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Financial Accounting Standards Board

Hedging Project

IASB Education Session

June 18, 2008

Kevin Stoklosa

IASB MEETING JUNE 2008 OBSERVER NOTE 5

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Hedging Project

• Project Objectives– Simplify accounting for hedging activities– Improve the financial reporting of hedging

activities to make the accounting model and the associated disclosures easier to understand for financial statement users

– Resolve hedge accounting practice issues that have arisen under Statement No. 133

– Address differences in the accounting for derivative instruments and hedged items or transactions

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Hedging Project

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

• The items and transactions currently eligible for hedge accounting would continue to be eligible under this approach.

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Hedging ProjectMajor Changes

• Hedge Effectiveness–Qualitative instead of Quantitative

–Reasonably effective

–No ongoing effectiveness testing unless circumstances suggest no longer reasonably effective

–No effectiveness testing at all was considered

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Hedging ProjectMajor Changes

• Dedesignation–Discontinuation of hedge accounting only if

hedging relationship is terminated

–Discontinuation of hedging relationship by merely dedesignating is not permitted

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Hedging ProjectMajor Changes

• Hedged Risk– General model is that the designated hedged risk

must be all changes in fair value or variability in cash flows (bifurcation-by-risk not permitted)

– Two exceptions:Foreign exchange rate risk can be designated as the

hedged risk

Interest rate risk can be designated as the headed risk in a hedge of an entity’s own debt at inception of the debt

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Hedging ProjectMajor Changes

• Measurement of Hedged Item in Fair Value Hedges– Hedged item and derivative hedging instrument

must be independently measured for changes in fair value Not permitted to take the change in fair value of the

derivative, change the sign and apply it to the hedged item

– All of contractual cash flows of the entire hedged item must be included in calculating the fair value

– Adjust the carrying value of hedged item for changes in fair value during the hedge period

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Hedging ProjectMajor Changes

• Measuring and Reporting Ineffectiveness in Cash Flow Hedges– Compare change in fair value of the actual derivative and the

present value of the cumulative change in expected future cash flows on the hedged transactionFor example, an entity could compare the change in fair value of

the actual derivative with the change in fair value of a derivative that would mature on the date of the forecasted transaction, be priced at market, and provide cash flows that would exactly offset the hedged cash flows

– The difference would be reported in earnings as ineffectiveness

– Nonperformance risk must be considered when calculating the fair value of the derivative hedging instrumentPermitted to use the same credit adjustment in the derivative that

would exactly offset the hedged cash flows as used in the actual derivative

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Hedging ProjectMajor Changes

• Measuring and Reporting Ineffectiveness in Cash Flow Hedges– Hedging with purchased options

When a purchased option contract is used as the hedging instrument to provide only one-sided protection, a purchased option derivative that would mature on the date of the forecasted transaction and provide cash flows that would exactly offset the one-sided change in the hedged cash flows could be used for calculating ineffectiveness.

Ineffectiveness can be measured using all changes in the option’s cash flows

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Hedging ProjectMajor Changes

• Measuring and Reporting Ineffectiveness in Cash Flow Hedges– Hedging groups of transactions – first 100M in

sales for JanuaryCompare actual derivative to derivative that settles within

a reasonable period of time of cash flows on forecasted transactions

Reasonable if the difference in forward rates between that derivative and derivative(s) that would exactly offset cash flows is minimal

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Hedging ProjectMajor Changes

• Disclosures–For hedged items in fair value hedges -

table showing amount reported in balance sheet, Statement 133 adjustment, Other fair value adjustments, amount excluding those adjustments

–Hedging interest rate risk in issued debt – how hedging derivative(s) changes maturity and interest rate on debt