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Business and Policy Areas
Business and Policy Areas

Deadline Approaching to Respond to GASB on Derivatives

July 24, 2007

GASB Proposes Standard Addressing Derivative Instruments

The Governmental Accounting Standards Board (GASB) issued "Accounting and Reporting for Derivative Instruments" on June 29. The Exposure Draft has a comment deadline of October 26. The document is the result of months of research and GASB deliberations on comments received from the April 2006 Preliminary Views document. The proposal addresses recognition, measurement, and disclosure requirements for derivative instruments.

A derivative instrument is a financial arrangement with a third party or parties typically entered to hedge financial risk associated with outstanding assets, liabilities, or future transactions; to lower the cost of borrowing; or to make investment. A derivative instrument’s fair value is derived from some other instrument, rate, or price. Common types of such instruments include interest rate and commodity swaps, interest rate locks and options, swaptions, forward contracts, and futures contracts.

A key provision of the Exposure Draft -- and a major change from common current practice -- is  that most derivatives covered in the scope of the proposal would be reported at fair value in the statement of net assets. Annual changes in fair values of derivative instruments that are not determined to be effective hedges would be reported in the change statement. Alternatively, derivatives that are effective hedges would have a hedge accounting requirement.

The Exposure Draft describes and illustrates methods of evaluating hedge effectiveness:

• The consistent critical terms method considers the terms of the hedging derivative instrument and the hedged item. If relevant terms match or in certain instances are similar, a potential hedging derivative instrument is considered to be effective.

• The synthetic instrument method considers whether a fixed-rate or price has been established within a prescribed range.

• The dollar-offset method evaluates changes in cash flows or fair values over time between the hedged item and the hedging derivative instrument.

• The regression analysis method considers the statistical strength of the relationship between the cash flows or fair values of the hedged item and the hedging derivative instrument. In this and the prior two quantitative methods, ranges of values are proposed for a potential hedging derivative instrument to be considered effective.

Quantitative methods other than those specified in the proposed statement would be permitted, provided that they address whether the changes in cash flows or fair values of the potential hedging derivative instrument substantially offset the changes in cash flows or fair values of the hedgeable item.

The disclosures of Technical Bulletin No. 2003-1, Disclosure Requirements for Derivatives Not Reported at Fair Value on the Statement of Net Assets, have been incorporated into this proposal for hedging derivative instruments. Disclosures for investment derivative instruments would be modified to be more consistent with the disclosures of other investments.

The requirements of the proposed statement would be effective for financial statements for periods beginning after June 15, 2009. The Exposure Draft and plain language article are available on the GASB Web site. The GASB also will be holding a public hearing in New York City on Nov. 1 -- several days after the October 26 comment deadline. NACUBO encourages public institutions to read and respond to the Exposure Draft by the comment deadline. NACUBO would like to represent higher education at the hearing and will use your thoughts and comments to inform its comment letter and testimony. Members with feedback on the proposed standard should contact Sue Menditto, director of accounting policy.