Financial Accounting Standards Board

1. Financial Accounting Standards Board National Association of Regulatory Utility Commissioners FASB Update October 13, 2008 Robert C. Wilkins Senior Project Manager rcwilkins@fasb.org 203-956-5236

2. Disclaimer The views expressed in this presentation are my own and do not represent positions of the Financial Accounting Standards Board. Official positions of the FASB Board are arrived at only after extensive due process and deliberations.

3. FASB Overview • Originated in 1973 • Recognized by the SEC under Section 108 of the Sarbanes-Oxley Act of 2002 • “Designated Private-Sector Standard Setter” • Recognized under Section 203 of the AICPA’s Code of Professional Conduct • Standard-setter, not a regulator • No enforcement authority

4. Changes to FASB Oversight, Structure and Operations • Reduce the size of the Board from seven members to five members, effective 7/1/2008 • Composition to be one at-large member and four others having experience as a preparer of financial statements, an auditor, an academic, and a financial analyst/investor, respectively • Retain the simple majority voting retirement • Adopted a leadership agenda process • The Board’s technical agenda is established solely by the FASB Chairman, following consultation with the other Board members

5. Our Mission • To establish and improve standards of financial accounting and reporting • Accounting standards are essential to the efficient functioning of the economy • Good financial reporting reduces the uncertainty premium charged by investors and lenders.

6. Our Strategic Objectives • Improvement in U.S. financial reporting • Simplification of U.S. accounting standards and the standard-setting process • Convergence of financial reporting standards internationally

7. Information on Websitewww.fasb.org • FASB Standards, Concepts, and Interpretations, and Staff Positions (FSPs) • Audio Webcast of Board Meetings • Semi-Annual Detailed Technical Plan – April/October • Separate Summary Page for Each Project • EITF Material

9. Communication Improvements • Weekly e-mail for Action Alert for free • under “Action Alert” at left side of home page • Major codification of all authoritative GAAP has been developed. • A verification draft was issued in January 2008 for feedback during a one-year period • Ultimately, the codification will become the single authoritative source of U.S. GAAP, superseding all existing standards

10. Organization of Topics • Hedging Related Documents • FAS 161, Disclosures about Derivative Instruments and Hedging Activities • FSP on Disclosures about Credit Derivatives and Certain Guarantees • Exposure Draft, Accounting for Hedging Activities • Emission Allowances & Inventory Valuation • Determining Fair Value without an Active Market • Disclosure of Certain Loss Contingencies

11. Financial Accounting Standards Board FASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities

12. Derivatives Disclosures • Background • Statement 133 has been criticized by constituents for lacking transparent disclosures, including criticism in: • November 2004 Fitch Ratings Report • Berkshire Hathaway’s 2002 Annual Report • Numerous published articles • Project added to the Board’s technical agenda on March 9, 2005 and an Exposure Draft was issued on December 8, 2006 12

13. Derivatives Disclosures Objective: to provide an enhanced understanding of: • How and why an entity uses derivatives • How derivatives and related hedged items are accounted for under Statement 133 and its related interpretations, and • How derivatives affect an entity’s financial position, results of operations, and cash flows. 13

14. Derivatives Disclosures Scope • Statement 161’s scope is limited to all derivatives and all related hedged items accounted for under Statement 133. • The Board decided not to add a fourth objective to require information about an entity’s risk exposures and strategy for mitigating those risks • The Board decided not to expand the scope to include all financial instruments. 14

15. Derivatives Disclosures Tabular Disclosures • Statement 161 requires 2 tables • Those 2 tables focus on (1) where in balance sheet derivatives are located and what is the fair value (balance sheet table) and (2) where in income statement change in fair value is located and what is the change in fair value (income statement table) • Information on hedged items is required but does not have to be part of the tabular format 15

16. Derivatives Disclosures Other Required Disclosures • Statement 161 requires disclosure of the existence and nature of credit-risk-related contingent features embedded in derivative instruments. Disclosure must include: • The aggregate fair value of derivative instruments that contain those features • The aggregate fair value of assets posted as collateral, the aggregate fair value of additional assets that would be required to be posted as collateral and/or needed to settle the instrument if the contingent features were triggered 16

17. Derivatives Disclosures Other Required Disclosures • The Statement requires entities to qualitatively discuss, by underlying risk, its objectives for holding or issuing derivative instruments • The Statement requires entities to provide information that would enable users to understand its volume of derivative activity 17

18. Derivatives Disclosures Effective Date • The effective date for the final Statement is for financial statements issued for fiscal years and interim periods beginning after November 15, 2008 • In the first fiscal year this Statement is applied, information related to interim periods that began on or prior to November 15, 2008 may be omitted. Periods covered must be identified. • For example, March 31 fiscal year entity must provide disclosures for its 4th Qtr interim period ending 3/31/09 in its 2009 annual financial statements 18

19. Financial Accounting Standards Board FASB FSP No. FAS 133-1 and FIN 45-4, Disclosures about Credit Derivatives and Certain Guarantees

20. Disclosures about Credit Derivatives Background • There is a current focus on credit default swaps (CDS) given turmoil in credit markets • $62 trillion estimated notional amount of outstanding CDS • On actively traded names CDS volume is substantially greater than outstanding debt making it difficult to settle contracts • When Delphi defaulted - $28 billion outstanding CDS against $5.2 billion of bonds

21. Disclosures about Credit Derivatives Objectives • Improve disclosures about credit derivatives and guarantees to help users better understand their impact on an entity’s financial position, financial performance, and cash flows • Close the gap in GAAP • Align recognition/measurement and disclosures in same standards

22. Disclosures about Credit Derivatives Gap in GAAP • FIN 45 requires disclosures by guarantors for guarantees within its scope, which includes some, but not all, credit derivatives • FAS133 CDS for which the party purchasing the protection owns the referenced obligation are within the scope of FIN 45’s disclosure requirements • FAS133 CDS for which the party purchasing the protection does not own the referenced obligation are not within the scope of FIN 45’s disclosure requirements • Project would amend FAS133 and FIN 45 to result in the disclosure requirements for all FAS133 credit derivatives being included in FAS133

23. Disclosures about Credit Derivatives Scope • Credit derivatives within Statement 133 • Hybrid instruments that have embedded credit derivatives • Credit derivative is a derivative in which one or more of its underlyings (1) is related to the credit risk of a specified entity (or a group of entities) or an index on a group of entities (2) exposes the seller to potential loss from credit risk-related events specified in the contract • Derivatives such as CDS and credit spread options included • Derivatives such as plain vanilla interest rate swap not included • Guarantees within FIN 45

24. Disclosures about Credit Derivatives Disclosures Required for Sellers of Credit Derivatives: • The nature of the credit derivative, including the approximate term of the credit derivative, the events or circumstances that would require the seller to perform under the credit derivative, and the current status of the credit derivative (for example, the current credit risk of the referenced obligation). • The maximum potential amount of future payments (undiscounted) the seller could be required to make under the credit derivative. • That maximum potential amount of future payments shall not be reduced by the effect of any amounts that may possibly be recovered under recourse or collateralization provisions in the credit derivative (which are addressed below). If the terms of the credit derivative provide for no limitation to the maximum potential future payments under the credit derivative, that fact shall be disclosed. If the seller is unable to develop an estimate of the maximum potential amount of future payments under the credit derivative, the seller shall disclose the reasons why it cannot estimate the maximum potential amount.

25. Disclosures about Credit Derivatives Disclosures Required for Sellers of Credit Derivatives • The fair value of the credit derivative. • The nature of (1) any recourse provisions that would enable the seller to recover from third parties any of the amounts paid under the credit derivative and (2) any assets held either as collateral or by third parties that, upon the occurrence of any specified pre-agreed event or condition under the credit derivative, the seller can obtain and liquidate to recover all or a portion of the amounts paid under the credit derivative. • The seller shall indicate, if estimable, the approximate extent to which the proceeds from liquidation of those assets would be expected to cover the maximum potential amount of future payments under the credit derivative. In its estimate of potential recoveries, the seller of credit protection should consider the effect of any purchased credit protection with an identical underlying(s).

26. Disclosures about Credit Derivatives Timeline • Exposure Draft of the FSP issued in May 2008 with 30 day comment period. • 16 comments letters received • Redeliberations completed • Final FSP issued in September 2008 • Effective for reporting periods (annual or quarterly interim) ending after November 15, 2008

27. Financial Accounting Standards Board Proposed FASB Statement, Accounting for Hedging Activities

28. Accounting for Hedging Activities Project Objectives • Simplify accounting for hedging activities • Improve the financial reporting of hedging activities to make the accounting model and the associated disclosures easier to understand for financial statement users • Resolve hedge accounting practice issues that have arisen under Statement No. 133 • Address differences in the accounting for derivative instruments and hedged items or transactions

29. Accounting for Hedging Activities • The hedge accounting approach would: • Establish a fair value methodology to hedge accounting • Eliminate bifurcation-by-risk, the shortcut method, critical terms match, and the requirement to quantitatively assess effectiveness in order to qualify for hedge accounting • Thus, the hedged risk must be the risk of all changes in fair value of the hedged item or all changes in the hedged cash flows

30. Accounting for Hedging Activities Major Changes • Hedge Effectiveness • Qualitative instead of Quantitative • “Reasonably effective” replaces “highly effective” • No ongoing effectiveness testing unless circumstances suggest no longer reasonably effective • Requiring no effectiveness testing at all was considered, but rejected

31. Accounting for Hedging Activities Major Changes • Dedesignation • Discontinuation of hedge accounting only if hedging relationship is terminated • Discontinuation of hedging relationship by merely dedesignating the relationship is not permitted

32. Accounting for Hedging Activities Major Changes • Hedged Risk • General model is that the designated hedged risk must be all changes in fair value or variability in cash flows (bifurcation-by-risk not permitted) • Two exceptions: • Foreign exchange rate risk can be designated as the hedged risk • Interest rate risk can be designated as the hedged risk in a hedge of an entity’s own debt at inception of the debt

33. Accounting for Hedging Activities Major Changes • Measurement of Hedged Item in Fair Value Hedges • Hedged item and derivative hedging instrument must be independently measured for changes in fair value • Not permitted to take the change in fair value of the derivative, change the sign and apply it to the hedged item • All of contractual cash flows of the entire hedged item must be included in calculating the fair value • Adjust the carrying value of hedged item for changes in fair value during the hedge period

34. Accounting for Hedging Activities Major Changes • Measuring and Reporting Ineffectiveness in Cash Flow Hedges • Compare change in fair value of the actual derivative and the present value of the cumulative change in expected future cash flows on the hedged transaction • For example, an entity could compare the change in fair value of the actual derivative with the change in fair value of a derivative that would mature on the date of the forecasted transaction, be priced at market, and provide cash flows that would exactly offset the hedged cash flows • The difference would be reported in earnings as ineffectiveness • Nonperformance risk must be considered when calculating the fair value of the derivative hedging instrument • Permitted to use the same credit adjustment in the derivative that would exactly offset the hedged cash flows as used in the actual derivative

35. Accounting for Hedging Activities Major Changes • Measuring and Reporting Ineffectiveness in Cash Flow Hedges • Hedging with purchased options • When a purchased option contract is used as the hedging instrument to provide only one-sided protection, a purchased option derivative that would mature on the date of the forecasted transaction and provide cash flows that would exactly offset the one-sided change in the hedged cash flows could be used for calculating ineffectiveness. • Ineffectiveness can be measured using all changes in the option’s cash flows

36. Accounting for Hedging Activities Major Changes • Measuring and Reporting Ineffectiveness in Cash Flow Hedges • Hedging groups of transactions – first 100M in sales for January • Compare actual derivative to derivative that settles within a reasonable period of time of cash flows on forecasted transactions • Reasonable if the difference in forward rates between that derivative and derivative(s) that would exactly offset cash flows is minimal

37. Accounting for Hedging Activities Major Changes • Disclosures • For hedged items in fair value hedges - table showing amount reported in balance sheet, Statement 133 adjustment, other fair value adjustments, and the carrying amount excluding those adjustments • Hedging interest rate risk in issued debt – how hedging derivative changes maturity and interest rate on debt and the overall weighted-average interest rate

38. Accounting for Hedging Activities • Analysis of the comment letters received is proceeding. • At the October 21, 2008 joint IASB/FASB meeting, the Board will discuss the feedback received on this Exposure Draft and the Invitation to Comment, Reducing Complexity in Reporting Financial Instruments, in preparation for decision-making meetings in November.

39. Emission Allowances • Request from constituent to add project to address trading emission allowances • Constituent noted differing views about emission allowances being either trading inventory or an intangible asset • Constituent supported reporting emission allowances at fair value

40. Emission Allowances • On February 21, 2007, the Board added a project to its agenda to provide comprehensive guidance for participants in emission trading programs • Project will provide guidance for emission allowances as well as liability recognition and measurement as a result of an entity emitting pollutants

41. Valuation of Commodity Inventory • On March 14, 2007, the Board added a project to its agenda to provide guidance on whether ARB No. 43 should be amended to require fair value accounting (through earnings) for certain nonfinancial assets with readily determinable fair values that are held in trading inventory, possibly including traded emissions allowances

42. Valuation of Commodity Inventory • Proposed FSP ARB 43-a, Amendment of the Inventory Provisions of Chapter 4 of ARB No. 43, was released for comment on May 1, 2008. • Comments were due by June 16, 2008 and 34 letters were received.

43. Valuation of Commodity Inventory • The proposed FSP specifies the accounting for inventories (under the scope of ARB 43) included in an entity’s trading activities. • Entities should determine trading inventories based on their specific facts and circumstances and guidance in current GAAP about trading activities. “Trading” is not further defined. • Inventories included in an entity’s trading activities shall be initially and subsequently measured at fair value through earnings .

44. Valuation of Commodity Inventory • The proposed FSP would not change the accounting for nontrading inventories, such as those that are held for production, retail, wholesale, distribution, or any other nontrading activities. • It would require disclosures that enable financial statement users to understand the measurement basis for its trading inventories and the effect of inventory transfers from nontrading to trading and vice versa, if any, on the entity’s financial performance.

45. Valuation of Commodity Inventory • The Notice for Recipients for the proposed FSP also solicits input from constituents regarding other possible scopes: • Commodity inventories that are not used in production, wholesale, retail, or distribution activities. • Trading inventories that have readily determinable fair values (that is, those whose fair value estimates use only Level 1 and Level 2 inputs under Statement 157)

46. Valuation of Commodity Inventory • Other possible scopes: • All trading items even though those not physical inventories (that is, inventories included in an entity’s trading activities, including trading items other than inventories within the scope of ARB 43). • That would also potentially include storage and transportation contracts and land included in trading activities. • Issuance of a final Statement is projected for the 4th quarter of 2008.

47. Emission Allowances • The emission allowances project is proceeding separately from the commodity inventory project. • Both the IASB and the FASB are pursuing this issue as a joint project referred to as Emissions Trading Schemes.

48. Emission Allowances • The Emissions Trading Schemes project is scheduled for discussion at the joint IASB/FASB meeting on October 21, 2008. . • The two Boards will discuss the accounting issues raised by those arrangements in preparation for decision-making meetings in November 2008. • Issuance of an Exposure Draft is projected for 3rd quarter 2009 with a final Statement expected in 2011.

49. Determining Fair Value without an Active Market • On September 30, 2008, 65 members of Congress issued a letter to the SEC urging that the use of fair market accounting (or “mark-to-market”) be suspended and replaced with a form of “mark to true value.” • “In periods of market turmoil, financial institutions are forced to write down the value of long-term, non-trading assets below their true economic value.”. • Mark-to-market exacerbates economic downturns.

50. Determining Fair Value without an Active Market • On that same day, September 30, 2008, the SEC and FASB issued a joint press release that provided clarifications about the fair value measurement guidance in FASB Statement No. 157, Fair Value Measurements. • On October 1, the Board added a project to its agenda and discussed how to determine the fair value of a financial asset in a market that is not active.