul><li>App A: IASB Comparison: ¶ A1 Table </li></ul><ul><li>App B: Methods for Measuring Changes in Credit ¶B1-B20 </li></ul><ul><li>App C: Amendments to Codification ¶C1 Table </li></ul>
    5. 5. Objective of Revision (BC212) <ul><li>Simplify hedge accounting to improve compliance </li></ul><ul><li>Make financial reporting of hedge activities useful and transparent </li></ul><ul><ul><li>Concern that falling in and out of hedge accounting distorts financials </li></ul></ul>
    6. 6. What Hasn’t Changed (BC213) <ul><li>Types of items and transactions currently eligible for hedge accounting under Topic 815 would continue </li></ul><ul><ul><li>Benchmark interest rate </li></ul></ul><ul><ul><li>FX (including interco transactions) </li></ul></ul><ul><ul><li>Credit risk </li></ul></ul><ul><ul><li>Overall </li></ul></ul><ul><li>Cash Flow, Fair Value, Net Investment hedging </li></ul>
    7. 7. What is Different
    8. 8. Effectiveness Testing (BC 218-220) <ul><li>Old </li></ul><ul><li>Emphasis on Quarterly Testing </li></ul><ul><li>Hedge accounting applied inconsistently period to period due to “failures” </li></ul><ul><li>New </li></ul><ul><li>Testing reserved for corner cases, and updated only under unusual circumstances (117) </li></ul><ul><li>Consistent application of special hedge accounting (119) </li></ul>
    9. 9. Effectiveness Testing (BC 218-220) <ul><li>Old </li></ul><ul><li>Focus on sophisticated quantitative statistical modeling and testing </li></ul><ul><li>“ Highly Effective” litmus test (80-125% offset) </li></ul><ul><li>New </li></ul><ul><li>Focus on qualitative support for economic relationship between derivative and hedged item </li></ul><ul><li>Use “Reasonably Effective” ( judgment not numbers BC220) -- holistic consideration of what lead to hedge relationship </li></ul><ul><ul><li>Prevents IR Swap from hedging tire inventory </li></ul></ul>
    10. 10. Effectiveness Documentation (116) <ul><li>Old </li></ul><ul><li>Document effectiveness test so that 3 rd party can re-perform the test and achieve similar results </li></ul><ul><ul><li>Algorithms </li></ul></ul><ul><ul><li>Data points </li></ul></ul><ul><ul><li>Data sources </li></ul></ul><ul><li>Partial compensation in derivative could trigger de/redesignation </li></ul><ul><li>New </li></ul><ul><li>Document sources of volatility in the cash flows of the forecasted transaction(116) </li></ul><ul><li>Document factors supporting conclusion of reasonably effective over the life of hedging relationship </li></ul><ul><li>Modification of derivative requires “update” in documentation of continuing relationship </li></ul>
    11. 11. Effectiveness Testing (BC 218-220) <ul><li>Old </li></ul><ul><li>Matched terms: FX & Commodity assumption that hedge is perfectly effective </li></ul><ul><li>Short-cut: IR assumption that hedge is perfectly effective </li></ul><ul><li>New </li></ul><ul><li>No longer have ability to assume hedge relationship is completely effective and recognize no ineffectiveness in net income during term of the hedge (114) </li></ul>
    12. 12. Effectiveness Measurement (BC 224-229) <ul><li>Old </li></ul><ul><li>Over-performance of the derivative only source of ineffectiveness in cash flow hedges </li></ul><ul><li>Inconsistent practice on credit effect on derivative & hedged item </li></ul><ul><li>New </li></ul><ul><li>Cash Flow Hedge over and underperformance of derivative impacts earnings (123) </li></ul><ul><ul><li>Hedged item recorded in income at Hypo rate </li></ul></ul><ul><li>Entity shall not ignore credit on derivative instrument fair value (114) </li></ul><ul><ul><li>Impact hedged item with derivative credit </li></ul></ul>
    13. 13. Debit/Credit Example <ul><li>DR Derivative Asset Pre-Credit Deriv FV </li></ul><ul><li>CR OCI Pre-Credit PEHD FV </li></ul><ul><li>DR/CR P&L per Docs Delta </li></ul><ul><li>DR OCI Deriv Credit Adj. </li></ul><ul><li>CR Derivative Asset Deriv Credit Adj. </li></ul>
    14. 14. Effectiveness Measurement (BC 116-118) <ul><li>Old </li></ul><ul><li>Precision in measuring ineffectiveness due to timing “not material” </li></ul><ul><li>Di minimis testing </li></ul><ul><li>New </li></ul><ul><li>An entity shall not assume there will never be any ineffectiveness (115) </li></ul><ul><li>When hedging group of transactions in specified period, can use single PEHD that settles within reasonable time (118) </li></ul><ul><ul><li>Qualify when forward points difference on dates in period are minimal </li></ul></ul><ul><ul><li>Avoid perfection </li></ul></ul>
    15. 15. Option Amortization
    16. 16. G20 Concept Plus…. <ul><li>“Include time value” concept on options remains with variations </li></ul><ul><li>Update requires effective option premium expense to be amortized to income in “rational way” </li></ul>
    17. 17. G20 Updated <ul><li>Our guess on entries assuming $100 premium for 4-month option, PEHD inception $92: </li></ul><ul><ul><li>Day 1 </li></ul></ul><ul><ul><ul><li>Dr Deriv Asset 100 </li></ul></ul></ul><ul><ul><ul><li>Cr Cash 100 </li></ul></ul></ul>
    18. 18. G20 Updated <ul><ul><li>Month End 1, Option Fair Value = 50, PEHD =55 </li></ul></ul><ul><ul><ul><li>Dr OCI (PEHD change assumption) 37 </li></ul></ul></ul><ul><ul><ul><li>Cr Deriv Asset (adjust to FV) 50 </li></ul></ul></ul><ul><ul><ul><li>Dr Ineffectiveness 13 </li></ul></ul></ul><ul><ul><ul><li>Dr Effective P&L Acct 23 </li></ul></ul></ul><ul><ul><ul><li>Cr OCI (PEHD premium/ # months) 23 </li></ul></ul></ul><ul><ul><ul><li>Dr OCI (credit adj) 1 </li></ul></ul></ul><ul><ul><ul><li>Cr Deriv Asset 1 </li></ul></ul></ul>
    19. 19. G20 Updated <ul><li>Balances </li></ul><ul><ul><li>Deriv Asset Dr 49 </li></ul></ul><ul><ul><li>P&L Effective Dr 23 </li></ul></ul><ul><ul><li>P&L Ineffective Dr 13 </li></ul></ul><ul><ul><li>OCI Dr 15 </li></ul></ul><ul><ul><li>Cash Cr 100 </li></ul></ul>
    20. 20. De-designation
    21. 21. No Election to Dedesignate <ul><li>Once hedge relationship designated, only terminated if </li></ul><ul><ul><li>Qualifying criteria for designation no longer met </li></ul></ul><ul><ul><ul><li>Relationship no longer expected to be reasonably effective </li></ul></ul></ul><ul><ul><ul><li>Probable not to occur, no longer firm commitment </li></ul></ul></ul><ul><ul><li>Hedging instrument expires, sold, terminated or exercised </li></ul></ul><ul><ul><ul><li>Compensating trade must documented at execution </li></ul></ul></ul>
    22. 22. Why No Dedesignation? <ul><li>No longer able to remove the designation </li></ul><ul><ul><li>Board notes “the economics of the relationship between the instrument and the hedged item have not changed” </li></ul></ul><ul><ul><li>Ergo, “the accounting should not change” </li></ul></ul><ul><li>Need to validate that as FX exposures go from anticipated to realized that “qualifying criteria are no longer met” </li></ul><ul><li>Quarterly redesignation net investment??? </li></ul>
    23. 23. Ineffectiveness Conclusion <ul><li>“The Board believes that ineffectiveness should be recognized in net income if an entity enters into a derivative that would not mature on the date of the forecasted transaction and provide cash flows that would exactly offset the hedged cash flows.” (BC228) </li></ul>
    24. 24. Foreign Denominated Financial Instruments
    25. 25. Financial Instruments Fundamental Change <ul><li>Initial measurement principle </li></ul><ul><ul><li>Financial instruments (financial assets and liabilities) will be measured at inception at fair value (12) </li></ul></ul><ul><li>Subsequent measurement principle </li></ul><ul><ul><li>Financial assets and liabilities will be measured at fair value each reporting date unless qualifying for scope exception </li></ul></ul><ul><ul><li>Changes in value will be recorded in Net Income or for some debt instruments to Other Comprehensive Income (19-24) </li></ul></ul>
    26. 26. Foreign Denominated Debt (92) <ul><li>Change in non-functional currency denominated debt is composed of two pieces: </li></ul><ul><ul><li>Change in price in the currency denominated </li></ul></ul><ul><ul><li>Change in exchange rates between currency of denomination and functional currency </li></ul></ul><ul><li>Both changes in fair value of qualifying* debt will be recognized as a single number in OCI (92) </li></ul><ul><li>Amends Topic 830 </li></ul><ul><li>*for qualifying debt instruments (21-24) </li></ul>
    27. 27. Disclosure
    28. 28. Additional Disclosure Requirements (127) <ul><li>Disclose the following for assets and liabilities reported within a single line item in BS: </li></ul><ul><li>Carrying amount of assets or liabilities included in line item </li></ul><ul><li>Cumulative Fair Value Hedge Adjustment </li></ul><ul><li>Fair Value changes other than from Hedge accounting </li></ul><ul><li>Carrying amount </li></ul>
    29. 29. Reference Paragraphs <ul><li>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>
    30. 30. <ul><li>Answers </li></ul>Contact: hkane@hedgetrackers.com

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