Board Meeting Handout Derivatives Disclosure September 6, 2006

Transcription

1 Board Meeting Handout Derivatives Disclosure September 6, 2006 At today s meeting, the Board will discuss the following issues related to derivatives disclosure: 1. Gross versus net presentation in tables summarizing an entity s use of derivatives in instances where an entity has qualified for net presentation in the statement of financial position in accordance with FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts 2. The level of aggregation to be required for notional amounts and fair value amounts in the tables summarizing an entity s use of derivatives 3. Whether to include financial statement presentation and classification in the current project scope 4. Whether gains and losses on hedged items should be included in tables summarizing an entity s use of derivatives 5. Effective date and transition GROSS VERSUS NET PRESENTATION IN TABLES SUMMARIZING AN ENTITY S USE OF DERIVATIVES The Board will discuss two issues associated with gross versus net presentation in tables summarizing an entity s use of derivatives in instances where an entity has qualified for net presentation in the statement of financial position in accordance with Interpretation 39. The first issue deals with whether derivatives subject to master netting arrangements should be displayed in disclosures in a manner that would ignore instances where an entity has qualified for net presentation in the statement of financial position in accordance with Interpretation 39. Question For Board Members: Should the disclosures about where and in what amount derivatives and related gains and losses are recorded be based on a gross The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

2 presentation or a net presentation in situations when the derivatives are subject to master netting arrangements? The second issue deals with whether cash collateral payables or receivables should be included in the disclosure presentation if the Board decides that netting is appropriate under a separate FASB project, Offsetting Cash Collateral Against Secured Obligations. That project deals with whether cash collateral payables or receivables should be netted against derivative positions that are already netted under master netting arrangements. Question For Board Members: Should cash collateral payables and receivables associated with derivative instruments subject to master netting arrangements be excluded from disclosures regarding where and in what amount derivatives and related gains and losses are recorded if the Board decides that netting is appropriate under the offsetting project? THE LEVEL OF AGGREGATION TO BE REQUIRED FOR NOTIONAL AMOUNTS AND FAIR VALUE AMOUNTS IN THE TABLES SUMMARIZING AN ENTITY S USE OF DERIVATIVES This issue deals with what level of aggregation should be required for notional amounts and fair value amounts in the tables summarizing an entity s use of derivatives. Within each table (determined by major underlying), derivatives will be required to be presented by accounting designation categories, and further by balance sheet classification and/or purpose. The staff has developed three alternative approaches for aggregation of notional amounts and fair value amounts: 1. Approach 1: Aggregate the notional amounts and fair value amounts within each accounting designation category. Aggregation of the fair value amounts would be determined by netting the asset value and liability value of the derivatives presented within each category. Aggregation of the notional amounts would be determined by netting the notional amounts tied to the respective derivatives having asset values and liability values. 2. Approach 2: Aggregate the fair value amounts within each accounting designation category. Notional amounts would be presented based on the

3 absolute amount associated with each derivative. Aggregation of the fair value amounts would be determined by netting the asset value and liability value of the derivatives presented within each category. 3. Approach 3: Require the fair value amounts to be presented as separate asset values and liability values. The notional amounts would be presented based on the absolute amount associated with each derivative. Question For Board Members: Which approach should be required for presenting notional amounts and fair value amounts in the tables summarizing an entity s use of derivatives? WHETHER TO INCLUDE FINANCIAL STATEMENT PRESENTATION AND CLASSIFICATION IN THE CURRENT PROJECT SCOPE This issue deals with whether to include presentation and classification of derivative instruments and related hedged items within the current scope of this project. The staff believes that financial statement presentation and classification of derivative instruments and hedged items can be addressed as part of a Phase 2 to this project or as part of another concurrent FASB project, such as the Financial Statement Presentation project or the Financial Instruments Disaggregation project. Questions For Board Members: Should the current scope of the project address financial statement presentation and classification of derivative instruments and hedged items falling within the scope of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities? If not, should those issues be addressed in a Phase 2 of this project or in another project? WHETHER GAINS AND LOSSES ON HEDGED ITEMS SHOULD BE INCLUDED IN TABLES SUMMARIZING AN ENTITY S USE OF DERIVATIVES

4 At the July 19, 2006 Board Meeting, the Board unanimously decided to require the following disclosure: Disclose where and in what amount derivatives and related gains and losses are recorded in the balance sheet and income statement, respectively. Disclosure should be by major underlying, accounting designation, and purpose. This issue deals with whether this disclosure should also include where and in what amount hedged items gains or losses are recorded in the income statement in instances where hedge accounting applies. The Board will discuss whether this disclosure should be required for situations when hedge accounting applies as well as when an economic hedge exists. Questions For Board Members: Should disclosure of where and in what amount the hedged items gains or losses are recorded in the income statement be required in instances where hedge accounting applies? Should this disclosure be encouraged where hedge accounting does not apply? EFFECTIVE DATE AND TRANSITION The Board will discuss the effective date and transition for the proposed disclosures for both interim and annual reporting periods. The staff recommends that the proposed disclosures be effective for both interim and annual reporting periods ending after December 15, 2007, with early application encouraged. The staff further recommends that the disclosures for earlier periods presented for comparative purposes also be required. Question For Board Members: Does the Board agree with the staff recommendation on effective date and transition?

5 Board Meeting Handout Fair Value Option Phase 1 September 6, 2006 PURPOSE OF THIS MEETING At today s meeting, the Board will redeliberate certain issues of Phase 1 of the Fair Value Option (FVO), including: 1. Election of the FVO and Related Documentation Issues 2. Recognition, Measurement, and Presentation Issues 3. Certain Disclosure Issues The staff s recommendations with respect to those issues are presented below. ELECTION OF THE FVO AND RELATED DOCUMENTATION ISSUES The Optionality of the FVO 1. The staff recommends that the Board reaffirm its support for creating an alternative measurement treatment for certain financial assets and financial liabilities that permits fair value to be used for both initial and subsequent measurement, with changes in fair value recognized in earnings as those changes occur. Required Contract-by-Contract Election 2. The staff recommends that the Board not modify the contract-by-contract FVO election, but note in the basis for conclusions that an entity s use of a preexisting documented policy for automatic election of the FVO for a specific type of financial asset or financial liability is permitted even though that action is essentially an election-by-type approach. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

6 3. The staff recommends that the term contract not be defined but that the Statement provide guidance consistent with the staff s understanding of the term contract. For a security (as defined by Statement 115), the term contract refers to the basic minimum trading unit for the security, which would be a single share for common stock and the minimum denomination (such as $1,000) for an individual debt security. The staff believes that approach is consistent with the application of the classifications of securities under Statement 115. For a nonsecurity, the election would need to be made for the entire contract, such as a loan agreement. For example, a loan syndicator that creates senior, mezzanine, and subordinate tranches would be prohibited from electing the FVO for only some (but not all) of the tranches it chooses to retain. If a syndicator enters into a single loan agreement with a borrower that specifies three separate prioritized loan tranches with cross-default provisions and separate assignability, the overall loan agreement constitutes the contract under the FVO Statement and the FVO election would need to be elected for all three tranches (or loans) or none. (See paragraph 7 of this handout regarding securitizations and the FVO election.) In contrast, if a lender had entered into three separate loan agreements with a single borrower, the FVO could be elected for only one or two of those loans, even if the loans had cross-default provisions. 4. The staff recommends that the FVO Statement (a) indicate that the determination of fair value must be consistent with the guidance in the forthcoming fair value measurement (FVM) Statement, (b) acknowledge in the basis for conclusions that, in determining the fair value of an individual financial instrument, the FVM Statement does not preclude an entity from measuring it as part of a portfolio rather than strictly on a standalone basis, and (c) indicate that the contract-by-contract election of the FVO does not limit the entity in determining the appropriate unit of account for measuring 2

7 the financial assets and financial liabilities for which the FVO has been elected. Election for a Portion of a Financial Asset or Financial Liability 5. The staff majority recommends that the Board maintain the prohibition against electing the FVO for only a portion of a contract since it will not result in the increased reporting of contracts at fair value or further convergence with the IASB s FVO. 6. However, a minority of the staff recommends that the Board allow insurance companies to elect the FVO for components of contracts that are required to be accounted for separately in accordance with existing GAAP since that separate accounting is effectively treating a single contract as two separate contracts, each of which the minority believes should be eligible for the FVO election. Timing of the Election of the Fair Value Option Delayed Election 7. The staff recommends that the requirement to elect the FVO on the date that the financial asset or financial liability is initially recognized or at a new-basis event be maintained without modification. However, the staff recommends that the basis for conclusions point out that if an entity is required to initially recognize a contract on the trade date rather than the settlement date, then the FVO could be elected on the trade date (which would be the date that the contract is initially recognized) and not on the settlement date. Under current GAAP, a securitization is not a new-basis event as defined in the Exposure Draft with respect to financial assets that continue to be held by a transferor. However, the Board plans to discuss possible changes to FASB Statement No. 140, Accounting for Transfers and 3

8 Servicing of Financial Assets and Extinguishments of Liabilities, under a separate project. Those changes could possibly cause a securitization to meet the definition of a new-basis event and, thus, create another opportunity for the election of the FVO. Need for Qualifying Criteria for the FVO Election 8. The staff recommends that the Board not modify the FVO document to impose any eligibility criteria. The staff believes that the comments received on the Exposure Draft do not provide any information that the Board did not already consider in making its original decision. The staff believes that the objectives of the FVO, as explained in paragraph 1 of the Exposure Draft, are better met without the incorporation of eligibility requirements. Documentation Requirements for the FVO Election 9. The staff recommends that the Board modify the documentation requirements of the FVO to allow for documentation of election of the FVO within a reasonable amount of time after initial recognition or a new-basis event, but no later than the end of the month in which the contract is initially recognized or the new-basis event occurs. RECOGNITION, MEASUREMENT, AND PRESENTATION ISSUES Recognizing Changes in Fair Value in Earnings 10. The staff recommends that the Board make no change in the ED s requirement that, under the FVO, changes in fair value be recognized in earnings as those changes occur. The staff believes that the need of users to understand the effect of the FVO on earnings should be addressed through the disclosure requirements. 4

9 Recognizing Changes in Fair Value Attributable Only to a Certain Risk 11. As part of the Board s redeliberations, the staff asks the Board to reaffirm its decision not to expand the FVO project to permit entities to elect (outside of the hedge accounting outlined in Statement 133) to recognize in earnings the change in an asset s or liability s fair value attributable to only certain selected risks (rather than the total change in fair value). Special Treatment for the Changes in a Liability s Fair Value Attributable to Changes in a Debtor s Creditworthiness 12. The staff recommends that the Board decide not to curtail the debtor s recognizing in earnings the effect of changes in its creditworthiness in reporting liabilities at fair value. Aggregating Fair Value Changes in the Income Statement 13. The staff recommends that the Board not provide specific presentation guidance for the effects of fair value measurements on earnings, but rather address the need for understanding the effects of changes in fair values of items for which the FVO has been elected through disclosures as discussed below. Distinguishing between Fair Value and Non-Fair-Value Carrying Amounts in the Statement of Financial Position 14. The staff recommends that the Board make no change to the requirement for separate presentation or parenthetical disclosure on the face of the statement of financial position. 5

10 Proposed Cash Flow Reporting Changes 15. The staff recommends that the Board maintain the guidance in the standards section of the Exposure Draft related to cash flow reporting without modification. The staff recommends against pursuing an amendment of Statement 95, as part of the FVO project, to permit changing the cash flow classification of financial assets and liabilities based on management s intent at the reporting date. CERTAIN DISCLOSURE ISSUES The Difference between the Liability s Fair Value Carrying Amount and the Aggregate Principal Amount 16. The staff recommends that the Board not modify paragraph 12(a) of the FVO document. The staff believes that existing disclosure requirements will enable users to analyze an entity s cash obligations. Information Sufficient to Understand the Effect of Subsequently Measuring at Fair Value under the FVO Election 17. Statement 107 requires disclosure of methods and significant assumptions used in determining fair value and encourages disclosure of quantitative information about the market risks of instruments. Because the scope of the FVO document includes items excluded from the scope of Statement 107, the staff recommends that paragraph 12(b) of the FVO document be revised to include the following for only the fair value measurements that, in their entirety, fall within Level 3 of the fair value hierarchy defined in the FVM Statement: (a) a requirement to disclose the method and significant assumptions used to estimate fair value and (b) the encouragement to disclose quantitative information about the market risks of instruments that is 6

11 consistent with the way it manages or adjusts those risks. The staff recommends not adding a specific requirement to provide sensitivity analyses. The staff also recommends not adding a specific requirement to provide information regarding model validation procedures. The staff recommends revising paragraph 12(b) to clarify that the entity is required to disclose information sufficient to users about changes in fair value for those items for which the FVO has been elected rather than disclosure of the effect on earnings resulting from election of the FVO. Quantitative Information Regarding Where Fair Value Changes Are Reported in the Income Statement 18. The staff believes that paragraph 12(c) is sufficiently clear that it applies to all gains and losses (not just unrealized ones) and no changes are necessary. The staff suggests that the basis for conclusions provide additional background on the Board s decisions regarding separate disclosures of only unrealized gains and losses. A Description Indicating How Interest and Dividends Are Measured and Reported in the Income Statement 19. The staff recommends revising paragraph 12(d) and the basis for conclusions to clarify that the FVO does not affect methods for recognizing and measuring the amount of interest and dividend income. The staff believes that any change in recognizing and measuring interest and dividend income is beyond the scope of this project. 7

12 Qualitative Information Regarding Significant Changes in the Fair Value of Financial Liabilities 20. The staff recommends that the Board require an entity that is reporting a financial liability at fair value and has experienced a significant change in creditworthiness during the reporting period to disclose an approximation of the amount of change attributable to its creditworthiness that is included in current period earnings. The staff recommends that the Board stipulate neither (a) guidance regarding when a change in a debtor s creditworthiness is considered significant nor (b) detailed computational guidance regarding how to determine the approximation of the amount of the liabilities fair value change attributable to the change in creditworthiness. 21. If the Board rejects the staff s recommendation above, the staff recommends that the ED s paragraph 13 be modified to require those proposed qualitative disclosures whenever a significant change in the debtor s creditworthiness occurs, not just when the overall change in fair value is significant. 8