Financial Reporting

Amendment Eases FASB No. 133 Implementation

In June, after numerous business entities reported problems implementing FASB Statement no. 133, Accounting for Derivative Instruments and Hedging Activities, FASB issued an amendment, FASB Statement no. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, to address those concerns.

The newly issued provisions will ensure companies can more easily implement Statement no. 133. They have until the beginning of their first fiscal year after June 15—which, for many, is January 1, 2001—to do so.

Robert E. Jensen, a professor in the Department of Business Administration at Trinity University in San Antonio, Texas, said, “The amendment is designed to address some of the complexities involved in implementing Statement no. 133.” He noted, for example, that it relaxed restrictions on cross-currency hedges, which Statement no. 133 had effectively prohibited.

In addition, the FASB amendment expanded the normal purchases and normal sales exception, redefined the specific risks that can be hedged and allowed the use of intercompany derivatives as hedging instruments in certain situations.

Kevin Stoklosa, a FASB project manager, explained the reasoning behind the amendment provisions related to hedges of interest rate risk and hedges of foreign-currency-denominated assets and liabilities. “Before the amendment, Statement no. 133 permitted the market interest rate, defined as the risk-free rate plus the credit sector spread, to be designated as the hedged risk in a hedge of interest rate risk.” (The risk-free rate is generally equated with the return on three-month U.S. Treasury obligations; sector spread is the premium borrowers offer lenders, in addition to the risk-free rate, as compensation for the risk associated with their debt instruments.)

“The problem,” Stoklosa continued, “was that the derivatives available for hedging interest rate risk were based on a definition of interest rates that did not include the sector spread.” Therefore, the definition in the amendment now permits the use of a benchmark interest rate that excludes the sector spread. This enables companies to hedge interest rate risk with available derivative products.

In addition, as Jensen observed, the amendment relaxes Statement no. 133’s restrictions on hedging recognized foreign-currency-denominated assets and liabilities. Stoklosa noted that Statement no. 133 prohibits hedging items remeasured with changes in fair value reported in earnings. That notion was extended to hedges of foreign-currency instruments remeasured at current spot exchange rates with the resulting gain or loss reported in earnings. “But,” he said, “a measurement anomaly existed for certain foreign-currency instruments in which remeasurement at spot exchange rates did not represent fair value.”

Stoklosa said earnings volatility resulted when the changes in those foreign-currency items were compared to changes in the derivative hedging instrument, which is required to be measured at fair value. He said such volatility is mitigated by the amendment provisions permitting the recognized items to be designated as hedged items.

The purpose of the amendment project, Stoklosa said, was to address a limited number of issues causing implementation difficulties for a large number of entities. In his view, the amendment has achieved its objective, especially for institutions heavily involved in interest rate derivatives, which are probably the most common type of derivatives in use today.

Other kinds of companies will have fewer, if any, adjustments to make, Jensen said.


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