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Accounting Flow Chart for FAS 133
Bob Jensen at Trinity
University
Flow Chart on Deciding to When and How to Book Derivatives
Flow Chart and illustrations for Cash Flow Hedging
Flowchart and Illustrations for Fair Value Hedging
Flowchart and Illustrations for Foreign Exchange (FX) Hedging
Flow Chart for IAS 39 Accounting  http://faculty.trinity.edu/rjensen/acct5341/speakers/39flow.htm
Flow Chart on Deciding to When and How to Book Derivatives
Is there a contract with (1) an underlying and (2) a notional amount, a payment provision, or both? 



Does the contract require no initial net investment or an initial net investment smaller than other types of contracts that have a similar response to changes in market factors? 



Is the contract contingent consideration in a business combination? (The accounting for contingent consideration issued in a business combination is addressed in Accounting Principles Board (APB) Opinion No. 16, Business Combinations.) 



Is the contract an insurance contract? (A contract is not subject to the requirements of SFAS 133 if it entitles the holder to be compensated only if, as a result of an identifiable insurable event (other than a change in price), the holder incurs a liability or there is an adverse change in the value of a specific asset or liability for which the holder is at risk.) 



Is the contract a financial guarantee? (Financial guarantee contracts are not subject to SFAS 133 if they provide for payments to be made only to reimburse the guaranteed party for a loss incurred because the debtor fails to pay when payment is due, which is an identifiable insurable event. In contrast, financial guarantee contracts are subject to the SFAS 133 if they provide for payments to be made in response to changes in an underlying  for example, a decrease in a specified debtor's creditworthiness.) 



Does the existence of this contract serve as an impediment to recognizing a related contract as a sale? (For instance, a call option enabling a transferor to repurchase transferred assets  an impediment to sales accounting under Statement 125  is not subject to SFAS 133, since the related assets are already recognized in the financial statements and to separately record the derivative would be to count the same thing twice.) 



Is the contract indexed to the reporting entity's own stock and classified in stockholders' equity by the reporting entity? (For example, if an entity purchases a call option on its own stock from someone else and that contract is reported in stockholders' equity, it is excluded from SFAS 133.) 



Is the contract issued by the reporting entity as part of a stockbased compensation arrangement? (The issuer's accounting is covered by SFAS 123, Accounting for StockBased Compensation, but the holder's accounting for a derivative instrument in a compensation arrangement addressed by Statement 123 is subject to SFAS 133.) 



A 
B 
A 
B 

Does the contract permit or require net settlement or is there a market mechanism to facilitate net settlement outside the contract?  



Is the underlying: 1. A climatic or geological or other physical variable? 2. The price or value of a nonfinancial asset of one of the parties that is not readily convertible to cash or a nonfinancial liability of one of the parties that does not require delivery of an asset that is readily convertible to cash? 3. Specified volumes of sales or service revenues by one of the parties to the contract? (For instance, a contract requiring $1 million to be paid if there is a hurricane in Florida during a specified time period is not a derivative under SFAS 133. However, a contract that requires $1 million to be paid if hurricane damage in Florida exceeds $1 billion during a specified time period is a derivative for the purposes of SFAS 133 because the underlying is not a physical variable. Rather, the underlying is claims exceeding a dollar amount.) 
Does the contract require delivery of a derivative
instrument or an asset readily convertible to cash? 


YES NO 

Is the contract exchangetraded?  


NO 

Apply SFAS 133 
Do not apply SFAS 133 
Source: Exhibit 1 in "Fair Value Accounting Gets Industry Input Through the Derivatives Implementation Group," Ira Kawaller and John J. Ensminger, Value Strategies, January/February 2000, pp. 1415.
Flow Chart on Deciding to When and How to Book Derivatives
Flow Chart and illustrations for Cash Flow Hedging
Flowchart and Illustrations for Fair Value Hedging
Flowchart and Illustrations for Foreign Exchange (FX) Hedging
Bob Jensen added the following journal entry flow chart for cash flow hedges scoped into FAS 133 and IAS 39. Assume that the derivative instrument change in fair value increases $100 and the question is what to credit. In the case of a cash flow hedge, assume that the derivative is effective by $90 in intrinsic value. The other $10 is attributed to ineffectiveness of the cash flow hedge and/or changes in time value of the derivative instrument. In the table below, AFS stands for "AvailableforSale" and HTM stands for "HeldtoMaturity" under FAS 115 definitions. The acronym OCI depicts Other Comprehensive Income or Accumulated OCI under FAS 130. For these and other definitions such as intrinsic value and time value, see the glossary at http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
The Delta ratio is the absolute value of the ratio of the change in the derivative hedge value divided by the change in the amount being hedged. A popular rule of thumb is that when Delta is expressed as a percentage, hedge accounting is allowed when Delta falls between 80% and 125%. When Delta falls outside this range, hedge accounting is not permitted. Look up the term "Ineffectiveness" at http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
Explanatory video files are available at http://www.cs.trinity.edu/~rjensen/video/acct5341/fas133/WindowsMedia/
Various outcomes in the guide below are illustrated at http://faculty.trinity.edu/rjensen/acct5341/class06a.htm
Warning: The flow charts below all assume
the $10 amount is all attributed to ineffectiveness, which in turn implicitly
assumes that hedge effectiveness testing is based upon full value (intrinsic
plus time value) changes in the hedging derivative.
If effectiveness testing is based upon only intrinsic value, the this $10 must
combine both ineffectiveness and changes in time value of the derivative.
You can read more about intrinsic value versus full value hedging at
http://faculty.trinity.edu/rjensen/caseans/IntrinsicValue.htm
Is the the derivative instrument deemed a speculation or otherwise not eligible for any special hedge accounting treatment? Changes in value of all derivative speculations and ineligible hedges are charged to current earnings. See Paragraph 405 of FAS 133. 



Is the hedged item carried
at historical cost (or lowerofcost or market) such as inventory
or an HTM security carried at amortized cost ? Note Paragraphs 5456
for AFS reclassifications. See Example 4 beginning in Paragraph 127 and Example 5 beginning in Paragraph 131. Download 133ex04a.xls and 133ex05a.xls from http://www.cs.trinity.edu/~rjensen/ Also see the J. Adams case at http://guweb2.gonzaga.edu/faculty/teets/index0.html 
YES The above entry is correct as long as Delta is within the 80%125% range. Otherwise the entire $100 is charged against current earnings due to severe ineffectiveness of the hedge. 
Is the derivative a cash flow hedge of a hedged item
that is an unbooked forecasted transaction such as a forecasted
inventory purchase, forecasted investment, or forecasted borrowing under
forecasted transaction rules in FAS 133 Paragraphs 2935? Note Example 6 beginning in Paragraph 140, Example 7 beginning in Paragraph 144, Example 8 beginning in Paragraph 153, and Example 9 beginning in Paragraph 162. Also note the Appendix A Example 7 beginning in Paragraph 93 and Example 9 beginning in Paragraph 100. Download 133ex06a.xls, 133ex07a.xls, 133ex08a.xls, and 133ex09a.xls from http://www.cs.trinity.edu/~rjensen/ Also see the C.L. Smith Case at http://guweb2.gonzaga.edu/faculty/teets/index0.html 
YES The above entry is correct as long as Delta is within the 80%125% range. Otherwise the entire $100 is charged against current earnings due to severe ineffectiveness of the hedge. 


Is the derivative a cash flow hedge of a hedged item
that will eventually be carried at fair market value with the changes
and value going to current earnings such as in the case of precious
metal inventory carried on the books or a securities investment classified
as a trading investment under FAS 115 or IAS 32 rules? Especially note Paragraph
405 and Paragraph 29d of FAS 133. Note that this case should not arise in theory since the cash flow risky hedged item should hold value constant such as in the case of a variable rate bond that has no change in credit risk. 
YES 

Flow Chart on Deciding to When and How to Book Derivatives
Flow Chart and illustrations for Cash Flow Hedging
Flowchart and Illustrations for Fair Value Hedging
Flowchart and Illustrations for Foreign Exchange (FX) Hedging
Bob Jensen added the following journal entry flow chart for fair value hedges scoped into FAS 133 and IAS 39. Assume that the derivative instrument change in fair value increases $100 and the question is what to credit. In the case of a cash flow hedge, assume that the derivative is effective by $90 in intrinsic value. The other $10 is attributed to ineffectiveness of the fair value hedge and/or changes in time value of the derivative instrument. In the table below, AFS stands for "AvailableforSale" and HTM stands for "HeldtoMaturity" under FAS 115 definitions. The acronym OCI depicts Other Comprehensive Income or Accumulated OCI under FAS 130. For these and other definitions such as intrinsic value and time value, see the glossary at http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
The Delta ratio is the absolute value of the ratio of the change in the derivative hedge value divided by the change in the amount being hedged. A popular rule of thumb is that when Delta is expressed as a percentage, hedge accounting is allowed when Delta falls between 80% and 125%. When Delta falls outside this range, hedge accounting is not permitted. Look up the term "Ineffectiveness" at http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
Explanatory video files are available at http://www.cs.trinity.edu/~rjensen/video/acct5341/fas133/WindowsMedia/
Various outcomes in the guide below are illustrated at http://faculty.trinity.edu/rjensen/acct5341/class06a.htm
Is the the derivative instrument deemed a speculation or otherwise not eligible for any special hedge accounting treatment? Changes in value of all derivative speculations and ineligible hedges are charged to current earnings. 



Is the derivative a fair value hedge of a hedged item
currently carried at historical cost (or
lowerofcost or market) such as inventory or an HTM security carried at
amortized cost?
See Example 2 beginning in Paragraph 111 of Appendix B of FAS 133. Also see Appendix A Examples 15 beginning in Paragraph 73.

YES The above entry is correct as long as Delta is within the 80%125% range. Otherwise the entire $100 is charged against current earnings due to severe ineffectiveness of the hedge. 
Is the derivative a fair value hedge of a hedged item
that is an unbooked firm commitment such as future inventory
purchase, future investment, or future borrowing under forecasted
transaction rules in FAS 133 Paragraphs 2027, Paragraph 4,
Paragraph 370, and Paragraph 442? The FASB invented an account
called "Firm Commitment" for fair value hedges of unbooked
hedged items such as purchase commitments. It can have a debit or a
credit balance. See Question 5 at http://faculty.trinity.edu/rjensen/acct5341/class06a.htm Also see See Example 4.13 beginning on Page 126 of KPMG's Derivatives
and Hedging Handbook  
YES The above entry is correct as long as Delta is within the 80%125% range. Otherwise the entire $100 is charged against current earnings due to severe ineffectiveness of the hedge. 


Is the derivative a fair value hedge of a hedged item currently carried at fair market value with gains and losses going to current earnings such as in the case of precious metal inventory carried on the books or a securities investment classified as a trading investment under FAS 115 or IAS 32 rules? See Paragraphs 23 and 405 of FAS 133.  YES 


Is the derivative a fair value hedge of a hedged item
currently carried at fair market value with gains
and losses going to OCI such as an AFS investment or liability
under FAS 115 rules? See Paragraphs 405 and 23 of FAS
133.
See Example 4.14
beginning in Paragraph 23.04 on Page 128 of
KPMG's Derivatives and Hedging Handbook. When
recording the changes in value of the hedged item, the change in value
attributed to intrinsic value is recorded through OCI and the
remainder (time value) to current earnings. 
YES 

Flow Chart on Deciding to When and How to Book Derivatives
Flow Chart and illustrations for Cash Flow Hedging
Flowchart and Illustrations for Fair Value Hedging
Flowchart and Illustrations for Foreign Exchange (FX) Hedging
Bob Jensen added the following journal entry flow chart for foreign currency (FX) hedges scoped into FAS 133 and IAS 39. Assume that the derivative instrument change in fair value increases $100 and the question is what to credit. In the case of a cash flow hedge, assume that the derivative is effective by $90 in intrinsic value. The other $10 is attributed to ineffectiveness of the FX hedge and/or changes in time value of the derivative instrument. In the table below, AFS stands for "AvailableforSale" and HTM stands for "HeldtoMaturity" under FAS 115 definitions. The acronym OCI depicts Other Comprehensive Income or Accumulated OCI under FAS 130. For these and other definitions such as intrinsic value and time value, see the glossary at http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
The Delta ratio is the absolute value of the ratio of the change in the derivative hedge value divided by the change in the amount being hedged. A popular rule of thumb is that when Delta is expressed as a percentage, hedge accounting is allowed when Delta falls between 80% and 125%. When Delta falls outside this range, hedge accounting is not permitted. Look up the term "Ineffectiveness" at http://faculty.trinity.edu/rjensen/acct5341/speakers/133glosf.htm
Explanatory video files are available at http://www.cs.trinity.edu/~rjensen/video/acct5341/fas133/WindowsMedia/
Is the the derivative instrument deemed a speculation or otherwise not eligible for any special hedge accounting treatment? Changes in value of all derivative speculations and ineligible hedges are charged to current earnings. See Paragraph 405 of FAS 133. 



Is the derivative a fair value
FX hedge of a hedged item that is an
unbooked firm commitment such as future inventory purchase, future
investment, or future borrowing under forecasted transaction rules in FAS
133 Paragraphs 3739? Note that FAS 138 amended FAS 133 restrictions
on cross currency hedges that hedge fair value and FX
simultaneously. The FASB invented an account called "Firm
Commitment" for fair value hedges of unbooked hedged items such as
purchase commitments. See FAS 133 Paragraphs 3739?
Note Example 3 beginning in Paragraph 121 of FAS
133. Also see See Example 6.6 beginning on Page 245 of KPMG's Derivatives
and Hedging Handbook. 
YES The above entry is correct as long as Delta is within the 80%125% range. Otherwise the entire $100 is charged against current earnings due to severe ineffectiveness of the hedge. 


Is the derivative a fair value
FX hedge of a hedged item currently carried at fair market value
with gains and losses going to current earnings such as in the case
of precious metal inventory carried on the books or a securities
investment classified as a trading investment under
FAS 115 or IAS 32 rules? Any change in the value of the
hedging derivative goes to current earnings.
See Paragraph 39.02 on Page 244 of KPMG's Derivatives and Hedging Handbook. 
YES 


Is the derivative a fair value
FX hedge of a hedged item currently carried at fair market value
with gains and losses going to OCI such as an
AFS investment or liability under FAS 115 rules? See
Paragraphs 3739 of FAS 133.
See See Example 6.7 beginning on Page 246 of KPMG's Derivatives
and Hedging Handbook. When recording the changes
in value of the hedged item, the change in value attributed to FX is
recorded through earnings and the remainder goes to OCI. 
YES 
Is the derivative a cash flow
FX hedge? If so, the accounting is the same as accounting for
cash flow hedges in general with the exception of net investments in
foreign operations under FAS 52. See FAS 133 Paragraphs 4041?
Note that FAS 138 amended FAS 133 restrictions on cross currency hedges
that hedge fair value and cash flows simultaneously.
Note Example 10 beginning in Paragraph 165 of FAS 133. Download 133ex10a.xls from http://www.cs.trinity.edu/~rjensen/ Also see FX Cash Flow Hedges beginning on Page 251 of KPMG's Derivatives and Hedging Handbook. 
YES The above entry is correct as long as Delta is within the 80%125% range. Otherwise the entire $100 is charged against current earnings due to severe ineffectiveness of the hedge. 
Flow Chart on Deciding to When and How to Book Derivatives
Flow Chart and illustrations for Cash Flow Hedging
Flowchart and Illustrations for Fair Value Hedging
Flowchart and Illustrations for Foreign Exchange (FX) Hedging
Flow Chart for IAS 39 Accounting  http://faculty.trinity.edu/rjensen/acct5341/speakers/39flow.htm
Bob Jensen's tutorials are at http://faculty.trinity.edu/rjensen/caseans/000index.htm
Differences between FAS 133 and IAS 39  http://faculty.trinity.edu/rjensen/caseans/canada.htm
Intrinsic Value Versus Full Value Hedge Accounting  http://faculty.trinity.edu/rjensen/caseans/IntrinsicValue.htm