Hedging Overview

1
www.trinity.edu/rjensen/acct5341/speakers/133glosf
.htmDisclosure
Disclosure And Documentation Issues
"New SEC Guidance for Management's Discussion and
Analysis" http//www.sec.gov/rules
/interp/33-8350.htm
2
IAS 39 Versus FAS 133 www.trinity.edu/rjensen/acct
5341/speakers/133glosf.htmDisclosure
Under IASB international disclosure rulings,
financial statements should include all of the
disclosures required by IAS 32, except that the
requirements in IAS 32 for supplementary
disclosure of fair values (IAS 39 Paragraphs 77
and 88) are not applicable to those financial
assets and financial liabilities carried at fair
value (Paragraph 166).  The following should be
included in the disclosures of the enterprise's
accounting policies as part of the disclosure
required by IAS 32 Paragraph 47b
3
IAS 39 Versus FAS 133 www.trinity.edu/rjensen/acct
5341/speakers/133glosf.htmDisclosure
(1) the methods and significant assumptions
applied in estimating fair values of financial
assets and financial liabilities that are carried
at fair value, separately for significant classes
of financial assets (see IAS 39 Paragraph
46)2) whether gains and losses arising from
changes in the fair value of those
available-for-sale financial assets that are
measured at fair value subsequent to initial
recognition are included in net profit or loss
for the period or are recognized directly in
equity until the financial asset is disposed of
and3) for each of the four categories of
financial assets defined in paragraph 10, whether
'regular way' purchases of financial assets are
accounted for at trade date or settlement date
(see paragraph 30)
4
IAS 39 Versus FAS 133 www.trinity.edu/rjensen/acct
5341/speakers/133glosf.htmDisclosure
IAS 39 Paragraph 169 With the exception of the
previously noted differences, Paragraph 169 is a
long paragraph that requires virtually all
disclosures of FAS 133.
5
FAS 133 DISCLOSURE REQUIREMENTS

• Required disclosures can be divided into four
  types
• qualitative disclosures
• quantitative disclosures
• disclosures relating to OCI and AOCI
• U.S. SEC Risk Disclosure Requirements

6
DISCLOSURE REQUIREMENTS (cont.)

• The Standard requires general derivative
  disclosures and specific hedge disclosures for
  cash flow hedges, fair value hedges and hedges of
  a net investment in a foreign operation

7
DISCLOSURE REQUIREMENTS (cont.)

• The Standard requires general derivative
  disclosures and specific hedge disclosures for
  cash flow hedges, fair value hedges and hedges of
  a net investment in a foreign operation

8
FAS 161 Summaryhttp//www.cs.trinity.edu/rjensen
/Calgary/CD/fasb/sfas161/

• Why Is the FASB Issuing This Statement and When
  Is It Effective?
• The use and complexity of derivative
  instruments and hedging activities have increased
  significantly over the past several years.
  Constituents have expressed concerns that the
  existing disclosure requirements in FASB
  Statement No. 133, Accounting for Derivative
  Instruments and Hedging Activities, do not
  provide adequate information about how derivative
  and hedging activities affect an entitys
  financial position, financial performance, and
  cash flows. Accordingly, this Statement requires
  enhanced disclosures about an entitys derivative
  and hedging activities and thereby improves the
  transparency of financial reporting. This
  Statement is effective for financial statements
  issued for fiscal years and interim periods
  beginning after November 15, 2008, with early
  application encouraged. This Statement
  encourages, but does not require, comparative
  disclosures for earlier periods at initial
  adoption.

9
FAS 161 Summaryhttp//www.cs.trinity.edu/rjensen
/Calgary/CD/fasb/sfas161/

• How Does This Statement Improve Financial
  Reporting?
• This Statement is intended to enhance the
  current disclosure framework in Statement 133.
  The Statement requires that objectives for using
  derivative instruments be disclosed in terms of
  underlying risk and accounting designation. This
  disclosure better conveys the purpose of
  derivative use in terms of the risks that the
  entity is intending to manage. Disclosing the
  fair values of derivative instruments and their
  gains and losses in a tabular format should
  provide a more complete picture of the location
  in an entitys financial statements of both the
  derivative positions existing at period end and
  the effect of using derivatives during the
  reporting period. Disclosing information about
  credit-risk-related contingent features should
  provide information on the potential effect on an
  entitys liquidity from using derivatives.
  Finally, this Statement requires
  cross-referencing within the footnotes, which
  should help users of financial statements locate
  important information about derivative
  instruments.

10
FAS 161 Summaryhttp//www.cs.trinity.edu/rjensen
/Calgary/CD/fasb/sfas161/

• What Is the Effect of This Statement on
  Convergence with International Financial
  Reporting Standards?
• In August 2005, the International Accounting
  Standards Board issued International Financial
  Reporting Standard (IFRS) 7, Financial
  Instruments Disclosures. The scope of IFRS 7
  includes all financial instruments, not just
  derivative instruments. The FASB decided to limit
  the scope of its disclosure project to derivative
  instruments because of its desire to not delay
  the improved transparency about the location and
  amounts of derivative instruments in an entitys
  financial statements. The FASB may consider a
  longer term project to improve disclosures about
  all financial instruments and to achieve greater
  convergence with IFRS 7 in the future.

11
DISCLOSURE REQUIREMENTS (cont.)

• Disclosures are different from prior requirements
• Systems may require enhancements to accumulate
  new information required to be disclosed
• Additional qualitative disclosures are encouraged

12
DISCLOSURE REQUIREMENTS 44-55QUALITATIVE
DISCLOSURES

• For all derivative instruments the entity shall
  disclose
• Objectives for holding derivatives
• Context needed to understand those objectives
• Entitys risk management policy
• Description of the items or transactions that are
  being hedged

13
QUANTITATIVE DISCLOSURE

• Fair Value Hedges
• Cash Flow Hedges
• Hedges of a net investment in a foreign operation

14
QUANTITATIVE DISCLOSURE REQUIREMENTSFOR FAIR
VALUE HEDGES 45(a)

• Net gain or loss recognized in earnings during
  the reporting period from hedge ineffectiveness
• Component of the derivatives gain or loss
  excluded from the assessment of hedge
  effectiveness

15
QUANTITATIVE DISCLOSURE REQUIREMENTSFOR FAIR
VALUE HEDGES 45(a)

• Where the net gain or loss is reported
• The amount of net gain or loss recognized in
  earnings when a hedged firm commitment no longer
  qualifies as a fair value hedge

16
QUANTITATIVE DISCLOSURE REQUIREMENTS - CASH FLOW
HEDGES 45(b)

• Net gain or loss recognized in earnings during
  the reporting period from hedge ineffectiveness
• Component of the derivatives gain or loss
  excluded from the assessment of hedge
  effectiveness
• Where the net gain or loss is reported

17
QUANTITATIVE DISCLOSURE REQUIREMENTS - CASH FLOW
HEDGES 45(b) (cont.)

• Description of transactions or other events that
  will result in reclassification of gains and
  losses reported in accumulated OCI into earnings
  and net amount expected within next 12 months
• Maximum length of time entity is hedging the
  variability in cash flows of a forecasted
  transaction

18
QUANTITATIVE DISCLOSURE REQUIREMENTS - CASH FLOW
HEDGES 45(b) (cont.)

• Gains and losses reclassified into earnings from
  discontinuance of cash flow hedges because it is
  probable that the forecasted transaction will not
  occur

19
QUANTITATIVE DISCLOSURE REQUIREMENTSHEDGES OF A
NET INVESTMENT

• For a hedge of a net investment in a foreign
  operation, entities must disclose the net amount
  of gains or losses included in the cumulative
  translation adjustment during the reporting
  period

20
DISCLOSURES RELATED TO OCI AND AOCI

• Required to display as a separate classification
  within Other Comprehensive Income the net gain or
  loss on derivative instruments designated and
  qualifying as cash flow hedging instruments
• As part of disclosures of AOCI, separately
  disclose the beginning and ending accumulated
  derivative gain or loss, the related net change,
  and the net amount of reclassification into
  earnings.

21
TYPICAL INTEREST RATE EXPOSURES

• Variable rate debt
• Fixed rate debt
• Prospective asset/liability purchases or sales
• Interest associated with funding/investing in a
  non-functional currency

22
TYPICAL CURRENCY EXPOSURES

• Prospective currency transactions
• Firm commitments
• Currency components of prospective cashflows
• Assets or liabilities denominated in a
  non-functional currency
• Non-functional currency funding/investing

23
NON-FUNCTIONAL CURRENCY

• Borrow fixed non- / swap to fixed
• Borrow floating non- / swap to fixed
• Borrow fixed non- /swap to floating
• Borrow floating non- /swap to floating

24
TYPICAL COMMODITY EXPOSURES

• Prospective purchase / sale
• Inventory price risk
• Firm commitment

25
FAS 107 Disclosures

• Requires fair value disclosures for all financial
  instruments (both on and off balance sheet) for
  which it is practicable to estimate that value.
• What is Fair Value?
• Focuses on market price of a single unit times
  the number of units
• Use single unit price even if an order to sell
  entire holding would move the market.
• Amount at which the instrument could be exchanged
  in a current transaction between willing parties,
  but not in a forced liquidation

26
FAS 107 Disclosures

• Disclose methods and significant assumptions used
  to make estimates
• Excludes core deposit intangibles
• A/R and A/P excluded if fair value approximates
  carrying amount
• If not practicable to estimate, disclose
• information pertinent to estimating the fair
  value such as effective interest rate, carrying
  amount, and maturity
• reasons why not practicable

27
Fair Value Hierarchy
Quoted Market Prices
Estimates based on MVs of similar items
Reliability
Estimates based on PV of cash flows
28
FAS 157

• Definitional Standard for Fair Value
• Deleted Controversial Option to Extend Fair Value
  Accounting to Virtually All Financial
  Instruments
• Jensen Working Paper on Fair Value
  Controversieshttp//www.trinity.edu/rjensen/FairV
  alueDraft.htm

29
REPORTING TO SENIOR MANAGEMENTKeys to Success

• Draft a risk management policy document that
  identifies exposures to hedge
• Require traders to be explicit about choice of
  hedge strategy and tactics
• Demand documentation as to rationale for
  adjusting strategies and tactics
• Implement a control function that measures hedge
  performance against expected results.

30
SEC REG. S-X S-K Risk Disclosrueshttp//www.tri
nity.edu/rjensen/acct5341/speakers/133glosf.htmDi
sclosure

• a tabular format --- a presentation of the terms,
  fair value, expected principal or transaction
  cash flows, and other information, with
  instruments grouped within risk exposure
  categories based on common characteristics
• a sensitivity analysis --- the hypothetical loss
  in earnings, fair values, or cash (the minumum
  percentage change seems to be 10 in Item 3.A of
  the Instructions to Paragraphs 305a and 305b.)
• flows resulting from hypothetical changes in
  rates or prices
• value-at-risk --- a measure of the potential loss
  in earnings, fair values, or cash
• flows from changes in rates or prices.

31
IFRS 7 Summary http//www.iasplus.com/standard/if
rs07.htm

• Adds certain new disclosures about financial
  instruments to those currently required by IAS
  32
• Replaces the disclosures now required by IAS 30
  and
• Puts all of those financial instruments
  disclosures together in a new standard on
  Financial Instruments Disclosures. The remaining
  parts of IAS 32 deal only with financial
  instruments presentation matters.

32
IFRS 7 Disclosure Requirements http//www.iasplus
.com/standard/ifrs07.htm

• An entity must group its financial instruments
  into classes of similar instruments and, when
  disclosures are required, make disclosures by
  class. IFRS 7.6  
• The two main categories of disclosures required
  by IFRS 7 are1. Information about the
  significance of financial instruments.2.
  Information about the nature and extent of risks
  arising from financial insturments.  Information
  about the significance of financial instruments

33
IFRS 7 Balance Sheet http//www.iasplus.com/stand
ard/ifrs07.htm

• Disclosure of the significance of financial
  instruments for an entity's financial position
  and performance. IFRS 7.7 This includes
  disclosures for each of the following categories
  IFRS 7.8  
• Financial assets measured at fair value through
  profit and loss, showing separately those held
  for trading and those designated at initial
  recognition.
• Held-to-maturity investments.
• Loans and receivables.
• Available-for-sale assets.
• Financial liabilities at fair value through
  profit and loss, showing separately those held
  for trading and those designated at initial
  recognition.
• Financial liabilities measured at amortised cost.
  
•  

34
IFRS 7 Balance Sheet http//www.iasplus.com/stand
ard/ifrs07.htm

• Special disclosures about financial assets and
  financial liabilities designated to be measured
  at fair value through profit and loss, including
  disclosures about credit risk and market risk and
  changes in fair values IFRS 7.9-10
• Reclassifications of financial instruments from
  fair value to amortised cost or vice versa IFRS
  7.12
• Disclosures about derecognitions, including
  transfers of financial assets for which
  derecogntion accounting is not permitted by IAS
  39 IFRS 7.13
• Information about financial assets pledged as
  collateral and about financial or non-financial
  assets held as collatersl IFRS 7.14-15
• Reconciliation of the allowance account for
  credit losses (bad debts). IFRS 7.16
• Information about compound financial instruments
  with multiple embedded derivatives. IFRS 7.17
• Breaches of terms of loan agreements. IFRS
  7.18-19

35
IFRS 7 Income Statement http//www.iasplus.com/st
andard/ifrs07.htm

• Items of income, expense, gains, and losses, with
  separate disclosure of gains and losses from
  IFRS 7.20(a)  
• Financial assets measured at fair value through
  profit and loss, showing separately those held
  for trading and those designated at initial
  recognition.
• Held-to-maturity investments.
• Loans and receivables.
• Available-for-sale assets.
• Financial liabilities measured at fair value
  through profit and loss, showing separately those
  held for trading and those designated at initial
  recognition.
• Financial liabilities measured at amortised cost.
  

36
IFRS 7 Income Statement http//www.iasplus.com/st
andard/ifrs07.htm

• Interest income and interest expense for those
  financial instruments that are not measured at
  fair value through profit and loss IFRS 7.20(b)
  
• Fee income and expense IFRS 7.20(c)
• Amount of impairment losses on financial assets
  IFRS 7.20(d)
• Interest income on impaired financial assets
  IFRS 7.20(e)

37
IFRS 7 Other Disclosureshttp//www.iasplus.com/s
tandard/ifrs07.htm

•  
• Accounting policies for financial instruments
  IFRS 7.21
• Information about hedge accounting, including
  IFRS 7.22  
• Description of each hedge, hedging instrument,
  and fair values of those instruments, and nature
  of risks being hedged.
• for cash flow hedges, the periods in which the
  cash flows are expected to occur, when they are
  expected to enter into the determination of
  profit or loss, and a description of any forecast
  transaction for which hedge accounting had
  previously been used but which is no longer
  expected to occur.

38
IFRS 7 Other Disclosures http//www.iasplus.com/s
tandard/ifrs07.htm

• If a gain or loss on a hedging instrument in a
  cash flow hedge has been recognised directly in
  equity, an entity should disclose the following
  IAS 7.23  
• The amount that was so recognised in equity
  during the period.
• The amount that was removed from equity and
  included in profit or loss for the period.
• The amount that was removed from equity during
  the period and included in the initial
  measurement of the acquisition cost or other
  carrying amount of a non-financial asset or non-
  financial liability in a hedged highly probable
  forecast transaction.

39
IFRS 7 Other Disclosures http//www.iasplus.com/s
tandard/ifrs07.htm

• For fair value hedges, information about the fair
  value changes of the hedging instrument and the
  hedged item. IFRS 7.24
• Hedge ineffectiveness recognised in profit and
  loss (separately for cash flow hedges and hedges
  of a net investment in a foreign operation).
  IFRS 7.24

40
IFRS 7 Fair Values http//www.iasplus.com/standa
rd/ifrs07.htm
Information about the fair values of each class
of financial asset and financial liability, along
with IFRS 7.25-30   Comparable carrying
amounts. Description of how fair value was
determined. Detailed information if fair value
cannot be reliably measured. Note that
disclosure of fair values is not required when
the carrying amount is a reasonable approximation
of fair value, such as short-term trade
receivables and payables, or for instruments
whose fair value cannot be measured reliably.
IFRS 7.29
41
IFRS 7 Risk (Qualitative)http//www.iasplus.com/s
tandard/ifrs07.htm

• The qualitative disclosures describe  
• Risk exposures for each type of financial
  instrument.
• Management's objectives, policies, and processes
  for managing those risks.
• Changes from the prior period.

42
IFRS 7 Risk (Quantitative)http//www.iasplus.com
/standard/ifrs07.htm

•   The quantitative disclosures provide
  information about the extent to which the entity
  is exposed to risk, based on information provided
  internally to the entity's key management
  personnel. These disclosures include IFRS 7.34
   
• Summary quantitative data about exposure to each
  risk at the reporting date.
• Disclosures about credit risk, liquidity risk,
  and market risk as further described below.
• Concentrations of risk.

43
IFRS 7 Risk (Quantitative) http//www.iasplus.com
/standard/ifrs07.htm

• Maximum amount of exposure (before deducting the
  value of collateral), description of collateral,
  information about credit quality of financial
  assets that are neither past due nor impaired,
  and information about credit quality of
  financial assets whose terms have been
  renegotiated. IFRS 7.36
• For financial assets that are past due or
  impaired, analytical disclosures are required.
  IFRS 7.37
• Information about collateral or other credit
  enhancements obtained or called. IFRS 7.38

44
IFRS 7 Liquidity Riskhttp//www.iasplus.com/stan
dard/ifrs07.htm

• Disclosures about liquidity risk include IFRS
  7.39  
• A maturity analysis of financial liabilities.
• Description of approach to risk management

45
IFRS 7 Market Riskhttp//www.iasplus.com/standar
d/ifrs07.htm

• Market risk is the risk that the fair value or
  cash flows of a financial instrument will
  fluctuate due to changes in market prices. Market
  risk reflects interest rate risk, currency risk,
  and other price risks.
• Disclosures about market risk include  
• A sensitivity analysis of each type of market
  risk to which the entity is exposed.
• IFRS 7 provides that if an entity prepares a
  sensitivity analysis for management purposes that
  reflects interdependencies of more than one
  component of market risk (for instance, interest
  risk and foreign currency risk combined), it may
  disclose that analysis instead of a separate
  sensitity analysis for each type of market risk.

46
IFRS 7 Application Guidance http//www.iasplus.c
om/standard/ifrs07.htm

• Application Guidance
• An appendix of mandatory application guidance is
  part of the standard.
• There is also an appendix of non-mandatory
  implementation guidance that describes how an
  entity might provide the disclosures required by
  IFRS 7.
• Effective Date
• IFRS 7 is effective for annual periods beginning
  on or after 1 January 2007, with earlier
  application encouraged. Early appliers are given
  some relief with respect to comparative prior
  period disclosures.