Transcript Emerging Issues for Not-for

Accounting for Interest Rate Swaps
2009 Telergee CFO Conference
Newcastle, New Hampshire
October 15, 2009
Presented by Bill Brown
Relationship of Audience Attention Span to
Number of Accounting Standards References
Minutes
Uninteresting professional standard references
It’s all about the Hedging
Definitions
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Interest rate swap
Derivative
Hedge
Hedge Accounting
Fair Value Hedge
Cash Flow Hedge
Disclaimer on 15 Minute Primer
• Discussion of important practical considerations, not
a structured study of the complex derivative
accounting rules
• Accounting Standards Codification - 815 Derivatives
and Hedging
• fka FAS 133 and 149
Executive Summary
• Cash settlements paid or received (quarterly) are
recorded as an increase or decrease to interest
expense
• The contract must be recorded at fair value, which is
typically zero at inception
• Changes in fair value are recorded in earnings
unless you can apply hedge accounting, in which
case they are recorded in Other Comprehensive
Income (equity)
2 Step Process to Apply Hedge Accounting
• Qualifying as a hedge (initial assessment)
• Assessing effectiveness/measuring ineffectiveness
(ongoing)
Qualifying as a Hedge
• Documentation
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Risk being hedged
Reason for undertaking
Method for assessing effectiveness
Method for measuring ineffectiveness
• Expectation of highly effective
– When financials prepared/at least every 3 months
– Prospective and retrospective
Highly Effective
• 80-125% correlation between cash flows associated
with hedged risk and cash flows of the swap
• This applies to expected future cash flows as well as
historical
• Regression analysis is sometimes used to make this
assessment
Measuring Ineffectiveness
• Standards discuss 3 methods:
– Change in variable cash flows method
– Hypothetical derivative method
– Change-in-fair-value method
Shortcut Method
• Criteria for no ineffectiveness
– Notional amount of swap matches principal amount
– Fair value of the swap at inception is zero.
– Formula for computing net settlements under the interest
rate swap is the same for each net settlement. (fixed rate
same throughout term and variable rate is based on same
index.)
– Debt not pre-payable separately or without penalty. Other
terms in the debt or swaps typical of those instruments
and do not invalidate the assumption of no
ineffectiveness.
Shortcut Method
• Criteria for no ineffectiveness (continued)
– All interest payments on the variable-rate liability during
the term of the interest rate swap are designated as
hedged
– If there is a floor or cap, it is comparable to the floor or cap
on the variable rate liability
– Repricing dates for swap and underlying debt occur on
same date and are calculated the same
– Quarterly assessments not required
– Specific to interest rate swaps
Match of Critical Terms
• Permits an assumption of a highly effective
relationship
• General – applies to different types of hedges
• Needs to be assessed on an ongoing basis
Disclosure
• Don’t forget that footnote disclosure is required
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Why
How
How much
Where
When
Terms
Madness
Madness does not always howl.
Sometimes, it is the quiet voice at the end of the day
saying,
"Hey, is there room in your head for one more?"
Enjoy New Hampshire!