GAAP Review Series - Part 4

• Chapter 1 - Accounting for Financial Assets and Derivative Instruments
  • Learning Objectives
  • Introduction
  • FASB ASC 860, Transfers and Servicing (SFAS No. 140)
  • FASB ASC 815, Derivatives and Hedging (SFAS No. 133)
  • Module 1 – Accounting for Transfers and Servicing of Financial Assets
    • Required Disclosures
    • Financial Statement Illustration
    • Servicing Assets and Liabilities
    • FSP FAS 140-3
  • Module 2 – Accounting for Derivative Instruments and Hedging Activities
    • Development of the New Guidance
    • New Definition of “Derivative Financial Instrument”
    • Fair Value Hedges
    • Cash Flow Hedges
    • Foreign Currency Hedges
    • Disclosure Requirements
    • Financial Statement Illustrations
    • Derivative Financial Instrument Examples
  • Module 3 – Accounting for Certain Hybrid Financial Instruments
    • Disclosure Requirements
  • Module 4 – Case Studies
    • Case 1-1 – Use of a Plain-Vanilla Interest-Rate Swap to Hedge Fixed-Rate Debt
    • Case 1-2 – Use of Futures Contracts to Hedge a Firm Commitment to Sell a Commodity
    • Case 1-3 – Bifurcating an Embedded Derivative for the Holder of the Instrument
• Chapter 2 - International Accounting
  • Learning Objectives
  • Introduction
  • Module 1 – International Convergence
    • International Organization of Securities Commissions
    • European Community
    • International Accounting Standards Board
    • The FAF – FASB Vision Report
  • Module 2 – International Accounting Standards
    • The IASC Framework
    • International Accounting Standards
    • IFRIC Interpretations
    • FASB Special Report – Provisions: Their Recognition, Measurement, and Disclosure in Financial Statements
  • Module 3 – FASB International Convergence Project Updates
    • Conceptual Framework – Joint Project of the IASB and FASB
    • Joint FASB – IASB Standards Projects
• Chapter 3 - Fair Value Accounting
  • Learning Objectives
  • Introduction
  • FASB ASC 820, Fair Value Measurements and Disclosures (SFAS No. 157)
  • FASB ASC 825, Financial Instruments (SFAS No. 159)
  • Module 1 – FASB ASC 820, Fair Value Measurements and Disclosures (SFAS No. 157)
    • Definition of Fair Value
    • Fair Value Measurement for Assets
    • Fair Value Measurement for Liabilities
    • Entry vs. Exit Prices
    • Valuation
    • Valuation Inputs
    • Hierarchy of Fair Value Measurements
    • FSPs Applicable to FASB ASC 820 (SFAS No. 157)
  • Module 2 – FASB ASC 825, Financial Instruments (SFAS No. 159)
    • The Fair Value Option
    • Application of the Fair Value Option
    • Recognized Financial Assets and Financial Liabilities That Are Not Eligible for the Fair Value Option
    • Election Dates
    • Application on an Instrument-by-Instrument Basis
    • Financial Statement Presentation of Items Measured at Fair Value
    • Required Disclosures
    • Required Disclosures as of Each Date for Which an Interim or Annual Statement of Financial Position Is Presented
    • Required Disclosures for Each Period for Which an Interim or Annual Income Statement Is Presented
    • Other Required Disclosures
• Chapter 4 - Business Combinations and Consolidated Financial Statements
  • Learning Objectives
  • Introduction
  • Module 1 – Business Combinations
    • Need for a Revised Guidance
    • Main Features of FASB ASC 805, Business Combinations [SFAS No. 141(R)]
    • Benefits and Costs
    • Effective Date
    • FSP FAS 141(R)-1
  • Module 2 – Accounting for Noncontrolling Interests in Consolidated Financial Statements
    • Effective Date
  • Module 3 – Consolidated Financial Statements
    • The IASB Consolidations Project
  • Module 4 – Consolidation of Variable Interest Entities
    • FASB Staff Positions on Variable Interest Entities
• Chapter 5 - Goodwill and Asset Impairment & Disposal Issues
  • Learning Objectives
  • Introduction
  • Module 1 – Goodwill and Other Intangible Assets
    • Initial Recognition of and Accounting for Intangible Assets
    • When to Conduct the Goodwill Impairment Test
    • FSP FAS 142–3
  • Module 2 – Accounting for the Impairment or Disposal of Long-Lived Assets
    • Long-Lived Assets to Be Held and Used
    • Long-Lived Assets to Be Disposed of Other Than by Sale
    • Long-Lived Assets to Be Disposed of by Sale
    • Assets That Must Be Reviewed for Impairment
  • Module 3 – Accounting for Asset Retirement Obligations
    • Initial Recognition and Measurement of a Liability for an Asset Retirement Obligation
    • Recognition and Allocation of an Asset Retirement Cost
    • Disclosure Issues
  • Module 4 – Accounting for Costs Associated with Exit or Disposal Activities
    • Reporting and Disclosure Issues
  • Module 5 – Case Study
    • Case 5-1 – Asset Held for Disposition
• Chapter 6 - Segment Disclosure
  • Learning Objective
  • Introduction
  • Module 1 – Segment Reporting
    • FASB ASC 280, Segment Reporting (SFAS No. 131)
    • Identification of Operating Segments
    • Required Disclosures
    • Required Disclosures in Interim Financial Statements
    • Identifying Reportable Operating Segments
    • Geographic Information
    • Financial Statement Illustration
• Chapter 7 - Long-Lived Assets: Interest Capitalization and Nonmonetary Exchanges
  • Learning Objectives
  • Introduction
  • Interest Capitalization
  • Nonmonetary Transactions
  • Module 1 – Assets Qualifying for Interest Capitalization
    • Assets for Which Capitalization Is Not Permitted
    • Disclosure Requirements
    • Financial Statement Illustrations
  • Module 2 – Capitalization Period
    • Expenditures Have Been Incurred
    • Activities Are Ongoing
    • Interest Is Being Incurred
  • Module 3 – Calculating the Amount of Interest to Be Capitalized
    • Step 1: Computation of the Average Accumulated Expenditure
    • Step 2: Computation of the Capitalization Rate
    • Step 3: Multiplying the Capitalization Rate by the Average Accumulated Expenditure
    • Offsetting Interest Income against Interest Cost
  • Module 4 – Accounting for Nonmonetary Exchanges of Assets
    • Nonreciprocal Transfers with Owners
    • Nonreciprocal Transfers with Nonowners
    • Nonmonetary Exchanges
  • Module 5 – Case Studies
    • Case 7-1 – Interest Capitalization – Qualifying for Capitalization
    • Case 7-2 – Interest Capitalization – Accumulated Expenditures
    • Case 7-3 – Interruption of Interest Capitalization
    • Case 7-4 – Nonmonetary Exchanges
• Chapter 8 - Latest Developments

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Chapter 1 - Accounting for Financial Assets and Derivative Instruments

Learning Objectives

As a result of this chapter you will be able to

• Apply the accounting guidance in Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 860, Transfers and Servicing (SFAS No. 140), to transactions involving the transfer or servicing of financial assets.

• Identify derivative financial instruments and prepare the required financial statement disclosures.

• Apply the accounting guidance in FASB ASC 815, Derivatives and Hedging (SFAS No. 133), for accounting for derivative instruments and hedging activities.

Introduction

This chapter describes accounting standards for reporting the use of derivative securities. This chapter also describes the new accounting rules for transactions that are common for financial institutions and may occur for industrial companies, namely, transfers and servicing of financial assets, and the use of derivative securities in hedging activities.

This chapter also provides an overview of the required accounting for certain hybrid financial instruments.

FASB ASC 860, Transfers and Servicing (SFAS No. 140)

FASB ASC 860, Transfers and Servicing (SFAS No. 140), provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. Those standards are based on consistent application of a financial-components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished.

FASB ASC 860 (SFAS No. 140)

• Requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in any of the following situations:

– A transfer of the servicer's financial assets that meets the requirements for sale accounting.

– A transfer of the servicer's financial assets to a qualifying special-purpose entity in a guaranteed mortgage securitization in which the transferor retains all of the resulting securities and classifies them as either available-for-sale securities or trading securities in accordance with FASB ASC 320, Investments-Debt and Equity Securities (SFAS No. 115).

– An acquisition or assumption of an obligation to service a financial asset that does not relate to financial assets of the servicer or its consolidated affiliates.

– Requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable.

– Permits an entity to choose either of the following subsequent measurement methods for each class of separately recognized servicing assets and servicing liabilities:

» Amortization method – Amortize servicing assets or servicing liabilities in proportion to and over the period of estimated net servicing income or net servicing loss and assess servicing assets or servicing liabilities for impairment or increased obligation based on fair value at each reporting date.

» Fair value measurement method – Measure servicing assets or servicing liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur.

• At its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities, provided that the availablefor- sale securities are identified in some manner as offsetting the entity's exposure to changes in fair value of servicing assets or servicing liabilities that a servicer elects to subsequently measure at fair value.

• Requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities.

The FASB added this project to its agenda because constituents asked the Board to reconsider FASB ASC 860 (SFAS No. 140) requirements for accounting for mortgage servicing assets and servicing liabilities. The FASB decided to broaden the scope of the project to include all servicing assets and servicing liabilities. Servicing assets and servicing liabilities may be subject to significant interest rate and prepayment risk, and many entities use financial instruments to mitigate those risks. Currently, servicing assets and servicing liabilities are amortized over the expected period of estimated net servicing income or loss and assessed for impairment or increased obligation at each reporting date. The FASB acknowledged that the application of the lower of carrying amount or fair value measurement attribute to servicing assets results in asymmetrical recognition of economic events, because it requires recognition of all decreases in fair value but limits recognition of increases in fair value to the original carrying amount.

An entity may use derivative instruments to mitigate the risks inherent in its servicing assets and servicing liabilities. An entity that does not apply hedge accounting to these derivative instruments is exposed to income statement volatility that arises from the use of different measurement attributes for the servicing assets and servicing liabilities and the related derivative instruments. For example, in rising interest rate environments, decreases in the fair value of derivatives are reflected in the income statement, but increases in the fair value of related servicing assets are not reflected in the income statement to the extent that fair value exceeds the amortized carrying amount. Some constituents believe that meeting current hedge accounting criteria is burdensome and unduly restrictive and that the asymmetrical accounting for mortgage servicing assets and servicing liabilities and the related financial instruments used to mitigate the related risks does not appropriately reflect the economics of the hedging techniques employed.

When adding this project to its agenda, the Board also considered the complexity of application of the amortization method, such as the timing and characterization of impairment allowances versus write-downs, as well as the desire to simplify the accounting requirements for servicing assets and servicing liabilities.

FASB ASC 815, Derivatives and Hedging (SFAS No. 133)

FASB ASC 815, Derivatives and Hedging (SFAS No. 133), establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (1) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (2) a hedge of the exposure to variable cash flows of a forecasted transaction, or (3) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction.

The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation.

For a derivative designated as hedging the exposure to changes in the fair value of a recognized asset or liability or a firm commitment (referred to as a fair value hedge), the gain or loss is recognized in earnings in the period of change together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. The effect of that accounting is to reflect in earnings the extent to which the hedge is not effective in achieving offsetting changes in fair value.

For a derivative designated as hedging the exposure to variable cash flows of a forecasted transaction (referred to as a cash flow hedge), the effective portion of the derivative's gain or loss is initially reported as a component of other comprehensive income (outside earnings) and subsequently reclassified into earnings when the forecasted transaction affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately.

For a derivative designated as hedging the foreign currency exposure of a net investment in a foreign operation, the gain or loss is reported in other comprehensive income (outside earnings) as part of the cumulative translation adjustment. The accounting for a fair value hedge described above applies to a derivative designated as a hedge of the foreign currency exposure of an unrecognized firm commitment or an available-for-sale security. Similarly, the accounting for a cash flow hedge described above applies to a derivative designated as a hedge of the foreign currency exposure of a foreign-currency-denominated forecasted transaction.

For a derivative not designated as a hedging instrument, the gain or loss is recognized in earnings in the period of change.

Under FASB ASC 815 (SFAS No. 133), an entity that elects to apply hedge accounting is required to establish at the inception of the hedge the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. Those methods must be consistent with the entity's approach to managing risk.

This guidance precludes designating a nonderivative financial instrument as a hedge of an asset, liability, unrecognized firm commitment, or forecasted transaction except that a nonderivative instrument denominated in a foreign currency may be designated as a hedge of the foreign currency exposure of an unrecognized firm commitment denominated in a foreign currency or a net investment in a foreign operation.

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