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Financial Instruments FEI November 2001

Financial Instruments FEI November 2001. Tim Bridges -- Goldman Sachs John Stewart -- Andersen LLP Tim Lucas -- FASB. Financial Instruments. FAS 133 + 138 Derivatives and Hedging FAS 140 Transfers and Servicing of Assets + Extinguishments of Liabilities Financial Instruments Projects

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Financial Instruments FEI November 2001

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  1. Financial InstrumentsFEI November 2001 Tim Bridges -- Goldman Sachs John Stewart -- Andersen LLP Tim Lucas -- FASB

  2. Financial Instruments • FAS 133 + 138 Derivatives and Hedging • FAS 140 Transfers and Servicing of Assets + Extinguishments of Liabilities • Financial Instruments Projects • FASB • JWG • AICPA • EITF Issues • SEC Hot Topics

  3. FASB Statement 133 - Overview • Amended twice since June 1998 • No. 137 deferred effective date • No. 138 amended several areas • ED in the works for D-1 • Single, integrated accounting framework • Effective for all fiscal years beginning after June 15, 2000 • DIG guidance and open items (200+ issues)

  4. What it Accomplishes - A Reminder • Concern about derivatives  FAS 133 increases visibility, comparability and understanding • Problems with existing accounting guidance • FAS 133 reduces inconsistency and incompleteness

  5. Scope • Always ask two questions: • Is the contract a derivative? • Very broad • If not, is the contract embedded with a derivative? • Foreign currency • Convertible debt • Beneficial interests • Prepaid swaps • Dual trigger and other insurance contracts • Indexed debt (equity, commodity, etc.) • Etc., etc.

  6. Valuation - What needs to be valued? • Each freestanding derivative • Each embedded derivative • Each host contract upon bifurcation • Each item hedged in a fair value hedge • Cash flows in a cash flow hedge • Intrinsic value and time value • Required quarterly for recognition, measurement and assessment of hedge effectiveness

  7. Qualification • Contemporaneous, formal documentation required at hedge at inception • Objectives and strategy • Hedged item • Hedging instrument • Risk being hedged • How effectiveness will be assessed • SEC has required restatement for improper documentation • All criteria for hedge accounting must be met

  8. Complexities - A sampler! • Scope • Equity warrants • Loan commitments • Financial guarantees and insurance • Residual value guarantees • Normal purchases and sales • Electricity • CPI • Forwards plus options • Cross indexes • When and how to bifurcate • Shortcut qualification

  9. Complexities - A sampler, continued! • Hedging the benchmark rate (methods 2 and 3) • Forward points in forward currency hedges • Purchased and complex options • Basis risk for nonfinancial assets • Aggregating (e.g. commercial paper programs and loans) • Tracking OCI • Impairment of long-lived assets

  10. Complexities - A sampler, continued! • Central treasury • Assessing effectiveness • Mortgage servicing rights • Net investment hedges • Call monetization • Prohibitions • Interaction with other literature (APBs and FASBs) Be sure to read the DIG issues!

  11. Other considerations • Disclosures • Open DIG issues • Transition for DIG issues • Impact on EITF guidance • New EITF issues

  12. FASB Statement 140 – Transfers of financial assets • Clarify criteria for determining whether a transferred asset has been sold under Statement 125 • Modify requirements for SPE to be a “qualifying” SPE • Modify the accounting for collateral in financings • Require extensive disclosures for securitizations

  13. FASB Statement 140 – Transfers of financial assets • Final statement issued September 2000 • Effective for transactions after 3/31/01 • Disclosures and collateral provisions required for fiscal years ending after 12/15/00 • Supercedes all of Statement 125 • FASB Staff Q&A (123 items) • Impact on EITF issues • Many implementation questions

  14. FASB Statement 140 – A sampler of implementation issues • Isolation (FDIC and other) • Constraints, partial sales, calls and puts, ROAPs • QSPE status • Holdings • Derivative use • Servicing • Warehousing • Liability management (commercial paper) • Disclosures • Scope • Securitizations • Collateral

  15. Liability/Equity Major Changes • Amendment of Concepts Statement 6 Some Liabilities settle in shares • Separation of components • Elimination of mezzanine section (Temporary Equity probably isn’t) • Classification of minority interests

  16. Amend Concepts Statement 6 • Definition of liabilities • Transfer of assets vs. issuance of shares • Ownership interest vs. debtor- creditor relationship • Comments 00-19 is Very Popular

  17. Liability/EquitySeparate Components • Some Instruments are Hybrid • Example = Convertible Debt • Separate at Issue using Relative FV or With-and-without • Comments and Visits – Instruments are Complex and Components are not Obvious

  18. Liability/EquityTemporary Equity in Mezzanine • Mezzanine Never Popular at FASB • Mandatory Redemption = Liability • Economic Compulsion = Not Liability • Comments: • Some Entities Redeem All Equity • Mixed Views Otherwise

  19. Liability/EquityMinority Interests • Are Considered Equity • Consolidated Net Income Includes MI • Sales of Subsidiary shares are Treasury Stock Transactions

  20. Measurement of financial instruments - FASB project • Preliminary views document issued in Q4 1999 • Goal is to provide guidance for accounting for all financial assets and liabilities at fair value • Implementation guidance • How to determine fair value • Scope of instruments • Company’s own creditworthiness • Presentation issues including Changes in FV • Intermediate objective - more specific guidance on how to determine fair value and improve disclosure • Coordination with JWG project

  21. Financial instruments - JWG project • Joint Working Group of standard setters • Australia, Canada, France, Germany, Japan, New Zealand, Nordic countries, U.K., U.S., and IASC • Special report issued December 2000 • Comments were due June 30, 2001 • IASB involvement • All financial instruments at fair value through earnings • No hedge accounting • New derecognition standards (  Statement 140) • New disclosures

  22. Other projects - Overview • FASB Concepts Statement No. 7 - PV measurement • IAS 39 - financial instruments and implementation guide • AICPA - loan loss allowances • AICPA - purchase of high risk receivables • International activity – leases + Insurance • FASB DIG D-1 project • FASB and SPEs

  23. Revenue Recognition and Sales Incentives Treatment of Other Costs (Capitalize versus Expense) Stock Compensation Equity Method Investments Financial Assets Real Estate Equity Transactions Derivative Related Nonmonetary Transaction Business Combination Leases Other Issues EITF issues

  24. EITF issues - Financial instruments • Residual interests in securitizations (99-20) • Measuring fair value of equity securities with restrictions in a nonmonetary exchange (00-N) • Creditor’s accounting for a modification or exchange of debt (01-7) • When to combine separate instruments (01-G) • Other items

  25. EITF issues - Equity transactions • Equity instrument received for providing goods or services (00-8) • Equity instruments granted to nonemployees (00-18) • Classification of equity derivatives (00-19) • Convertible securities with beneficial conversion features (00-27) • Convertible instrument issued for goods or services (01-1) • Combining 00-19 instruments (01-F)

  26. EITF issues - Derivative related • Majority owner's accounting for the minority interest in a subsidiary and a derivative (00-4) • Derivatives indexed to stock of consolidated subsidiary (00-6) • Derivative instruments under Issue 96-13 that could require net cash settlement (00-7) • Gain or loss classification from extinguished hedged debt (00-9) • Measuring the fair value of energy-related contracts (00-17) • Determination of whether share settlement is within the control of the issuer (00-19) • Meaning of “indexed to a company’s own stock” (01-6)

  27. EITF issues - Leases • Meeting the ownership transfer requirements of FASB Statement 13 for leases of real estate (00-11) • Accounting for sales of fractional interests in equipment (01-4) • Determining when an energy-related contract is a lease (01-8) • Interaction of FASB Statements 13 and 133 on residual value guarantees (01-H)

  28. SEC “Hot Topics” - Financial instruments • Documentation and disclosures related to derivative instruments and hedging activities • Valuation • Allowance for loan losses • Equity and warrant issues • SPEs • Nontemporary impairment • Statement 140 QSPE treatment and disclosures • Mezzanine classification (D-98)

  29. NOW to Your QUESTIONS

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