Financial Accounting Standards Board

1
Financial Accounting Standards Board

• National Association of Regulatory Utility
  Commissioners
• FASB Update
• October 13, 2008
• Robert C. Wilkins
• Senior Project Manager
• rcwilkins_at_fasb.org 203-956-5236

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Disclaimer

• The views expressed in this presentation are my
  own and do not represent positions of the
  Financial Accounting Standards Board.
• Official positions of the FASB Board are arrived
  at only after extensive due process and
  deliberations.

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FASB Overview

• Originated in 1973
• Recognized by the SEC under Section 108 of the
  Sarbanes-Oxley Act of 2002
• Designated Private-Sector Standard Setter
• Recognized under Section 203 of the AICPAs Code
  of Professional Conduct
• Standard-setter, not a regulator
• No enforcement authority

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Changes to FASB Oversight, Structure and
Operations

• Reduce the size of the Board from seven members
  to five members, effective 7/1/2008
• Composition to be one at-large member and four
  others having experience as a preparer of
  financial statements, an auditor, an academic,
  and a financial analyst/investor, respectively
• Retain the simple majority voting retirement
• Adopted a leadership agenda process
• The Boards technical agenda is established
  solely by the FASB Chairman, following
  consultation with the other Board members

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Our Mission

• To establish and improve standards of financial
  accounting and reporting
• Accounting standards are essential to the
  efficient functioning of the economy
• Good financial reporting reduces the uncertainty
  premium charged by investors and lenders.

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Our Strategic Objectives

• Improvement in U.S. financial reporting
• Simplification of U.S. accounting standards and
  the standard-setting process
• Convergence of financial reporting standards
  internationally

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Information on Website www.fasb.org

• FASB Standards, Concepts, and Interpretations,
  and Staff Positions (FSPs)
• Audio Webcast of Board Meetings
• Semi-Annual Detailed Technical Plan
  April/October
• Separate Summary Page for Each Project
• EITF Material

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(No Transcript)
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Communication Improvements

• Weekly e-mail for Action Alert for free
• under Action Alert at left side of home page
• Major codification of all authoritative GAAP has
  been developed.
• A verification draft was issued in January 2008
  for feedback during a one-year period
• Ultimately, the codification will become the
  single authoritative source of U.S. GAAP,
  superseding all existing standards

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Organization of Topics

• Hedging Related Documents
• FAS 161, Disclosures about Derivative Instruments
  and Hedging Activities
• FSP on Disclosures about Credit Derivatives and
  Certain Guarantees
• Exposure Draft, Accounting for Hedging Activities
• Emission Allowances Inventory Valuation
• Determining Fair Value without an Active Market
• Disclosure of Certain Loss Contingencies

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Financial Accounting Standards Board

• FASB Statement No. 161,
• Disclosures about Derivative Instruments and
  Hedging Activities

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Derivatives Disclosures

• Background
• Statement 133 has been criticized by constituents
  for lacking transparent disclosures, including
  criticism in
• November 2004 Fitch Ratings Report
• Berkshire Hathaways 2002 Annual Report
• Numerous published articles
• Project added to the Boards technical agenda on
  March 9, 2005 and an Exposure Draft was issued on
  December 8, 2006

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Derivatives Disclosures

• Objective to provide an enhanced understanding
  of
• How and why an entity uses derivatives
• How derivatives and related hedged items are
  accounted for under Statement 133 and its related
  interpretations, and
• How derivatives affect an entitys financial
  position, results of operations, and cash flows.

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Derivatives Disclosures

• Scope
• Statement 161s scope is limited to all
  derivatives and all related hedged items
  accounted for under Statement 133.
• The Board decided not to add a fourth objective
  to require information about an entitys risk
  exposures and strategy for mitigating those risks
• The Board decided not to expand the scope to
  include all financial instruments.

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Derivatives Disclosures

• Tabular Disclosures
• Statement 161 requires 2 tables
• Those 2 tables focus on (1) where in balance
  sheet derivatives are located and what is the
  fair value (balance sheet table) and (2) where in
  income statement change in fair value is located
  and what is the change in fair value (income
  statement table)
• Information on hedged items is required but does
  not have to be part of the tabular format

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Derivatives Disclosures

• Other Required Disclosures
• Statement 161 requires disclosure of the
  existence and nature of credit-risk-related
  contingent features embedded in derivative
  instruments. Disclosure must include
• The aggregate fair value of derivative
  instruments that contain those features
• The aggregate fair value of assets posted as
  collateral, the aggregate fair value of
  additional assets that would be required to be
  posted as collateral and/or needed to settle the
  instrument if the contingent features were
  triggered

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Derivatives Disclosures

• Other Required Disclosures
• The Statement requires entities to qualitatively
  discuss, by underlying risk, its objectives for
  holding or issuing derivative instruments
• The Statement requires entities to provide
  information that would enable users to understand
  its volume of derivative activity

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Derivatives Disclosures

• Effective Date
• The effective date for the final Statement is for
  financial statements issued for fiscal years and
  interim periods beginning after November 15, 2008
  
• In the first fiscal year this Statement is
  applied, information related to interim periods
  that began on or prior to November 15, 2008 may
  be omitted. Periods covered must be identified.
• For example, March 31 fiscal year entity must
  provide disclosures for its 4th Qtr interim
  period ending 3/31/09 in its 2009 annual
  financial statements

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Financial Accounting Standards Board

• FASB FSP No. FAS 133-1 and FIN 45-4,
• Disclosures about Credit Derivatives and Certain
  Guarantees

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Disclosures about Credit Derivatives

• Background
• There is a current focus on credit default swaps
  (CDS) given turmoil in credit markets
• 62 trillion estimated notional amount of
  outstanding CDS
• On actively traded names CDS volume is
  substantially greater than outstanding debt
  making it difficult to settle contracts
• When Delphi defaulted - 28 billion outstanding
  CDS against 5.2 billion of bonds

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Disclosures about Credit Derivatives

• Objectives
• Improve disclosures about credit derivatives and
  guarantees to help users better understand their
  impact on an entitys financial position,
  financial performance, and cash flows
• Close the gap in GAAP
• Align recognition/measurement and disclosures in
  same standards

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Disclosures about Credit Derivatives

• Gap in GAAP
• FIN 45 requires disclosures by guarantors for
  guarantees within its scope, which includes some,
  but not all, credit derivatives
• FAS133 CDS for which the party purchasing the
  protection owns the referenced obligation are
  within the scope of FIN 45s disclosure
  requirements
• FAS133 CDS for which the party purchasing the
  protection does not own the referenced obligation
  are not within the scope of FIN 45s disclosure
  requirements
• Project would amend FAS133 and FIN 45 to result
  in the disclosure requirements for all FAS133
  credit derivatives being included in FAS133

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Disclosures about Credit Derivatives

• Scope
• Credit derivatives within Statement 133
• Hybrid instruments that have embedded credit
  derivatives
• Credit derivative is a derivative in which one or
  more of its underlyings (1) is related to the
  credit risk of a specified entity (or a group of
  entities) or an index on a group of entities (2)
  exposes the seller to potential loss from credit
  risk-related events specified in the contract
• Derivatives such as CDS and credit spread options
  included
• Derivatives such as plain vanilla interest rate
  swap not included
• Guarantees within FIN 45

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Disclosures about Credit Derivatives

• Disclosures Required for Sellers of Credit
  Derivatives
• The nature of the credit derivative, including
  the approximate term of the credit derivative,
  the events or circumstances that would require
  the seller to perform under the credit
  derivative, and the current status of the credit
  derivative (for example, the current credit risk
  of the referenced obligation).
• The maximum potential amount of future payments
  (undiscounted) the seller could be required to
  make under the credit derivative.
• That maximum potential amount of future payments
  shall not be reduced by the effect of any amounts
  that may possibly be recovered under recourse or
  collateralization provisions in the credit
  derivative (which are addressed below). If the
  terms of the credit derivative provide for no
  limitation to the maximum potential future
  payments under the credit derivative, that fact
  shall be disclosed. If the seller is unable to
  develop an estimate of the maximum potential
  amount of future payments under the credit
  derivative, the seller shall disclose the reasons
  why it cannot estimate the maximum potential
  amount.

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Disclosures about Credit Derivatives

• Disclosures Required for Sellers of Credit
  Derivatives
• The fair value of the credit derivative.
• The nature of (1) any recourse provisions that
  would enable the seller to recover from third
  parties any of the amounts paid under the credit
  derivative and (2) any assets held either as
  collateral or by third parties that, upon the
  occurrence of any specified pre-agreed event or
  condition under the credit derivative, the seller
  can obtain and liquidate to recover all or a
  portion of the amounts paid under the credit
  derivative.
• The seller shall indicate, if estimable, the
  approximate extent to which the proceeds from
  liquidation of those assets would be expected to
  cover the maximum potential amount of future
  payments under the credit derivative. In its
  estimate of potential recoveries, the seller of
  credit protection should consider the effect of
  any purchased credit protection with an identical
  underlying(s).

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Disclosures about Credit Derivatives

• Timeline
• Exposure Draft of the FSP issued in May 2008 with
  30 day comment period.
• 16 comments letters received
• Redeliberations completed
• Final FSP issued in September 2008
• Effective for reporting periods (annual or
  quarterly interim) ending after November 15,
  2008

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Financial Accounting Standards Board

• Proposed FASB Statement,
• Accounting for Hedging Activities

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Accounting for Hedging Activities

• 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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Accounting for Hedging Activities

• The hedge accounting approach would
• Establish a fair value methodology to hedge
  accounting
• Eliminate bifurcation-by-risk, the shortcut
  method, critical terms match, and the requirement
  to quantitatively assess effectiveness in order
  to qualify for hedge accounting
• Thus, the hedged risk must be the risk of all
  changes in fair value of the hedged item or all
  changes in the hedged cash flows

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Accounting for Hedging Activities Major Changes

• Hedge Effectiveness
• Qualitative instead of Quantitative
• Reasonably effective replaces highly
  effective
• No ongoing effectiveness testing unless
  circumstances suggest no longer reasonably
  effective
• Requiring no effectiveness testing at all was
  considered, but rejected

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Accounting for Hedging Activities Major Changes

• Dedesignation
• Discontinuation of hedge accounting only if
  hedging relationship is terminated
• Discontinuation of hedging relationship by merely
  dedesignating the relationship is not permitted

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Accounting for Hedging Activities Major 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
  hedged risk in a hedge of an entitys own debt at
  inception of the debt

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Accounting for Hedging Activities Major 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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Accounting for Hedging Activities Major 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 transaction
• For 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 instrument
• Permitted 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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Accounting for Hedging Activities Major 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 options cash flows

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Accounting for Hedging Activities Major Changes

• Measuring and Reporting Ineffectiveness in Cash
  Flow Hedges
• Hedging groups of transactions first 100M in
  sales for January
• Compare 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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Accounting for Hedging Activities Major Changes

• Disclosures
• For hedged items in fair value hedges - table
  showing amount reported in balance sheet,
  Statement 133 adjustment, other fair value
  adjustments, and the carrying amount excluding
  those adjustments
• Hedging interest rate risk in issued debt how
  hedging derivative changes maturity and interest
  rate on debt and the overall weighted-average
  interest rate

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Accounting for Hedging Activities

• Analysis of the comment letters received is
  proceeding.
• At the October 21, 2008 joint IASB/FASB meeting,
  the Board will discuss the feedback received on
  this Exposure Draft and the Invitation to
  Comment, Reducing Complexity in Reporting
  Financial Instruments, in preparation for
  decision-making meetings in November.

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Emission Allowances

• Request from constituent to add project to
  address trading emission allowances
• Constituent noted differing views about emission
  allowances being either trading inventory or an
  intangible asset
• Constituent supported reporting emission
  allowances at fair value

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Emission Allowances

• On February 21, 2007, the Board added a project
  to its agenda to provide comprehensive guidance
  for participants in emission trading programs
• Project will provide guidance for emission
  allowances as well as liability recognition and
  measurement as a result of an entity emitting
  pollutants

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Valuation of Commodity Inventory

• On March 14, 2007, the Board added a project to
  its agenda to provide guidance on whether ARB No.
  43 should be amended to require fair value
  accounting (through earnings) for certain
  nonfinancial assets with readily determinable
  fair values that are held in trading inventory,
  possibly including traded emissions allowances

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Valuation of Commodity Inventory

• Proposed FSP ARB 43-a, Amendment of the Inventory
  Provisions of Chapter 4 of ARB No. 43, was
  released for comment on May 1, 2008.
• Comments were due by June 16, 2008 and 34
  letters were received.

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Valuation of Commodity Inventory

• The proposed FSP specifies the accounting for
  inventories (under the scope of ARB 43) included
  in an entitys trading activities.
• Entities should determine trading inventories
  based on their specific facts and circumstances
  and guidance in current GAAP about trading
  activities. Trading is not further defined.
• Inventories included in an entitys trading
  activities shall be initially and subsequently
  measured at fair value through earnings .

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Valuation of Commodity Inventory

• The proposed FSP would not change the accounting
  for nontrading inventories, such as those that
  are held for production, retail, wholesale,
  distribution, or any other nontrading activities.
• It would require disclosures that enable
  financial statement users to understand the
  measurement basis for its trading inventories and
  the effect of inventory transfers from nontrading
  to trading and vice versa, if any, on the
  entitys financial performance.

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Valuation of Commodity Inventory

• The Notice for Recipients for the proposed FSP
  also solicits input from constituents regarding
  other possible scopes
• Commodity inventories that are not used in
  production, wholesale, retail, or distribution
  activities.
• Trading inventories that have readily
  determinable fair values (that is, those whose
  fair value estimates use only Level 1 and Level 2
  inputs under Statement 157)

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Valuation of Commodity Inventory

• Other possible scopes
• All trading items even though those not physical
  inventories (that is, inventories included in an
  entitys trading activities, including trading
  items other than inventories within the scope of
  ARB 43).
• That would also potentially include storage and
  transportation contracts and land included in
  trading activities.
• Issuance of a final Statement is projected for
  the 4th quarter of 2008.

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Emission Allowances

• The emission allowances project is proceeding
  separately from the commodity inventory project.
• Both the IASB and the FASB are pursuing this
  issue as a joint project referred to as Emissions
  Trading Schemes.

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Emission Allowances

• The Emissions Trading Schemes project is
  scheduled for discussion at the joint IASB/FASB
  meeting on October 21, 2008. .
• The two Boards will discuss the accounting issues
  raised by those arrangements in preparation for
  decision-making meetings in November 2008.
• Issuance of an Exposure Draft is projected for
  3rd quarter 2009 with a final Statement expected
  in 2011.

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Determining Fair Value without an Active Market

• On September 30, 2008, 65 members of Congress
  issued a letter to the SEC urging that the use of
  fair market accounting (or mark-to-market) be
  suspended and replaced with a form of mark to
  true value.
• In periods of market turmoil, financial
  institutions are forced to write down the value
  of long-term, non-trading assets below their true
  economic value..
• Mark-to-market exacerbates economic downturns.

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Determining Fair Value without an Active Market

• On that same day, September 30, 2008, the SEC and
  FASB issued a joint press release that provided
  clarifications about the fair value measurement
  guidance in FASB Statement No. 157, Fair Value
  Measurements.
• On October 1, the Board added a project to its
  agenda and discussed how to determine the fair
  value of a financial asset in a market that is
  not active.

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Determining Fair Value without an Active Market

• Proposed FSP FAS 157-d, Determining the Fair
  Value of a Financial Asset in a Market That Is
  Not Active, was issued on 10/03/08.
• Because of the imminence of reporting on periods
  ending on September 30, the Board suspended the
  customary comment period requirements and
  requested that comments be received by October 9.

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Determining Fair Value without an Active Market

• Proposed FSP emphasizes the key principles in
  Statement 157
• A fair value measurement represents the price at
  which a transaction would occur between market
  participants at the measurement date. As
  discussed in paragraph 30 of Statement 157, in
  situations in which there is little, if any,
  market activity for an asset at the measurement
  date, the fair value measurement objective
  remains the same that is, the price that would
  be received by the holder of the financial asset
  in an orderly transaction that is not a forced
  liquidation or distress sale at the measurement
  date.

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Determining Fair Value without an Active Market

• Additional key Statement 157 principles
  emphasized
• In determining fair value for a financial asset,
  the use of management's internal assumptions
  about future cash flows and appropriately
  risk-adjusted discount rates is acceptable when
  relevant observable market data do not exist.
• Regardless of the valuation technique, an entity
  must include appropriate risk adjustments that
  market participants would make for nonperformance
  and liquidity risks.

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Determining Fair Value without an Active Market

• Additional key Statement 157 principles
  emphasized
• Broker quotes may be an input when measuring fair
  value, but they are not necessarily determinative
  if an active market does not exist for the
  financial asset.
• In weighing a broker quote as an input to fair
  value, an entity should place less reliance on
  quotes that do not reflect the result of market
  transactions.

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Determining Fair Value without an Active Market

• Proposed FSP also provides a clarifying example
  on determining the fair value of a financial
  asset in a market that is not active, which would
  be added to Statement 157.
• The Board members have emphasized that the
  guidance in the proposed FSP is a clarification
  of the existing provisions in Statement 157, not
  a revision.

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Determining Fair Value without an Active Market

• Proposed FSP would be effective upon issuance.
• It would also be effective for prior periods for
  which financial statements have not yet been
  issued.

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Determining Fair Value without an Active Market

• Some of the comment letters have supported the
  suspension of fair value accounting.
• One passionate letter (10) begins by stating
  May the souls of all of those who developed FASB
  157 burn in the 7th circle of Dante's hell. It
  concludes You are garbage. The comment letters
  are available on our website.
• The redeliberations occurred last Friday, October
  10.

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Disclosure of Certain Loss Contingencies

• The Exposure Draft, Disclosure of Certain Loss
  Contingencies, was issued on June 5, 2008. The
  comment period ended on August 8, 2008. .
• The proposal would significantly expand and
  improve the qualitative and quantitative
  disclosures about loss contingencies

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Disclosure of Certain Loss Contingencies

• On September 24, 2008, the Board decided on a
  plan for redeliberations of its Exposure Draft,
  Disclosure of Certain Loss Contingencies. The
  Board directed the staff to prepare an
  alternative model that will attempt to address
  the concerns that certain constituents raised
  about the Exposure Draft. This alternative model
  will be field tested along with the model in the
  Exposure Draft.
• The Board also decided that any final Statement
  on this topic will be effective no sooner than
  for fiscal years ending after December 15, 2009.

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Questions?
Fair Value Option
Statement 157
Emission Allowance
IAS 39
Intl Convergence
Statement 140