1. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA GASB 53: Accounting and Financial Reporting for Derivative Instruments Presented by: Roger Martinez, Kathy Lai, KPMG LLP, and Ben Cheng, CO AUDIT

2. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Agenda Overview of GASB Statement No. 53 Definition of a Derivative Instrument Settlement Factors Leverage Net Settlement Scope Exceptions Hybrid Instruments What is a Derivative Recognition and Measurement Deferred Inflows and Outflows Presentation 2 May 2010 Year-End GAAP Training

3. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Agenda Cont. Miscellaneous Recognition and Measurement Items Determining Fair Value What is Hedging? Types of Hedges Association with a Hedgeable Item What Can Be Hedgeable Items? Overview of Hedge Effectiveness Hedge Effectiveness Testing Methods Other Quantitative Methods Termination of Hedge Accounting Disclosures for Hedging Derivative Instruments 3 May 2010 Year-End GAAP Training

4. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Agenda Cont. Effective Date and Transition CSU Survey Results Questions? 4 May 2010 Year-End GAAP Training

5. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Overview of GASB Statement 53 Statement issued in June 2008 Effective for periods beginning after June 15, 2009 Will require derivative instruments to be reported at fair value in financial statements prepared under the economic resources measurement focus Reporting changes in fair value will depend on whether derivative instrument is an effective hedge GASB has also issued a plain-language document on derivative instruments 5 May 2010 Year-End GAAP Training

6. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Overview of GASB Statement 53 Certain aspects of GASB Statement 53 are conceptually similar to FASB Statement 133, as amended: – Definition of a derivative instrument – Certain scope exceptions – Hedge accounting Although conceptually similar, there are many differences in application: – Hedge accounting required under GASB 53 if applicable – “All or nothing” approach to reporting changes in fair value using hedge accounting Not required to quantify ineffectiveness – Use of deferred inflows and outflows No other comprehensive income item – Methods of testing hedge effectiveness 6 May 2010 Year-End GAAP Training

7. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 7 Definition of a Derivative Instrument A derivative instrument is a financial instrument or contract that has all of the following: – Settlement factors One or more reference rates (underlyings) One or more notional amounts or payment provisions or both – Leverage Requires little or no net investment yet responds to market changes – Net settlement Contract terms require or permit net settlement Can be readily settled net outside the contract through a market mechanism; or Provides for delivery of an asset that is readily convertible to cash or is itself a derivative instrument See also Implementation Guide 7 May 2010Year-End GAAP Training

8. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Settlement Factors Reference Rates – Reference rate can be any variable with changes that are observable or otherwise objectively verifiable (cannot be the asset or liability itself) – Value of a derivative instrument generally changes by direct reference to changes in the reference rate Notional Amount – The number of units specified in a derivative contract (e.g. currency, shares, etc): – Amount applied to change in reference rate to determine settlement Payment Provisions – Fixed or determinable payment made if an underlying changes in a specified manner (e.g. payment if commodity price increases 10%) – Often included in lieu of a notional amount 8 May 2010 Year-End GAAP Training

9. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Leverage No initial net investment or smaller initial investment than required for other types of contracts having a similar response to changes in market factors Evaluated from perspective of one party to contract but determines the accounting for both parties Commodity example: – To buy 10,000 gallons of diesel fuel today at $3 gallon, must pay $30,000 – No money required to enter into forward contract for 10,000 gallons of oil at future date at forward spot price – Fair value of both the purchased diesel fuel and forward contract change similarly with changes in market price of diesel fuel 9 May 2010 Year-End GAAP Training

10. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Net Settlement Contractual Terms Net settlement characteristic has been met if neither party to the contract is required to deliver an asset that: – is associated with the underlying, and – has a principal amount, stated amount, face value, number of shares, or other determination that is equal to the notional amount in the contract Generally contracts with only a payment provision will meet net settlement under contractual terms 10 May 2010 Year-End GAAP Training

11. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Net Settlement Market Mechanism A market mechanism that facilitates net settlement must have ALL of the following characteristics: – Enables one party to the contract to readily liquidate its net position – Results in one party to the contract becoming fully relieved of its rights and obligations under the contract – Liquidation of net position: Does not require significant transaction costs Occurs without significant negotiation and due diligence Occurs within a customary time frame 11 May 2010 Year-End GAAP Training

12. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Net Settlement Readily Convertible to Cash Puts the recipient in a position not substantially different from net settlement through the contract Key characteristics: – Interchangeable (fungible) units – Quoted prices available in an active market – Market can rapidly absorb the quantity held by the entity without significantly affecting the quoted price – Significance of transaction costs 12 May 2010 Year-End GAAP Training

13. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Scope Exceptions Normal purchases and normal sales contracts Insurance contracts covered under Statement 10 Financial guarantee contracts that provide payments to the holder only for losses incurred because a specified debtor fails to make payment Certain contracts not exchange traded with an underlying based on: – A climatic, geological or other physical variable – A price or value of a nonfinancial asset Loan commitments 13 May 2010 Year-End GAAP Training

14. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Hybrid Instruments Derivative instruments are often free-standing instruments: – Swaps – Forward contracts Other times, derivative instruments may accompany or be embedded within a companion instrument: – Combined instrument referred to as a hybrid instrument – Important to identify because derivative instrument may require separate reporting from the companion instrument 14 May 2010 Year-End GAAP Training

15. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Hybrid Instruments Where to look: – Financial assets and liabilities – Purchase and service contracts – Leases What to look for: – Renewal, extension, cancellation and prepayment options – Caps, floors, collars – “If…then” contract provisions 15 May 2010 Year-End GAAP Training

16. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Reporting Hybrid Instruments The derivative and the companion instrument should be reported separately if: – Companion instrument is not measured at fair value – A separate instrument with the same terms as the embedded component would meet definition of a derivative instrument; and – Economic characteristics and risks of the derivative instrument are not closely related to those of the companion instrument Contracts outside the scope of GASB 53 need not be evaluated as a hybrid instrument 16 May 2010 Year-End GAAP Training

17. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Knowledge Check #1 Which factor is not considered a settlement factor based on the definition of a derivative: A.Reference rates B.Notional amount C.Leverage D.Payment provisions 17 May 2010 Year-End GAAP Training

18. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Knowledge Check #1: Answer C. Leverage A derivative must have settlement factors, leverage and net settlement. The settlement factors are reference rates, notional amount and payment provisions. 18 May 2010 Year-End GAAP Training

19. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Common Derivative Instruments AUDIT 2009 GASB 53 IMPLEMENTATION TEAM TRAINING Common Derivative Instruments May 2010 19 Year-End GAAP Training

20. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA What is a Derivative? An instrument value “depends on” or is “derived from” the value of an underlying asset, reference rate, or index GASB 53 defines derivatives based on characteristics versus listing instruments Continued innovations in financial markets render any definitions based on listing obsolete Understanding characteristic-based definition is essential to applying the statement May 2010 20 Year-End GAAP Training

21. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Types of Derivative Instruments Common Types – Futures – Forwards – Swaps – Options – Combinations of the above Synthetic financial instruments Uncommon Types – Basket Options – Barrier Options – Contingent Forwards – Currency Translated or Quanto- products – Combinations of items from both columns May 2010 21 Year-End GAAP Training

22. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Futures/ Forward Contracts Futures Contracts An exchange-traded security to buy or sell a security, commodity, foreign currency, or other financial instrument at a certain future date for a specific price Examples include: Commodity futures (including oil and natural gas) Interest rate futures Forward Contracts Contract to buy or sell a financial asset or commodity at a specified date in the future for a price agreed upon at inception Examples include: Forward rate agreements Forward commodity contracts May 2010 22 Year-End GAAP Training

23. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Forward Purchase Contract Value at Maturity V = Value of Contract P = Price $400 May 2010 23 Year-End GAAP Training

24. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Swap Agreements Agreement between two counterparties to exchange sequences of cash flows over a specified period of time (e.g. interest rate swaps, currency swaps, commodity swaps) Exotic swaps Forward-starting swaps Index-amortizing swaps Leveraged swaps Swaptions – can be used to monetize a call feature in a bond Swaps with embedded options May 2010 24 Year-End GAAP Training

25. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Option Contracts Provide holder the right, but not the obligation, to buy or sell underlying instrument at a specified price Strike price Exercise style American options European options Bermudan options* Asian options* Premium Call vs. put options Option value = time value + intrinsic value Exotic option types (includes Bermudan and Asian) May 2010 25 Year-End GAAP Training

26. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Examples of Option Contracts Equity options Interest rate and currency options Embedded options May 2010 26 Year-End GAAP Training

27. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Combinations of Options Caps Series of individual call options Gives buyer the right to receive positive difference between the cap rate and reference rate Requires payment of a premium Floors Series of individual put options Gives buyer the right to receive the negative difference between the floor rate and reference rate Collars Combination of a purchased cap and a written floor Combination of a written cap and a purchased floor May 2010 27 Year-End GAAP Training

28. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Valuation of Derivative Instruments GASB 53 paragraph 21 Zero coupon method (for swaps) Par value method (for forwards) SAS No. 92, Auditing Derivative Instruments, Hedging Activities, and Investment Securities SAS No. 101, Auditing Fair Value Measurements and Disclosures May 2010 28 Year-End GAAP Training

29. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Knowledge Check #2 29 An entity enters into an agreement with a supplier to purchase a quantity of heating oil at a certain future time, for a certain price, and a certain quantity. What type of derivative is this considered? A.Futures Contract B.Forward Contract C.Option D.Swap Agreement May 2010Year-End GAAP Training

30. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Knowledge Check #2: Answer 30 B. Forward Contract A forward contract is a contractual agreement to buy or sell a security, commodity, foreign currency, or other financial instrument, at a certain future date for a specific price. May 2010Year-End GAAP Training

31. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Valuation Examples Valuation is outside the scope of this course Examples: – Valuing Forwards – Valuing Interest Rate Swaps 31 May 2010 Year-End GAAP Training

32. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Common Derivative Instruments AUDIT 2009 GASB 53 IMPLEMENTATION TEAM TRAINING Recognition and Measurement Provisions May 2010 32 Year-End GAAP Training

33. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 33 Recognition and Measurement Derivative Instruments are Reported at Fair Value Generally, all derivative instruments within the scope of GASB 53 should be reported on the statement of net assets at fair value – Exception for certain synthetic guaranteed investment contracts Reporting the changes in fair value depends on the classification of the derivative instrument: 1. Hedging derivative instrument (HDI) → Apply hedge accounting Entire fair value change is deferred on the statement of net assets (deferred inflow and outflow accounts) Continue to apply hedge accounting until a termination event occurs 2. Investment derivative instrument → Apply investment accounting All derivative instruments not considered HDIs are investment derivative instruments Fair value change is reported on the change statement in the period it occurs (investment revenue classification) May 2010Year-End GAAP Training

34. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Recognition Under Hedge Accounting For HDIs that have positive fair values: – Report HDI as an asset – Report deferred inflow (credit) offsetting the asset For HDIs that have negative fair values: – Report HDI as a liability – Report deferred outflow (debit) offsetting the liability Unlike under FASB 133, entire amount of the HDI is offset by the deferred inflow or outflow: – No calculation of “ineffectiveness” amount that would be reported as a current period change statement item 34 May 2010 Year-End GAAP Training

35. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Presentation of Derivative Instruments Currently, there is no specific guidance on how to present derivative instruments on the Statement of Net Assets: – Aggregated gross under “derivatives” captions within assets and liabilities sections? – Aggregated net under a single “derivatives” caption? – HDIs netted with hedged assets and liabilities? – Investment derivative instruments reported within investments captions? – Combination of all of the above? – How should derivatives be classified within the net asset categories? Where derivatives are reported in Statement of Net Assets will be part of required note disclosures 35 May 2010 Year-End GAAP Training

36. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Miscellaneous Recognition and Measurement Items Hedge accounting is mandatory under GASB 53 HDIs should be reported in the same fund as the item being hedged Transactions for exchange-traded derivatives should be accounted for based on the trade date, not the settlement date Entities applying FASB 71 for regulated utilities must still apply hedge accounting 36 May 2010 Year-End GAAP Training

37. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 37 Determining Fair Value Use market price if there is an active market for the derivative instrument If a market price is not available, then use a forecast of expected cash flows (discounted) Also acceptable: – Formula-based methods – Mathematical methods Zero-coupon method Par-value method Matrix pricing Black-Scholes-Merton Model – Pricing services, provided they use the principles described above FASB 157 approach may, but is not required, to be applied May 2010Year-End GAAP Training

38. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 38 Knowledge Check #3 Except certain synthetic guaranteed investment contracts, all derivative instruments within the scope of GASB 53 should be reported on the statement of net assets at fair value A.True B.False May 2010Year-End GAAP Training

39. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 39 Knowledge Check #3: Answer A. True An entity should use market price if there is an active market for the derivative instrument to estimate fair value. If a market price is not available, then use a discounted cash flows methods. Formula or mathematical based methods or pricing services are also acceptable May 2010Year-End GAAP Training

40. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Common Derivative Instruments AUDIT 2009 GASB 53 IMPLEMENTATION TEAM TRAINING Hedge Accounting May 2010 40 Year-End GAAP Training

41. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA What is Hedging? Hedging is a method governments employ to reduce identified financial risks: – Increases in interest costs – Increases in commodity prices – Losses due to counterparty default – Fair value declines due to changes in market interest rates Governments use derivative instruments as a mechanism to hedge identified financial risks – Risks hedged through changes in cash flows or fair values of derivative instruments offsetting changes in cash flows or fair values of associated items 41 May 2010 Year-End GAAP Training

42. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Types of Hedges Cash flow hedges: – Address risks that arise due to prices or rates that are variable: – Manage risks by eliminating variable or market fluctuations to which the cash flows of the associated item are subject: – Majority of hedges undertaken by governments are cash flow hedges Fair value hedges: – Address risks of changes in fair values of items that have prices or rates that are fixed or known – Manage risks by “unlocking” fixed prices and rates thereby allowing item to be valued as if it had current market rate/price 42 May 2010 Year-End GAAP Training

43. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 43 Hedging Derivative Instruments A Hedging Derivative Instrument (HDI) is established, and hedge accounting MUST be applied if there is: – Association: Derivative instrument is associated with a hedgeable item AND – Substantial Offset: Derivative instrument is effective in substantially offsetting changes in cash flows or fair value of the hedgeable item resulting from the identified financial risk  hedge effectiveness Hedge accounting is NOT an option Contemporaneous documentation of the hedge is encouraged, but NOT required for application of hedge accounting May 2010Year-End GAAP Training

44. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Association with a Hedgeable Item Absent a documentation requirement, it may not always be apparent whether a derivative instrument is associated with a hedgeable item Consider facts and circumstances of derivative instrument, including whether: – Notional amount of derivative instrument is consistent with principal/quantity of hedgeable item – Derivative instrument will be reported in the same fund as the hedgeable item – Term or time period of derivative instrument is consistent with that of the hedgeable item Derivative instrument that is associated with a hedgeable item, but has yet to be determined effective is referred to in GASB 53 as a potential hedging derivative instrument (PHDI) 44 May 2010 Year-End GAAP Training

45. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA What Can Be Hedgeable Items? Hedgeable items can be all or a portion of: – A single asset or liability An entire bond issuance $60 million of a $100 million bond issuance may be hedgeable item – Groups of similar assets and liabilities Individual assets or liabilities in the group must be exposed to the same identified financial risk being hedged – An expected transaction Expected bond issuance Expected commodity purchase/sale Assets and liabilities measured at fair value cannot be hedgeable items – Fair value of hedgeable item reported in change statement so no need for hedge accounting Transactions within primary government cannot be hedgeable items Transactions between primary government and discretely presented component units can be hedgeable items 45 May 2010 Year-End GAAP Training

46. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA What Can Be Hedgeable Items? Expected Transactions For an expected transaction to be a hedgeable item, it should be probable of occurring Probability should be supported by observable facts, including: – The frequency, volume and amount of past transactions – The financial, operational, and legal ability of the government to carry out the transaction – The extent of loss or disruption to a government’s activities that could result if the transaction does not occur – The government’s budget or other planning documents If the hedgeable item is an expected transaction, the evaluation of effectiveness should consider the probable terms of the transaction 46 May 2010 Year-End GAAP Training

47. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Knowledge Check #4 An entity issues fixed-rate bonds and at the same time, it enters into an interest rate swap that would swap its fixed bond payments for interest payments that are at market. What type of hedge is this? A.Cash flow hedge B.Fair value hedge 47 May 2010 Year-End GAAP Training

48. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Knowledge Check #4: Answer B. Fair value hedge By entering into the interest rate swap, the entity would synthetically be paying the market interest rate, keeping the fair value of the bond liability consistently at par. 48 May 2010 Year-End GAAP Training

49. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Overview of Hedge Effectiveness Hedge effectiveness testing should be performed for each PHDI: – At the end of the reporting period of the inception of the hedge; and – At the end of each subsequent reporting period for as long as the hedge is effective End of reporting period applies to interim periods if financial statements are prepared on a GAAP basis Hedge effectiveness testing is not required at the inception of the hedge Different testing methods may be used across the population of PHDIs 49 May 2010 Year-End GAAP Training

50. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Hedge Effectiveness Testing Methods GASB 53 provides the following methods for testing hedge effectiveness: – Consistent Critical Terms Method – Quantitative Methods Synthetic Instrument Method Dollar-Offset Method Regression Analysis Method GASB 53 also provides conceptual requirements for other quantitative methods not specified in Statement 50 May 2010 Year-End GAAP Training

51. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 51 Overview of Hedge Effectiveness Order of Application of Methods The methods for testing hedge effectiveness should be applied as follows: First Reporting Period If use CCT first and it fails  MUST use at least one quantitative method before concluding the relationship is ineffective If use quantitative method first and it fails  MAY, but not required to use other methods before concluding the relationship is ineffective Subsequent Reporting Periods First use method applied in previous period  if fails, MAY, but not required to use other methods before concluding the relationship is ineffective May 2010Year-End GAAP Training

52. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 52 Evaluation of Hedge Effectiveness New Market Conditions New market conditions are caused by events that significantly change the historical relationship between the derivative and the hedgeable item Examples of new market conditions: – Changes in income tax rates that affect the demand for tax- exempt debt – Natural disaster that upsets the supply of a commodity  If new market conditions occur, only hedge effectiveness methods that use forward-looking data should be used: – Dollar-offset method (change in fair values or expected cash flows) – In some instances, regression analysis that uses fair values May 2010Year-End GAAP Training

53. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 53 Other Quantitative Methods GASB 53 allows for use of other quantitative methods To be used, method should: – Demonstrate through analysis of quantitative critical terms that hedged changes in cash flows or fair values of PHDI offset those of hedgeable item – Generate replicable, consistent evaluations of effectiveness such that different evaluators would achieve similar results – Incorporate consideration of substantive characteristics of PHDI and hedgeable item that could affect cash flows or fair values If used, details of method should be disclosed To date, GASB has not specifically identified any other quantitative methods May 2010Year-End GAAP Training

54. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 54 Knowledge Check #5 If an entity uses a quantitative method first (in the first reporting period) and it fails they are required to use other methods before concluding the relationship is ineffective. A.True B.False May 2010Year-End GAAP Training

55. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 55 Knowledge Check #5: Answer B. False If an entity uses a quantitative method first (in the first reporting period) and it fails, they MAY, but are not required to use other methods before concluding the relationship is ineffective May 2010Year-End GAAP Training

56. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 56 Termination of Hedge Accounting GASB 53 identifies 6 events that result in termination of hedge accounting: a. HDI is no longer effective b. Likelihood that a hedged expected transaction will occur is no longer probable c. Hedged asset or liability is sold or retired, but not refunded or defeased d. HDI is terminated e. Hedged debt is refunded or defeased f. Hedged expected transaction occurs Key decision to be made when hedge accounting is terminated is how to dispose of the related deferred inflow or outflow Disposition depends on the event resulting in the termination of hedge accounting May 2010Year-End GAAP Training

57. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Common Derivative Instruments AUDIT 2009 GASB 53 IMPLEMENTATION TEAM TRAINING Required Note Disclosures May 2010 57 Year-End GAAP Training

58. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 58 Summary of Derivative Instrument Activity Summary of derivative instrument activity provided by: 1. Governmental activities, business-type activities, and fiduciary activities 2. Then by fair value hedges, cash flow hedges, and investment derivatives 3. Then by type: Receive-fixed interest rate swap Rate caps Futures contracts May 2010Year-End GAAP Training

59. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Summary of Derivative Instrument Activity Summary should include the following information: – Notional amount – Fair values and changes in fair value and where such amounts are reported in the financial statements – Fair values of derivatives reclassified from hedging to investment derivatives and the deferral amount reported in investment revenue upon termination of hedge accounting 59 May 2010 Year-End GAAP Training

60. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 60 Summary of Derivative Instrument Activity Change in Fair Value Fair Value at June 30, 2008 Dr. (Cr.) NotionalClassificationAmountClassificationAmount Governmental activities Fair value hedges Receive-fixed interest rate swap $ 30,000 Deferral$(277)Debt $ 1,572 Cash flow hedges Pay-fixed interest rate swaps $ 84,000 Deferral(143)Debt(1,253) Rate cap $ 10,000 Deferral28Debt77 Investment derivatives Pay-fixed interest rate swap $ 18,000 Investment income 1,277Investment(1,277) Business-type activities Cash flow hedges Pay-fixed interest rate swap $ 37,000 Deferral (548) (548)Debt4,236 Commodity forward 1,000,000 MMBTUs Deferral (111) (111)Derivatives111 Fiduciary funds Investment derivatives Foreign currency forward 20,000UK Investment income 721Investment(721) The pay-fixed interest rate swap listed as an investment derivative under governmental activities was evaluated to be an ineffective hedge for accounting and financial reporting purposes during fiscal year 2008. Accordingly, the changes in fair value of the swap that had been deferred through June 30, 2007 of $(1,409) along with the change in fair value of the swap in fiscal year 2008 of $132 have been recorded as investment income for the year ended June 30, 2008. May 2010Year-End GAAP Training

61. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Summary of Derivative Instrument Activity If derivative instrument fair values are determined by other than quoted prices, disclose methods and significant assumptions used to estimate fair value If fair value determined by pricing service, not required to disclose significant assumptions if pricing service: – Considers them proprietary; and – Declines to make information available Disclose pricing service would not make information available 61 May 2010 Year-End GAAP Training

62. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Disclosures for Hedging Derivative Instruments Disclosures in the following areas should be provided for hedging derivative instruments (HDIs): – Objectives and strategies – Terms – Financial risks – Impact on cash flows related to hedged debt 62 May 2010 Year-End GAAP Training

63. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Disclosures for Hedging Derivative Instruments Credit risk Interest Rate Risk Basis Risk Termination Risk Rollover Risk and Market Access Risk Foreign Currency Risk 63 May 2010 Year-End GAAP Training

64. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Knowledge Check #6 Which of the following risk(s) is/are required disclosures under GASB 53? A.Credit Risk B.Interest Risk C.Basis Risk D.All of the above 64 May 2010 Year-End GAAP Training

65. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Knowledge Check #6: Answer D. All of the above Credit risk, interest rate risk, and basis risk are all required disclosures in addition to termination risk, rollover risk, market access risk and foreign currency risk. 65 May 2010 Year-End GAAP Training

66. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Other Disclosure Requirements Disclosures for Hedging Derivative Instruments—Use of Other Quantitative Method Disclosures for Investment Derivative Instruments Contingent Features Other Required Disclosures Miscellaneous Disclosure Items 66 May 2010 Year-End GAAP Training

67. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA 67 Effective Date and Transition Effective for financial statements for periods beginning after June 15, 2009 Provisions should be retroactively applied; restate prior periods presented if practical Perform effectiveness testing of existing HDIs at the end of the period of implementation: – If effective, apply as if effective since inception – If ineffective, test as of end of prior period: If effective, write-off deferral during implementation period If ineffective, fair value incorporated into cumulative effect of change in accounting Take note of retroactive application for hybrid instruments and termination of hedge accounting provisions May 2010Year-End GAAP Training

68. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA CSU Applicability Survey Results 68 May 2010 Year-End GAAP Training

69. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Presenters Roger Martinez KPMG Partner (213) 955-8671 ramartinez@kpmg.com Kathy V. Lai KPMG Senior Manager (949) 885-5516 kvillanueva@kpmg.com Ben Cheng Sr. Financial Reporting Manager (562) 951-4548 bcheng@calstate.edu 69 May 2010 Year-End GAAP Training

70. © 2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 15996ORA Questions? 70 May 2010 Year-End GAAP Training