FAS133 Regulation hedge accounting.ppt

SAP AG 2000 SAP Corporate Finance Management / 1

FAS 133


Agenda

Sample Business Scenario

Hedge Management - Applicationand Customizing

1111

2222

FAS 133 - Key Concepts

3333


Agenda

Sample Business Scenario


1111

2222


3333


Hedging vs Hedge Accounting

Hedging:

Hedging of an open risk position by building up an offsetting position, so that gains and losses from the open underlying transaction and the hedging transaction clear each other

Problem From an Accounting Perspective:

If different balance sheet values are applied to the underlying and hedging transactions (carrying value and valuation), then the mutually clearing gains and losses are shown in different periods (distortion of the income statement in at least two periods)

Hedge Accounting:

Exceptional accounting rule that enables the mutually clearing gains and losses from the underlying transaction and the hedging transaction to be shown in the same period and, therefore, to allow a correct statement of profit


Hedge Accounting - Definition

Hedge Accounting…

…matches the impact of the hedged item and the

hedging instrument in the income statement. Without hedge accounting, income volatility can result...


FAS 133 - Definition

FAS 133 is a US-GAAP regulation which was issued by the FASB (Financial Accounting Standards Board)

FAS 133 standardizes accounting for derivative instruments by requiring that

all derivatives have to be reported on the balance sheet

all derivatives have to be valuated at their fair value

Full adoption of these requirements would create large volatility in a company‘s income statement.

To prevent this, the board has introduced special accounting rules.

If a company can prove that a derivative is designated to hedge a certain specified risk, there is an opportunity to defer the earnings impact of changes in fair value of the derivative. This is referred to as qualifying for hedge accounting under FAS 133.


FAS 133 - Fundamental Decisions

“Derivative instruments represent rights or obligations that meet the definitions of assets or liabilities and should be reported in financial statements.”

“Fair value is the most relevant measure for financial instruments and the only relevant measure for derivative instruments.”

“Only items that are assets or liabilities should be reported as such in financial statements.”

“Special accounting for items designated as being hedged should be provided only for qualifying items. One aspect of qualification should be an assessment of the expectation of effective offsetting changes in fair values or cash flows during the term of the hedge for the risk being hedged.”

In developing FAS 133, the Financial Accounting StandardsBoard (FASB) concluded...


Hedge Accounting - Basic Questions

Which basic forms of hedge accounting exist (hedge categories)?

Which basic transactions can be hedged (hedged items)?

Which hedging instruments can be used?

When does a hedge qualify for hedge accounting? Which hedge accounting rules have to be applied to the hedged item and the hedging instrument?








Cash flow hedge:

Hedging of underlying transactions (included in the balance sheet) or of anticipated transactions against fluctuations in future cash flows

Fair value hedge:

Hedging of underlying transactions included in the balance sheet (or of clearly identified parts of underlying transactions) against changes in their Fair Value

Hedge categories:

Fair value hedge

Cash flow hedge

(Foreign currency hedge = special case)

FAS 133 - Hedge Categories


Fair Value Hedge vs Cash Flow Hedge (1)

Risk:

possible fluctuations in future fair values from balance sheet items (and firm commitments)

Hedging by:

Removal of price fixing, making future payment flows ‘variable’

Cause:

Future payment flows fixed by contract (for example, purchase or sales prices, interest, exchange rates)

Fair Value Hedge

Risk:

possible fluctuations in future fair values from balance sheet items and expected transactions

Hedging by:

Price fixing, determining future payment flows by contract

Cause:

Non-fixed future payment flows (for example, purchase or sales prices, interest, exchange rates)

Cash Flow Hedge


Fair Value Hedge vs Cash Flow Hedge (2)

Fixed-interest financial instruments

Variable-interest financial instruments

Possible fluctuations in future market

values

Fair value hedge

Possible fluctuations in future cash flows

Cash flow hedge








Hedged Items

Recognized assets and liabilities - It is also permissible to designate percentage shares of assets/liabilities or certain contracted payment flows or their values as hedge items

Unrecognized firm commitments are contractual obligations or liabilities with external third parties. All important parameters such as quantity and price are fixed.

Forecasted transactions are expected future underlying transactions that are not recorded in the balance sheet, and are not contract-related.


Firm Commitments vs Forecasted Transactions

Firm Commitments

Contracts with fixedprices, quantities and settlement times

The risk is the possible changes in the future fair values

Forecasted Transactions

No fixed agreements

The risk is the possible fluctuations in the future cash flows

Fair value risk/fair value hedge

Cash flow risk/cash flow hedge








Hedging Instruments (I)

The following can be used as hedging instruments....

All derivative financial instruments that are concluded with external third parties

Exception: written options

Further exceptions:

Own equity capital instruments

Instruments whose fair value cannot be determined reliably


Hedging Instruments (II)

Note that....

Hedging instruments can be used either partially (percentage share) or completely

Simultaneous use of several derivatives as a hedging instrument is possible

Designation of a derivative as a hedge for several (sub) risks is permitted








Qualifying Criteria

The derivative needs to be linked with the exposure in a hedging relationship, stating the hedge strategy at the beginning of the hedging relationship.

Identification of hedging instrument (derivative)

Identification of hedged item (underlying exposure)

Identification of nature of risk being hedged (e.g. interest rate risk, exchange rate risk)

Documentation of how the hedging instrument´s effectiveness in offsetting value changes in the hedged item will be assessed.

Determine the algorithm (method) used for assessing effectiveness (e.g. methods based on spot or forward rates, discounted or non-discounted)

Determine the components of the derivative´s value change that are included in the subsequent effectiveness assessment

FAS 133 requires that certain criteria be met for all types of hedges in order for them to qualify for hedge accounting:


Qualifying Criteria - Effectiveness

The effectiveness of a hedge is a measure of how a derivative protects against the underlying risk (exposure).

The “Effectiveness Ratio” shows the value changes in the derivative compared to the value changes in the underlying risk.

Both at inception of the hedge and on an ongoing basis, the hedging relationship is expected to be highly effective (effectiveness ratio of between 80 and 120%) in achieving offsettting value changes. An effectiveness assessment is required whenever financial statements or earnings are reported, and at least every three months.

An effectiveness assessment is not required if the hedging relationship qualifies for the shortcut method in the case of a perfect hedge, that is when the critical terms of hedging instrument and hedged item are the same (e.g. notional and principle amount, receive/pay rates and the related bases, contract term and maturity, settlement dates).


Accounting treatment:

• Show the change in fair value of derivatives in the P/L• Show the change in fair value of the hedged item (firm commitment) in the P/L

Hedge categories

Fair value hedge

Cash flow hedge


Conclusion: Synchronous P/L treatment of derivative and underlying transaction in order to avoid volatility in profits

Transactions + exposure: • Fair value of a recognized asset/liability • Fair value of an unrecognized firm commitment


Transactions + exposure: • Variability in future cash flows of recogn. asset/liab. • Variability in future cash flows of forecasted transact.

Hedge categories

Fair value hedge

Cash flow hedge

Accounting treatment:• Effective portion of the change in market value of the derivative is recorded on a cumulative basis in Other Comprehensive Income (OCI) • The ineffective portion is recorded in the current P/L • The accumulated amounts in Other Comprehensive Income are reclassified to the P/L in the same period in which the corresponding underlying transaction is posted to the P/L .


Conclusion: Synchronous P/L treatment of derivative and underlying transaction in order to avoid volatility in profits


Agenda

Example Business Scenario


System Demo

1111

2222


3333

4444


Integration in CFM

Hedge Manage-

ment

FI-GLFI-GL

Market Risk Analyzer

MarketData

Transaction Manager

managing financial deals and positions

valuation of instruments and transfer to Financial Accounting

Accounts

Calculations e.g. net present value calculation

OCI

Basic values for calculations


• Forecasted Transactions: sales and purchases with FX forwards and FX options

• Firm Commitments: sales and purchases with FX forwards and FX options

• Recogn. Fin. Assets/Liab. : cash flow hedge using interest-rate swap & floating-rate instrument • Recogn. Fin. Assets/Liab. : fair value hedge using interest-rate swap & fixed-rate instrument

FAS133 - Scope of the first release (with CFM 1.0)

• Interest rate (IR) • FX- risk

Risk categories

Hedge scenarios


SAP Hedge Management - Functions

Making hedge decisions

Monitoring ongoing effectivenessand OCI balances

Hedge Management Application

Managing exposures



Define Transaction Category and Activity

Define Exposure

Define Hedge Plan

Making hedge decisionsMonitoring ongoing effectivenessand OCI balances

Hedge Management ApplicationManaging exposures

Po-sition

ForecastForecast Recogn. Fin.Assets/Liab.Recogn. Fin.Assets/Liab.

Firm commitment

Firm commitment

Assets/Liabilities

Sale Pur-chase

Cash Flow


Define Hedge Plan


Define Exposure



Define Hedge Category

Define Target Hedge Ratio that is to be hedged

Designate Derivative(s) to one/many hedge(s)

Choose Hedge Strategy for hedging relationship




Fair value hedge Cash flow hedge


Define Hedge


Define Hedging Relationship


SAP‘s system solution to FAS133: Key aspects

many-to-many links between derivative (hedging instrument) and underlying exposure (Hedged Item)

SAP’s solution offers...

16 different calculation categories for calculating fair value changes in the effectiveness test

automatic posting of all postings relating to an event.

Various reports for fulfilling FASB and company reporting requirements for monitoring hedging relationships, effectiveness results and balances on certain deferral acounts.



Effectiveness Test

Determine whether the derivative effectively hedges changes in fair value

or future cash flows - Effectiveness Assessment Once the hedging relationship is determined as having been effective, the

system will perform the Effectiveness Measurement which determines the amounts of the derivative´s changes in fair value and distributes those values according to the rules of FAS 133





Hedge Strategy - Customizing

Precondition ...

Effectiveness Calculation Types



Precondition...

Effectiveness AssessmentTypes





Effectiveness testing - Process

Hedge Strategy definitionHedge Strategy definition

Effectiveness assessment prospective

Effectiveness assessment prospective

Effectiveness assessment retrospective

Effectiveness assessment retrospective

Effectiveness measurementEffectiveness measurement

Customizing



Application

Done once: Done once: at inception of hedging relationshipat inception of hedging relationship

Done on an ongoing Done on an ongoing basisbasis


FAS 133 Reports I

Hedging Relationship per Derivative

This report shows the derivatives and the exposures they are hedging. It is thus possible to report on the derivatives that are hedging/are not hedging exposures, and where hedge capacities remain.

OCI Balance Overview Report

This report provides the OCI and P&L balance for derivatives and their hedging relationships as of the selected date.

Exposure Expiration Report

This reports enables you to monitor the expiration for a specified exposure. Upon expiration, the system updates the hedging relationships and generates accounting entries (for instance, OCI reclassification) according to the hedge category (cash flow hedge, fair value hedge) and the transaction activity (such as sale or purchase).


FAS 133 Reports II

Effectiveness Test Report

By using the combined effectiveness assessment and measurement report, hedge effectiveness can be calculated at any point during the lifetime of the hedging relationship, and can be used for simulation purposes, e.g. „what-if“ scenarios.

Prospective Effectiveness Assessment

The Prospective Effectiveness Assessment lets the user record, for a hedging relationship or several hedging relationships and for a given date, whether it is expected to be effective in the future. This data is manually entered as of the first FAS 133 release; double-clicking on the „effective“ column in the report marks a hedging relationship as not being effective prospectively.

Hedging Relationship Dedesignation

This report allows the user to manually dedesignate single hedging relationships as of a certain date, or groups of hedging relationships, e.g. all hedging relationships of a derivative.


FAS 133 Reports III

Hedge Plan Expiration

This report shows all hedging relationships of hedge plans expiring on a certain date, and dissolves them. It thus ensures that all hedging relationships of a hedge plan are dissolved at the latest upon hedge plan expiration.

Retrospective Effectiveness Assessment: Dissolve Ineffective Hedging Relationships

This reports allows the user to dissolve all or a selection of hedging relationships that have been ineffective in the period just ended.

Manual OCI Reclassification

This report allows the user to manually reclassify all or parts of the OCI balances of the selected hedging relationships.


FAS 133 Reports IV

Fair value changes to be posted

This report shows all fair value changes that have been calculated for the selected hedges in effective hedging relationships, and thus provides the user with the informations about what needs to be posted for the underlying exposure.

Prematurely reclassified OCI

This report shows all OCI balances that have been reclassified prematurely, i. e. before the underlying exposure affected earnings, or was scheduled to affect earnings. It thus provides the exception reporting required.


Agenda

Example Business Scenario


1111

2222


3333


FX Forward and Forecasted Sale

An internationally operating company hedges forecasted sales figures (forecasted transaction) denominated in a foreign currency using FX forward contracts (cash flow hedge).

The business plan in the scenario is a sales forecast of EUR 10 mill. for the period of September until December of the year 2000.

The company‘s policy is to hedge the exposure at a ratio of 60%.

The treasurer‘s responsibility is to comply with this ratio. He enters into an FX forward contract to sell 10 mill. EUR on 30th of November, of which he designates a portion of 6 mill. EUR to the hedging relationship [the remaining portion of the forward may be entered into for a different purpose].


Scenario description

Forecast period: 09/01/00 - 12/31/00

Sales forecast: EUR 10 mill. EUR (forecasted transaction)

Hedge category: Cash flow hedge (hedging the functional currency equivalent of the expected sales forecast)

Hedge instrument: FX forward

Data: Contract date: 11/01/00

Value date: 12/31/00

Forward Rate: 0.87

Spot: 0.86

Swap: 0.01

Amounts:

EUR 10 mill. Sale / USD 11.49 mill. Purchase


Scenario description

Inception date: 11/01/00

Designation: 6 mill. EUR

Target hedge ratio: 60%

Actual hedge ratio: 60%

Spot EUR/USD: 11/30/00 (valuation): 0.8012/31/00 (expiration): 0.90


Timeline

HedgePlan

Sept./Oct. November December

FX forward

Sales forecast

Sales forecast InceptionInception ValuationValuation Forecast

expirationForecast

expiration

Ex-posure

Valid fromValid from

Due date

Due date

Contractdate

Contractdate

SettlementSettlement


Procedure

Hedge Management 09/01/00 - 12/31/00:

Create Exposure, Hedge, Hedging Relationship

Valuation 11/30/00:

Determine Net Present Value

Effectiveness test

Key date valuation

Expiration 12/31/00:

Post derivative

Effectiveness test

Realized gains and losses derivative

Exposure Expiration: reclassification posting of OCI


Calculate net present value


Detailed log net present value calculation


Effectiveness assessment calclulation 30/11/00


Detailed log Effectiveness assessment


Detailed log effectiveness assessment


Key date valuation on 30/11/00


Posting Logic FX forward

Valuation 11/30/00:

1. Unrealized gain derivative (683.370,41 USD)

2. Transfer to OCI - effectiveness calculation - (410.022,25 USD)

3. Transfer to P/L free - non-designated portion of derivative - (273.348,16 USD)



FX forward clearing account

1 683.370,41 USD

OCI clearing account

1 683.370,41 USD2 410.022,25 USD

3

Transfer to P/L

3 273.348,16 USD

Transfer to OCI

2 410.022,25 USD

273.348,16 USD

0,00 USD 0,00 USD


Post derivative on 31/12/00


Effectiveness assessment on 31/12/00


Realized Gains and Losses derivative


Exposure expiration report


Post OCI reclassification at exposure expiration


Exposure expiration/expiration of derivative 12/31/00:


1. Dissolve OCI balance from valuation on 11/30/00 (410.022,25 USD)

2. Dissolve P/L free from valuation on 11/30/00 (273. 348,16USD)

3. Reverse unrealized gain from valuation on 11/30/00 (683.370,41 USD)

4. Realized loss (forex) due to expiration on 11/30/00 (300.000,00 USD)

5. Transfer to P/L free - not designated portion of derivative - (120.000,00 USD) 6. Transfer to OCI - effectiveness calculation - (180.000,00 USD)

7. Reclassification of OCI - Exposure expiration ( 180.000,00 USD)



300.000,00 USD

7

683.370,41 USD

4

7

683.915,78 USD

1 410.022,25 USD

3

273.348,16 USD

5

6

683.370,41 USD1

OCI clearing accountFX forward clearing account

2

2

410.022,25 USD

273.348,16 USD

683.370,41 USD1

300.000,00 USD

0,00 USD 0,00 USD

Transfer to OCI

3

5

410.022,25 USD 410.022,25 USD2180.000,00 USD

Transfer to P/L

2 1

6

273.348,16 USD

4

273.348,16 USD3

2

180.000,00 USD

120.000,00 USD

120.000,00 USD 180.000,00 USD

180.000,00 USD

Date post:	08-Nov-2014
Category:	Documents
Upload:	peter-w-schat
View:	51 times
Download:	2 times

FAS133 Regulation hedge accounting.ppt

Documents