Discussion:FASB 133

Before 2008, each hydro facility (3) was in a different state and each was owned by a separate entity: 1 S corporation and 2 LLCs. The combined financials created no real financial statement issues and intercompany loans and management fees were eliminated. My clients, although engineers by training, are fairly simple people as well and spend very little time considering financial matters except to screw up their payroll every year so I can answer the IRS notices and/or redo both W-2 forms and the 941 forms.

My last observation to them was that I noticed payments from an LLC to a certain individual had grown substantially during 2008. I had assumed this individual was a subcontractor and noted that not only had we not issued a 1099 but perhaps the payments to the individual were substantial enough that a capital asset had been created. I had assumed the expenditures were for repairs. They replied that this individual was paid due to an “interest swap” contract they had. They said that they paid him the difference between the interest the bank charges (now down to 4%) and 9%. If interest rates rise in the future over 8.61% the roles reverse and my clients get paid the difference between the bank rates and 9%. My clients say the bank is aware of the agreement, which was not disclosed on the 2007 financials. The payments in 2007 were insignificant.

If I understand my client’s intentions fully, this seems to be a “cash flow hedge” rather than a “fair value hedge”. Both hedges in the FASB seem to have certain requirements such as having “a reasonable basis for how the entity plans to assess the hedging instrument’s effectiveness”, “An assessment of effectiveness is required whenever financial statements or earnings are reported, and at least every three months”, and “All assessments of effectiveness shall be consistent with originally documented risk strategy for the particular hedging relationship”.

My client does none of these things. Does this mean they do not have a derivative or a hedging activity? And since they are a small operation they need not adjust assets and liabilities to fair market values? And, can I “get by” with a disclosure of the existence of the “interest swap” to the extent needed for the user to analyze cash flows?

133 is a beast. Good luck.

First of all what explains my client's behavior"(e.g. no effectiveness documentation, no real accounting for hedging activity, etc.)" applies to all aspects of accounting not just hedges. They write a couple hundred checks a year total and they send me the banks statements and loan statements. I look at the next year's statements to find the accrual items.

However, with clients like these I have easily avoided such issues as derivatives and Other comprehensive income. Ironically, now that I am no longer a CPA and I am (trying to) focus on tax matters, many new accounting issues have arisen including one of my simplest clients entering into a hedging arrangement.

FASB 133 is difficult for those of us with little or, in my case, no financial markets background. Without that knowledge of financial transactions the examples in the FASB don’t help much either. I confess that in FASB 133 paragraph 112 describing the “zero coupon method” that the wording “involves computing and summing the present value of each future net settlement that would be required by the contract terms if future spot interest rates match the forward rates implied by the current yield curve” was beyond my comprehension. I did follow the example in the FASB after paragraph 112, though, which seems to apply to a “fair value hedge”.

It seems that there is no way I can avoid recording a liability to account for the agreement. The client’s debt to a bank last December was $1.4M and over the next 8 years (through December 2016) the debt will be paid down to $900,000. The current (variable) interest rate charged by the bank is 4%. The bank requires monthly payments (and the principal portion is the same amount each month). The “hedge” agreement rate is a fixed 9%. It seems my clients have a $350,000 liability since the NPV of the payments to the bank if paid at 9% would create a $1,750,000 liability at 4%. And, based upon your comments, (if I understand them) I have to book a balance sheet item (in this case a liability since the hedge currently to cost more than the bank debt)

But the article in the NYSSCPA seems to quote one Society member as saying that the shortcut method requires no entries. Another says that using fair values can avoid the hedge accounting altogether. I assume maybe FASB 157 comes into play here? Maybe the lack of documentation means I have to use the accounting for a “fair value hedge”?

An effective “fair value hedge” merely shifts value between the bank debt (in my issue) and the hedge agreement? No P&L items and no other comprehensive income? The lack of documentation seems to preclude either method, am I now implementing FASB 157 regarding fair values (as amended)?

I am thinking of the following disclosure in the Long Term Debt section of my client’s financial statements:

The Company has entered into an agreement over the term of the above notes to the bank in an attempt to minimize risks from the variable interest rates. This agreement requires the company make monthly payments to an individual. The amount paid is based on interest accrued on the principal balance each month. Each monthly amount equals the difference between the interest charged by the bank for that month and 9%. If the bank rates exceed 9% the company will receive payments for the difference in rates.

The Company has no plans to assess the effectiveness or ineffectiveness of this strategy and has therefore is unable to ascertain the value of this agreement.I think that will give the bank loan analysts sufficient information to determine future cash flows and deal with a renewal of another loan that uses the LLC as collateral. In fact, it is probably more useful that FASB 133 information.

I realize there are too many considerations to properly address hedging in an online forum. If any of my comments above are way out of line, I would appreciate knowing that. No explanation necessary.

Thank you again for your previous comments.

Am weighing need to have financial data to a couple regional banks ASAP for loan renewals and likelihood of finding an expert in FASB 133 and obtaining his input on transaction within a few days. No one within 100 miles of me has touched derivatives, just heard about them in classes that made us aware that derivatives exist and what they might look like.

Since the bank assisted in arranging the interest swap (although they are not a party to it), the facts concerning the swap are in the notes right at the long term debt section, and the only user of the financials is the bank I am not concerned about misleading anyone.

Frankly, do you think the FASB 133 inclusion of balance sheet amounts provides more information; at least regarding interest swaps? I have read several disclosures over the past week and have found them obtuse. I think that a company trading in derivatives may need to calculate values of contracts. But having company calculating the (momentary) value of a swap seems about as useful as calculating a deferred tax liability or (more so) asset. I have spent hours explaining accounting concepts to bankers, especially items peculiar to contractors. I can see where the recording of a liability/asset, amortizing it, and making entries to interest expense and Other Comprehensive income would really bog down the folks at the bank.

Since you have worked in both small and large firms you may have a better grasp on the usefulness of information than most.