Recent FASB Developments Regarding Financial Instruments: What May Change in Current Financial Reporting?

Transcription

1 The Financial Reporting series presents: Recent FASB Developments Regarding Financial Instruments: What May Change in Current Financial Reporting? Bob Uhl James May Chris Rogers Rob Comerford August 11, 2008

2 Agenda Proposed Statement Hedging Activities Statement 161 Disclosures about Derivative Instruments and Hedging Activities Proposed Statement Disclosures of Certain Loss Contingencies FASB s Derecognition Project FASB s Consolidation Project Proposed Disclosure Requirements Question & Answer

3 Learning Objective To enhance participants understanding of important financial instrument accounting issues and developments pertaining to: Hedging activities and disclosures Loss contingency disclosures FASB s projects on derecognition and consolidation

4 Proposed Statement Hedging Activities

5 Proposed Statement Hedging Activities Objectives: Resolve major practice issues Simplify hedge accounting Improve financial reporting and make accounting model and disclosures easier to understand Address differences in accounting for derivatives and hedged items Important dates Exposure Draft issued June 6, 2008 Comments due by August 15, 2008 Final Statement expected Q Effective date fiscal years beginning after June 15, 2009 no early adoption

6 Proposed Statement Hedging Activities What Are The Proposed Changes? Adopting a fair value approach Eliminates: Bifurcation-by-risk, some exceptions Shortcut method Critical-terms-match method Dedesignation Mandatory quantitative effectiveness assessments Mandatory quarterly assessments Replaces highly effective requirement with reasonably effective requirement Requires qualitative assessments (quantitative, if necessary)

7 Proposed Statement Hedging Activities Exceptions to Bifurcation-by-Risk: Foreign currency exchange risk An entity s own issued debt For example, a swap used to synthetically create fixed or variable-rate debt At inception, allowed to designate: Interest rate risk Foreign currency exchange risk Or a combination of both Bifurcation-by-risk not permitted after inception of debt

8 Polling Question #1 Do you agree with the FASB s proposal to essentially eliminate the current bifurcation-by-risk hedging model? Yes No Don t know/not applicable

9 Proposed Statement Hedging Activities How Would Assessments Work? At designation, must have formal, contemporaneous documentation Qualitative assessment supporting hedging relationship is reasonably effective Economic relationship must exist Expected to reasonably offset changes or variability (all risks) Quantitative assessment in certain situations Subsequent assessments Qualitatively (or quantitatively) reassess as circumstances dictate

10 Proposed Statement Hedging Activities What About Measurement? Fair value hedges Adjust carrying value of hedged item for changes in overall FV of the hedged item Cash flow hedges Amount recorded in AOCI is equal to change in FV of a perfect derivative since inception: Amount recorded in AOCI is not limited to change in FV of actual derivative Perfect derivative may settle within reasonable period of time of the cash flows for hedged group of transactions

11 Proposed Statement Hedging Activities Dedesignation is Prohibited: May enter into offsetting positions with appropriate documentation Hedge accounting discontinued only if either: Conditions for hedge accounting are no longer met Derivative expires, is sold, terminated or exercised

12 Proposed Statement Hedging Activities New Disclosure Requirements: Carrying value and adjustment disclosures for fair value hedges Disclosures when synthetically creating fixed-rate or variable-rate debt hedging interest rate risk on issued debt

13 Proposed Statement Hedging Activities Amendments to paragraphs 13, 40, and 61(e) Transition: Dedesignate all hedging relationships (unless the risk being hedged is permitted before and after the effective date) No adjustment for fair value hedges Adjustment to retained earnings for continuing cash flow hedges One-time elections under Statements 156 or 159 No transition disclosures required Reference: See our June 11, 2008 Heads Up, FASB Trims Hedging Requirements

14 Polling Question #2 Do you believe the FASB should move forward with this proposed Statement without significant modification? Yes No Don t know/not applicable

15 Statement 161 Disclosures about Derivative Instruments and Hedging Activities

16 Statement 161 Disclosures The Proposal At a Glance: Objective expanded Statement 133 disclosures To provide users with an enhanced understanding of an entity s use of derivatives and the related accounting and affect on the financials Not meant to be a catch-all for derivative and hedging disclosure guidance Both qualitative and quantitative disclosures Tabular requirement Credit risk disclosures Effective for periods beginning after November 15, 2008 Reference: See our March 27, 2008, Heads Up, FASB Expands Disclosures About Derivative Instruments and Hedging Activities

17 Proposed Statement Disclosures of Certain Loss Contingencies

18 Loss Contingency Disclosures Proposal At a Glance: Issued on June 5, 2008 Amends FAS 5 and FAS 141(R) Comment period ended August 8, 2008 Effective for fiscal ending after November 15, 2008 Calendar year-end filers must include disclosures in December 31, 2008 annual filings

19 Loss Contingency Disclosures The Proposal Now must disclose certain remote loss contingencies Expands the types of contingencies requiring disclosure Specifies new qualitative and quantitative disclosures Requires a tabular reconciliation of recognized contingency amounts

20 Loss Contingency Disclosures Remote Loss Contingencies: Now must disclose remote loss contingencies if : Resolution is expected within one year; and Contingency could have a severe-near term impact

21 Loss Contingency Disclosures New Qualitative Disclosure Requirements: Description of the contingency including: How it arose Its legal or contractual basis Its current status The anticipating timing of resolution Description of factors likely to effect outcome The most likely outcome Significant assumption as used in estimated disclaimed amounts

22 Loss Contingency Disclosures New Quantitative Disclosure Requirements: The amount of the claims or assessments; or An estimate of the maximum exposure to loss Note: May also disclose best estimate of loss or range of possible loss Only disclose maximum exposure if there is no claim or assessment against the company

23 Loss Contingency Disclosures Required Tabular Reconciliation: Beginning balance $100,000 Plus: New contingencies recognized 15,000 Plus: Increases for changes in estimates 5,000 Minus: Decreases for changes in estimates (25,000) Minus: Derecognition of loss contingency (5,000) Minus: Decreases for cash payments (settlements) (10,000) Ending balance $80,000 Note: Must provide qualitative description of any significant activity

24 Loss Contingency Disclosures Prejudicial Information Exemption: Allowed if disclosure of loss contingency is prejudicial Two step approach 1. Permitted to aggregate disclosure at higher level in financial statements 2. If still prejudicial at higher level may forgo Only in rare cases

25 Polling Question #3 Do you believe the information required to comply with the new qualitative and quantitative disclosures of a lost contingency will be difficult to gather? Yes No Don t know/not applicable

26 FASB s Derecognition Project

27 Proposed Amendment to Statement 140 FASB Statement No. 140 Refresher: Primary source of accounting guidance for transfers of financial assets and securitization transactions Paragraph 9 derecognition conditions Paragraph 9(a) Transferred assets must be legally isolated from the transferor Paragraph 9(b) The transferee must be able to pledge or exchange the assets unless the transferee is a qualifying special-purpose entity (QSPE) Paragraph 9(c) The transferor does maintain effective control over the transferred assets

28 Proposed Amendment to Statement 140 Background on Project: Significant practice issues applying QSPE guidance Numerous EITF Issues and SEC guidance FASB s servicer discretion project Subprime loan modifications SEC mandate to fix QSPE guidance FASB began project to eliminate QSPEs in early 2008 Reference: See our August 27, 2008 Heads Up, Accounting Consequences of Subprime Loan Modifications and our Financial Reporting Alert 08-1

29 Polling Question #4 Do you agree that the current derecognition guidance in Statement 140 has resulted in a lack of transparency regarding securitization transactions? Yes No Don t know/not applicable

30 Proposed Amendment to Statement 140 Summary of Decisions Reached as of June 11, 2008 Eliminate the concept of a QSPE Remove the QSPE scope exceptions in FIN 46(R) Clarify the legal isolation analysis in paragraph 9(a) Eliminate paragraph 9(b) Incorporate transferor constraint into paragraph 9(c) Reference: See our June 15, 2008 Heads Up, Mind your V(IE)s and Qs

31 Proposed Amendment to Statement 140 Proposed changes to derecognition criteria (included in the April 2, 2008 Board handout) Paragraph 9(a) Legal Isolation Legal isolation must consider all arrangements made in connection with the transfer Transferred assets must be legally isolated in bankruptcy from the transferor and any of its consolidated affiliates Even if not entered into at the time of the transfer

32 Proposed Amendment to Statement 140 Guarantee Considering legal isolation for purposes of Transferor A s consolidated F/S Guarantor C Investors Mortgage Loans Transferor A Cash Trust Investors Servicer B Servicing Investors Parent ABC

33 Proposed Amendment to Statement 140 Guarantee Considering legal isolation for purposes of Transferor A s consolidated F/S Guarantor C Investors Mortgage Loans Transferor A Cash Trust Investors Servicer B Servicing Investors Parent ABC True Sale Opinion

34 Proposed Amendment to Statement 140 Proposed changes to derecognition criteria (included in the April 2, 2008 Board handout) Paragraph 9(b) Transferee control Criteria is deleted in its entirety Concept of transferor constraint now included in paragraph 9(c) No longer consider who caused the constrain. Only consider its effect

35 Proposed Amendment to Statement 140 Proposed changes to derecognition criteria (included in the April 2, 2008 Board handout) Paragraph 9(c) Effective Control Effective control is retained if a constraint on a transferee provides the transferor with a benefit Effective control is retained if the transferee may be compelled to force the transferor to repurchase the assets

36 Proposed Amendment to Statement 140 Other Statement 140 Amendments: Transfers of portions of financial assets must be participating interests Retained interests initially recognized at fair value Guaranteed mortgage securitization exception eliminated

37 Proposed Amendment to Statement 140 Potential consequences of the Board s decisions: Increased judgment regarding derecognition Legal opinions may be necessary for each subsidiary involved in a transfer FIN 46(R) must be considered if you have involvements with a QSPE Gain/loss recognition on swap and hold transactions

38 Polling Question #5 Do you agree with the Board s decisions to eliminate the qualifying special-purpose entity (QSPE)? Yes No Don t know/not applicable

39 FASB s Consolidation Project

40 Proposed Amendment to FIN 46(R) Decisions reached as of July 30, 2008*: Modify process for identifying the primary beneficiary Require continuous reconsideration of FIN 46(R) conclusions Enhance disclosures (ED) regarding an entity s involvement with VIEs and methodologies for apply FAS 140 and FIN 46R * Based on June 18 th project update on FASB s website and Deloitte s observations at subsequent FASB meetings. Participants should monitor FASB s website for issuance of ED as actual provisions of ED may differ from our observations

41 Proposed Amendment to FIN 46(R) FASB s New Consolidation Model Step 1: Qualitatively determine if an enterprise has: 1. The power to direct matters that significantly impact the activities of and success of a variable interest entity (VIE); and 2. The right to receive potentially significant benefits from the VIE and/or the obligation to absorb potentially significant losses of the VIE If both conditions 1 and 2 are met, the enterprise is the Primary Beneficiary (PB). If Step 1 is inconclusive, proceed to Step 2 Ignore Kick Out Rights! Note absence of expected

42 Proposed Amendment to FIN 46(R) FASB s new consolidation model Step 2: Quantitatively determine if an enterprise has: 1. An obligation to absorb a majority of the expected losses of the VIE; or 2. A right to receive a majority of the expected residual returns of the VIE The enterprise that absorbs/receives a majority of the expected losses or expected residual returns is the PB

43 Proposed Amendment to FIN 46(R) Consequences of FASB s New Consolidation Model Conceptual: 1. PB analysis places new emphasis on control 2. Exposure to variability de-emphasized in Step 1 3. Impact of best/worst case scenario on VI holder takes on new significance in Step 1 Operational: 1. Requires process for performing & documenting results of continuous assessments 2. Potentially increases quantitative burden for some (operating) VIEs 3. Increases reliance on professional judgment when determining whether an enterprise has power to direct activities of entity Impacts all entities not just financial (Q)SPEs

44 Proposed Amendment to FIN 46(R) Example 1 CMBS Securitization Fixed Fee Servicing/Special Servicer Agreement Tranche A $100 Loans Transferor B Trust A $12 BI Tranche B $94 Cash Tranche C $6 Residual Equity Third Party Investors

45 Proposed Amendment to FIN 46(R) Example 1 CMBS Securitization Step 1 Qualitative Assessment Interest Holder Tranche A Tranche B Tranche C Residual Equity Power Over Activities? Benefits and Loses? Transferor B Servicer Special Servicer

46 Proposed Amendment to FIN 46(R) Example 1 CMBS Securitization Step Conclusion: 1 Qualitative Assessment Transferor B is the Primary Beneficiary and must consolidate Tranche A Trust A Interest Holder Tranche B Power Over Activities? Benefits and Loses? Tranche C Residual Equity Transferor B Servicer Special Servicer

47 Proposed Amendment to FIN 46(R) Example 2 Joint Venture Arrangement Mutual Restriction on Sale (Par. 16a Related Parties) True JV Control split 50/50 Enterprise A Enterprise B Economics split 50/50 Restrictions on sale Not a VIE at inception Incurred significant losses Joint Venture Equity investment at risk no longer sufficient due to losses VIE at reconsideration date

48 Proposed Amendment to FIN 46(R) Example 2 Joint Venture Arrangement Step 1 Qualitative Assessment Interest Holder Enterprise A Enterprise B Power Over Activities? Benefits and Loses? Enterprise A and Enterprise B are related parties Consider paragraphs Neither venturer has unilateral power over activities

49 Proposed Amendment to FIN 46(R) Example 2 Joint Venture Arrangement Step 1 Qualitative Assessment Interest Holder Related Party Group Power Over Activities? Benefits and Loses? Note: As a related party group, Enterprise A and B have power to direct matters that impact the JV s activities

50 Proposed Amendment to FIN 46(R) Example 2 Joint Venture Arrangement Step 1 Qualitative Assessment Paragraph 17 requires enterprise most closely associated with the activities of the JV to consolidate Existence of principal-agency relationship? Relationship and significance of activities? Exposure to expected losses? Design and redesign of the entity? Conclusion: We re not done yet! Despite 50 / 50 split of control and economics, one of the venturers would need to be the PB. Second and fourth factor would take on more significance

51 Polling Question #6 Did you realize that the proposed amendments to FIN46R could also impact operating companies? Yes No Don t know/not applicable

52 Effective Date and Transition Amendments to both FAS 140 and FIN 46(R) are effective for fiscal years beginning after November 15, 2009 for: 1. New transfers of financial assets occurring after the effective date; 2. All interests in VIEs created before the effective date; 3. All new VIEs created after the effective date; and 4. All QSPEs created before the effective date

53 Effective Date and Transition Transition Guidance: Consolidate assets and liabilities of the VIE at fair value Recognize a cumulative effect adjustment to retained earnings in year of adoption Next Steps: Exposure Draft is expected in late August or early September ED will have a 60 day comment period What About Disclosures Requirements??? FASB is expected to invite prepares to participate in roundtable discussions during the comment period

54 Proposed Disclosure Requirements

55 Proposed Disclosure Requirements Proposed FASB Staff Position Expected to be issued in August or September 30 day comment period Require most of the disclosures included in the Statement 140 and FIN 46(R) amendments be effective ASAP Alternative effective dates: Fiscal Years (and interim periods) ending after November 15, 2008 Fiscal Years beginning after November 15, 2008 New disclosures for non-transferor interest holders in QSPEs

56 Proposed Disclosure Requirements New Statement 140 Disclosures Proposed by the FASB The carrying value of assets restricted to satisfy a particular obligation (and the nature of the restriction) Qualitative information about a transferor s continuing involvement in the transferred assets including risks inherent in the transferred assets The terms of any financial support provided to the transferee The type and amount of any non-contractual support provided to a transferee The cash flows between the transferor and transferee

57 Proposed Disclosure Requirements New FIN 46(R) Disclosures Proposed by the FASB The methodology and process for making its consolidation conclusions Significant factors considered and significant assumption/judgements made when making consolidation conclusions Whether non-contractual financial or other support was provided to a VIE Qualitative information about involvements with a VIE (for PBs, sponsors, and significant VIHs) Maximum exposure to loss and significant exposures to VIEs (for sponsors and significant VIHs)

58 Proposed Disclosure Requirements New Disclosures Proposed by the FASB for Non- Transferors with Interests in QSPEs The nature, purpose, and activities of the QSPE The carrying amount and classification of variable interest(s) related to involvement with the QSPE The terms of any potential financial support provided to the QSPE (including liquidity facilities and letters of credit) The type, amount, and primary reasons for providing any non-contractual financial or other support to the QSPE

59 Polling Question #7 What alternative would you recommend the FASB pursue for the proposed disclosure requirements? Fiscal Years (and interim periods) ending after November 15, 2008 Fiscal Years beginning after November 15, 2008 Don t know/not applicable

60 Questions & Answers

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63 Contact Information Bob Uhl James May Chris Rogers Rob Comerford

64 Other Resources Heads Up Mind Your V(IE)s and Qs: FASB Decides to Eliminate QSPEs and Modify the Consolidation Model in Interpretation 46(R) Heads Up FASB Trims Hedging Requirements: Changes Proposed to Accounting for Hedging Activities Heads Up Finding the Remote: FASB Proposes Expanding Contingencies Disclosure

65 This presentation contains general information only and is based on the experiences and research of Deloitte practitioners. Deloitte is not, by means of this presentation, rendering business, financial, investment, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this presentation.

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