1 Financial Accounting Standards Board Hedging Project IASB Education Session June 18, 2008 Kevin Stoklosa IASB MEETING JUNE 2008 OBSERVER NOTE 5

2 Hedging Project 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

3 Hedging Project The hedge accounting approach would establish a fair value methodology to hedge accounting. The approach would eliminate many elements that exist under the current hedge accounting model, including bifurcation-by-risk, the shortcut method, critical terms match, and the requirement to quantitatively assess effectiveness in order to qualify for hedge accounting The items and transactions currently eligible for hedge accounting would continue to be eligible under this approach.

4 Hedging Project Major Changes Hedge Effectiveness – Qualitative instead of Quantitative – Reasonably effective – No ongoing effectiveness testing unless circumstances suggest no longer reasonably effective – No effectiveness testing at all was considered

5 Hedging Project Major Changes Dedesignation – Discontinuation of hedge accounting only if hedging relationship is terminated – Discontinuation of hedging relationship by merely dedesignating is not permitted

6 Hedging Project 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 headed risk in a hedge of an entity’s own debt at inception of the debt

7 Hedging Project 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

8 Hedging Project 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

9 Hedging Project 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

10 Hedging Project 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

11 Hedging Project Major Changes Disclosures – For hedged items in fair value hedges - table showing amount reported in balance sheet, Statement 133 adjustment, Other fair value adjustments, amount excluding those adjustments – Hedging interest rate risk in issued debt – how hedging derivative(s) changes maturity and interest rate on debt