CFO Accounting Alert

New Rules Coming if You Use Derivatives
 

Derivatives? Tell Me More?
Derivatives, complex financial instruments that can help a company manage - or mismanage! - its risks, are increasingly common in the business world today. By far, the most common derivative in use is an interest rate swap, which is an agreement with a financial institution that can help a company lock in its interest rate on borrowings, generally at a lower rate than it could achieve with a fixed-rate loan. Companies also use derivatives to provide a hedge against changes in commodity prices, foreign currency exchange rates, and many other risks.

Due to the potentially significant impact of these instruments on a company's financial performance, new rules effective next year will require companies to disclose more information about their use of derivatives. Accounting rules require companies to record their derivatives at fair market value, although changes in fair market value are excluded from earnings (and reported directly in stockholders' equity on the balance sheet) if certain stringent criteria are met.

Effective in 2009, the rule requires the following new disclosures be included in a company’s financial statements:

  • A discussion of the company's objectives in using derivatives, and related risks
  • The fair value of derivatives at year-end, and where that amount is classified in the balance sheet
  • The amount of gains and losses during the year, and the portions thereof included in earnings and included directly in stockholders' equity. The latter should be broken out by category, as follows (based on definitions included in Financial Accounting Standards Board (FASB) Statement No. 133, which governs the accounting for derivatives):
    • fair value hedge
    • cash flow hedge (this is the category into which most interest rate swaps fall)
      • effective portion
      • ineffective portion
    • foreign currency hedge
    • other (i.e., derivatives for which hedge accounting isn't used)

For more information, please contact Tracy Harding at 207-991-5114 or email Tharding@bdmp.com.