FASB Projects Update – Spring 2015

Presentation to the American Petroleum Institute March 31, 2015

Mark Pollock, Practice Fellow

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This presentation has been prepared to help stakeholders understand the current status of the projects

discussed herein. The views expressed in this presentation are those of the presenter. Official positions of the

FASB and the IASB are reached only after extensive due process and deliberations.

Financial Instruments:

- Hedging

- Classification & Measurement

Disclosure Framework

Simplification Initiative

Projects on the Horizon

Agenda

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Financial Instruments Hedging

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Timeline

FASB issued exposure drafts in June 2008 and May 2010 – focused on

targeted improvements to current hedging model in Topic 815 (FAS 133)

- No new Standard was issued

FASB issued a discussion paper in 2011 to obtain views on the IASB’s

proposed model at the time

IASB issued its final standard on the general hedge accounting model in

November 2013

Project moved from research to active status in November 2014

Project Status

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Targeted improvements to Topic 815 rather than fundamental revisions

(similar to IFRS 9):

- Hedge effectiveness (quantitative vs. qualitative)

- Component hedging for nonfinancial items

- Application issues related to FV hedges of interest rate risk

- Potential elimination of shortcut and critical terms match

- Voluntary dedesignations

- Recording ineffectiveness for cash flow underhedges

- Potential simplifications to documentation requirements

- Presentation and disclosure

Project Direction

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At the February 25, 2015 non-decision making Board Meeting two main approaches

emerged as possible changes to the hedge accounting model for nonfinancial items

Hedging Model for Nonfinancial Items

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Alternative Description

A An “alternative model” only for cash flow hedges of nonfinancial items

Move to a reasonably effective quantitative threshold (for example 50% to 200%)

Changes in fair value of derivative deferred to OCI as long as the hedged item and

hedging instrument maintain a reasonably effective relationship on a total price basis

When the hedged item affects earnings the amount in OCI related to the derivative

would be reclassed into the income statement line item hedged (i.e. COGS)

No hedge ineffectiveness would be recorded during the life of the hedge or at the

end of the hedge

B1 or B2 Retain the highly effective threshold in Topic 815 (80% to 125%)

Allow the hedged item to be a component of the overall total price, either:

o A contractually specified component (B1)

o B1 above or a component which is not contractually specified but for which it is

the market convention to use the component as an underlying basis for

determining the price of an overall product. Essentially a sub-component of a

contractually specified component (B2)

On Jan 1, 20X1 Airline Co. hedges a forecasted purchase of jet fuel with a crude oil futures contract.

Assume the purchase and subsequent use in operations of the jet fuel occur in the year ended 20X2.

Information related to the hedging relationship is as follows:

Jan 1, 20X1

Jet fuel spot price = $100/barrel

Jet fuel 1 year forward price = $110/barrel

Dec 31, 20X1

Jet fuel spot price = $150/barrel

Change in crude oil future = $50/barrel gain

Change in hypothetical “perfect” jet fuel derivative = $40/barrel gain

Example – Alternative A (reasonably effective threshold)

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Amount Line Item Details Amount Line Item Details

10.00$ Other Income Hedge ineffectiveness

40.00$ OCI Effective portion

Alternative A * 50.00$ OCIFull change in value of

derivative(100.00)$ COGS

$150 fuel cost less $50

derivative reclass

COGS(110.00)$ Current GAAP$150 fuel cost less $40

derivative reclass

Financial Statements

Year Ended Dec 31, 20X1

Financial Statements

Year Ended Dec 31, 20X2

*$50 change in value of derivative/$40 change in hypothetical = 125% offset. Derivative qualifies for hedge

accounting under current GAAP and Alternative A model and all “ineffectiveness” deferred into OCI. A

reasonably effective quantitative threshold is not yet defined but would be wider than today’s 80% - 125%.

Alternative A Observations

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Advantages Disadvantages

Relatively simple to apply

Preparers understand and have several years

experience performing quantitative tests of

hedge effectiveness on total price risk basis

Presents “full cost of hedging” in line item

hedged when the hedged item affects earnings

Easier for users to understand the effects of

hedging

Only works for hedging primary components

since effectiveness test carried out on total

price risk basis

No portfolio hedging since hedged item is

measured on a total price risk basis

Dual threshold between financial (highly

effective) and nonfinancial hedging (reasonably

effective) could create complexity or uneven

playing field

Deliberate “overhedge” could lead to artificially

high gross margins when the reclass of

derivative gain reduces cost of goods sold

Creating and valuing hypothetical derivative on

a total price risk basis could be difficult (same

as current GAAP)

On Jan 1, 20X1 ABC Co. hedges a forecasted purchase of 1,000 bushels of corn with a corn based derivative.

The purchase contract is structured as the CME spot price on 1/1/20X2 + transportation + taxes/fees.

Assume the purchase of corn and the sale of corn as inventory occur in the year ended 20X2. Information

related to the transaction is as follows:

Hedging Instrument Information

The change in the value of derivative was $1,040 loss as of 12/31/20X1

Effectiveness test done at component level. $5 ineffectiveness due to different settlement dates.

Example – Alternative B1 or B2 (Component Hedging)

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Total Price = Corn Component +

Transportation/Fees

Component

01/01/X1 $4,332.50 $4,242.50 $90.00

12/31/X1 $3,357.50 $3,207.50 $150.00

Change ($975.00) ($1,035.00) $60.00

Amount Line Item Details Amount Line Item Details

(65.00)$ Other Inc./(Exp.) Hedge ineffectiveness

970.00$ OCIEffective portion of change

in value of derivative

Alternative B (5.00)$ Other Inc./(Exp.) Hedge ineffectiveness

1,030.00$ OCIEffective portion of change

in value of derivative

(4,387.50)$ COGSPrice paid $3,357.50 and

reclass of OCI

COGS(4,327.50)$ Current GAAPPrice paid $3,357.50 and

relcass of OCI

Fianncial Statements

Year Ended Dec 31, 20X1

Financial Statements

Year Ended Dec 31, 20X2

Alternative B Observations

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Advantages Disadvantages

Component hedging better reflects risk

management strategy and objectives.

Constituents indicated treasurers view hedging

from a components and not total price perspective

Valuing hypothetical derivative on a commodity

component basis easier than on a total price risk

basis (don’t have to consider changes in

transportation, fees, taxes and other adders)

Works for any contractually specified component

regardless of what percentage of the total price

the item is (i.e. contractually specified fuel

component that is only 10% of total price)

Enables portfolio hedging of the same commodity

which cannot be hedged today or under

Alternative A because other aspects of the total

price (e.g. transportation) prevent portfolio

hedging.

Additional documentation that entity has

100% price risk to the component being

hedged

Potential that entities will invent pricing

formulas to get hedge accounting (Board can

put safeguards in place)

Identifying components could create

complexity or auditability issues

Works well for traded commodities with liquid

derivative markets earlier in the supply chain.

Finished goods are less likely to have a

contractually specified component linked to a

traded commodity

Financial Instruments

Classification & Measurement

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Changes to current GAAP Investments in equity securities

Measured at FV-NI, except for equity method investments

An entity (other than a broker dealer or an investment company) may

elect to measure equity securities without readily determinable fair

values at cost minus impairment, if any, plus or minus changes

resulting from observable price changes in orderly transactions for

the identical investment or a similar investment of the same issuer

- The entity cannot elect this option for equity securities that qualify to be measured

at NAV under Topic 820.

- These investments would be assessed for impairment at every reporting period

using a qualitative assessment

- The following disclosures would be required for these equity securities

Carrying amount, as well as the amount of the adjustments made to the carrying

amount due to observable price changes and impairment charges during the

reporting period

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Changes to current GAAP Financial liabilities measured under fair value option

The portion of the total fair value change resulting from a change in

entity-specific credit risk (own credit) would be presented separately

in other comprehensive income.

- An entity may consider the portion of the total FV change that exceeds the amount

resulting from a change in a base market rate (such as a risk-free) to be the result

of a change in entity-specific credit risk. Alternatively, an entity may determine the

effect of entity-specific credit risk by using another method it considers to more

faithfully represent that change.

- Required to disclose the method used to calculate the amount recorded in other

comprehensive income.

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Changes to current GAAP Disclosures: FV of Financial Instruments not recognized at FV in Balance Sheet

An entity other than a public business entity would not be required to provide the incremental disclosures about fair value required by Section 825-10-50 (originally issued as FAS 107, Disclosures about Fair Value of Financial Instruments)

The following disclosure requirements would be removed from Section 825-10-50 - The method(s) and significant assumptions used to estimate the fair value of

financial instruments consistent with the requirements of paragraph 820-10-50-2(bbb)

- A description of the changes in the method(s) and significant assumptions used to estimate the fair value of financial instruments, if any, during the period

The fair values of financial instruments disclosed under the requirements of Section 825-10-50 should be determined in accordance with the guidance in Topic 820 (originally issued as FAS 157, Fair Value Measurements)

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Changes to current GAAP Disclosures: Hybrid Financial Instruments

Entities would be required to disclose the carrying amount,

measurement attribute, and line item within the balance sheet and

income statement in which bifurcated embedded derivatives and

related host contracts are presented

- This decision was exposed for public comments in 1Q 2015 (comment period will

end on April 30, 2015).

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Changes to current GAAP Disclosures: Other disclosures

Disclose in the notes all financial assets and financial liabilities

grouped by measurement category

- Financial assets would be further disaggregated by form of

financial assets (that is, security versus loan/receivable)

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Disclosure Framework

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Improving the effectiveness of notes requires both:

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Disclosure Framework: Two Components

Appropriate exercise of discretion by reporting entities when assessing disclosure requirements

Phase I: Board’s Decision Process

Phase II: Entity’s Decision Process

Consistent considerations by the

Board in each standard-setting

activity

Changes to Codification

Promoting Discretion

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Eliminate language that limits discretion

“Provide to the extent material”

Add guidance on applying materiality

Promoting Discretion (cont’d)

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US Supreme Court’s description

Omission not an accounting error

Applied individually and in the aggregate

Quantitative and qualitative

Guidance on Applying Materiality

Fair Value Measurement

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Disclosures provide information about:

• Ways an entity arrives at fair value • The effects on financial statements • Uncertainty in measurement • Measurement change period to

period

Objectives based on proposed framework

Disclosure Updates

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Sensitivity Information

Possible Changes to FVM

Forward-looking Information

Process and Policies

Gains and Losses

Rollforwards

Defined Benefit Plans

Fair Value Measurement

Income Taxes

Inventory

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Planned Exposure Drafts Q2

- Entity’s Decision Process

- Defined Benefit Plans

- Fair Value Measurement

Redeliberate Proposed Concepts in the

Disclosure Framework

Interim Considerations

Next Steps

Simplification Initiative

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Objective is to reduce cost and complexity while maintaining or improving the usefulness of the information

Projects would include narrow-scope items that the Board can complete in the short term

Welcome input on ideas

Simplification Initiative Objective

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Simplifying Income Taxes – Balance Sheet Classification of Deferred Taxes

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Presentation in a classified

balance sheet:

- Current deferred tax asset

and liability

- Noncurrent deferred tax

asset and liability

Classification:

- Based on classification of

related asset or liability

- Generally not classified

based on when the

temporary differences will

reverse

Classify all deferred tax assets

and liabilities as noncurrent

Current GAAP Solution

Simplifying Income Taxes – Intra-Entity Asset Transfers

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Buyer and seller defer the

recognition of income tax

consequences of an intra-

entity asset transfer until the

assets have been sold to an

outside third party

Exception to the accounting

model for comprehensive

recognition of income taxes

Eliminate the exception

Require recognition of the

income tax consequences of

an intra-entity asset transfer

when the transfer occurs

Current GAAP Solution

Simplifying Presentation of Debt Issue Costs

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- Debt issue costs presented

as deferred charge

- Discounts or premiums

presented as an adjustment

to debt balance

Debt issue costs presented

as an adjustment to debt

balance, consistent with

premiums or discounts

Current GAAP Solution

Simplifying Balance Sheet Classification of Debt

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- Classification considers:

Debt covenants

Subjective acceleration

clauses

Revolving credit and lock-

box arrangements

Increasing rate debt

Debt due on demand

Callable debt

ST obligations expected

to be refinanced

Classify as noncurrent if one

or both of the following are

met at the balance sheet

date:

Debt is contractually due

more than 12 months after

the balance sheet date

Entity has a contractual

right to defer settlement

for at least 12 months

after the balance sheet

date

Current GAAP Solution

Simplifying the Measurement of Inventory

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Lower of cost or market

Measures for market value

include:

Replacement cost

Net realizable value

Net realizable value less

a normal profit margin

Inventory will be measured at

the lower of cost or net

realizable value

Reduce cost and complexity

of the subsequent

measurement

Maintain or improve the

usefulness of the information

required to be reported by an

entity

Current GAAP Solution

Projects on the Horizon

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Recently added to agenda: - Simplifying equity method accounting - Simplifying measurement period adjustments in business

combinations - Accounting for put / calls in debt (EITF) - Effect of derivative novations on hedge accounting (EITF) - Definition of a business

Potential: - Simplifying asset retirement obligations measurement

On the horizon

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Questions or Comments?

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Mark Pollock, FASB Practice Fellow

Mark is a Practice Fellow at the Financial Accounting Standards

Board (FASB) with 15 years of combined experience, heavily

focused on technical accounting and reporting matters. Prior to

joining the FASB staff, Mark was a Senior Manager in PwC’s

Assurance practice where he provided accounting and auditing

services to clients in the energy industry, including the exploration

and production, transportation and drilling services sectors. Mark is

also an alumni of PwC’s National Office where he specialized in the

accounting for financial instruments, such as leases, derivatives,

and debt / equity transactions.

Mark Pollock Practice Fellow

Financial Accounting Standards Board

401 Merritt 7, P.O. Box 5116, Norwalk, CT

06856

T: 203.956.3476 / Email: mapollock@fasb.org

www.fasb.org