National Accounting Group, with a specialization in derivatives and hedging. He also serves clients in the insurance and transportation industry.
FAS 133 dramatically changes the way many derivatives and hedging transactions are reported. But it is also very complex, which will make implementation difficult for many companies, so the authors strongly urge CFOs to begin adopting the new standard as soon as possible and present a useful ten-step program for doing so. Β©1999 John Wiley & Sons.
T he Financial Accounting Standards Board issued its controversial new standard on derivatives-Statement No. 133, Accounting for Derivative Instruments and Hedging Activities in June 1998. Statement 133 provides a comprehensive and consistent standard for the recognition and measurement of derivatives and hedging activities. The new Statement resolves the inconsistencies that existed with respect to derivatives accounting, and dramatically changes the way many derivatives and hedging transactions are reported.
The new Statement requires all derivatives to be recorded on the balance sheet at fair value and establishes "special accounting" for the following three different types of hedges: hedge of the exposure to changes in the fair value of a recognized asset or liability, or of an unrecognized firm commitment (referred to as a fair value hedge); hedge of the exposure to variability in the cash flows of a recognized asset or liability, or of a forecasted transaction (cash flow hedge); and hedge of the foreign currency exposure of a net investment in foreign operation. Though the accounting treatment and criteria for each of the three types of hedges is unique, all three ensure that, to the extent effective, the hedging instrument and hedged item are recognized in earnings in the same period. The ineffective portion of the hedging instrument, the portion of the hedging instrument excluded from the assessment of hedge effectiveness, and changes in the fair value of derivatives that do not meet the criteria of one of these three categories of hedges are included directly in earnings with no offset.
The Statement is effective for years beginning after June 15, 1999, but companies can early adopt as of the beginning of any fiscal quarter starting July 1, 1998. Because hedge accounting is based on an entity's intent at the time a hedging relationship is established, retroactive application to previous periods, even previous quarters within the same fiscal year, is not permitted. Many