Derivatives may be complex instruments, but they nevertheless have to be calculated, accounted for and reported on to investors and other users of financial information.The Financial Accounting Standards Board tried to settle the issue when it issued Statement 133, Accounting for Derivative Instruments and Hedging Activities in 1998, but people who read financial statements still had questions. For example, how do derivatives activities impact a company's operations? And how does a given derivative relate to a given risk?'

In response, the board recently issued an exposure draft of a proposed amendment to Statement 133.

It proposes disclosures on how and why an entity uses derivative instruments, how they and related hedged items are accounted for under Statement 133, and how they affect a company's financial position, results of operations and cash flows.

The comment period for the draft closed in March, and thus far, the comment letters expressed concerns that ranged from the picky to the profound.

FASB project manager Kevin Stoklosa said that the comment letters were generally supportive, but there were concerns about the amount of information that would be provided in a tabular disclosure format, too little time before the effective date, and definitions that were seen as too broad or vague.

The most serious criticisms, however, came from the investment banking sector. "The investment banking-type entities believe the project should not move forward in its current state and the scope of the project should be to improve disclosures on all financial instruments," Stoklosa said. "Derivatives are just one form of instrument that they use to manage risk, and providing information only on derivatives provides misleading information."

The International Swaps and Derivatives Association was among those that saw the proposal falling short of its objective. "While we are supportive of meeting users' desires for additional transparency about how and why an entity uses derivative instruments and the impact of derivatives on an entity's financial statements, the level of disaggregation required by the exposure draft is not needed to meet the stated transparency objective," the group's comment letter stated.

Lee Hee, a partner with Big Four firm Ernst & Young, which is a consultant to the ISDA, expressed concern about the narrow scope of the standard. "[The proposal] focuses only on derivative instruments and the creation of another unique framework of disclosures specific to certain instruments," Hee said. "In this regard, the ISDA prefers FASB take a more comprehensive approach by incorporating the objectives and scope into its existing broader presentation and disclosure conceptual framework project."

Calling the ED "internally inconsistent [and] unclear as to the overall objective," financial services conglomerate Merrill Lynch objected to the idea of issuing a standard for derivatives and hedging instruments, rather than an all-inclusive standard on disclosures for all kinds of financial instruments. "For financial institutions in particular, requiring different disclosures for derivatives, as compared to other financial instruments, creates an artificial distinction that bears little relationship to the way these derivatives and other financial instruments are used in practice," the firm's letter read. "There seems to be a conflict between the board's stated objective of increasing transparency of derivatives, and the implied objective, which seems more geared towards disclosure of enterprise risk and how it is managed."

The letter went on to say that while the proposal might work for a manufacturing company with few derivatives, it would be inappropriate for a financial institution.


Audit firms were generally more supportive, even if less than totally satisfied.

KPMG criticized only a few relatively minor points in the proposal. It asked for a clear definition of a derivative's "contingent features" that would have to be disclosed. It agreed with the required disclosure of the aggregate fair value of assets that would be required to be posted as collateral, but felt that the rule should apply to equity as well. PricewaterhouseCoopers had no difficulties with the lack of definition, but felt that contingency features should be disclosed for all "default provisions," even those only remotely possible. The firm also believed that interim reports need not reflect full disclosure about derivatives.

Shell International expressed concerns that may be shared by other large international companies. It sharply criticized the ED's failure to converge with the recently issued International Financial Reporting Standard 7, and added, "We see no benefit - for either accounts preparers or account users - to introducing new divergence."

The company also complained that not only would compilation and presentation be onerous, but also the amount of detail and granularity could lead to inconsistency in interpretation.

As FASB began its redeliberations, Stoklosa declined to predict whether the board still expected to issue a final statement in the second quarter of 2007.

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