Derivatives Implementation Group
Statement 133 Implementation Issue No. A6
| Title: |
Definition of a Derivative:
Notional Amounts of Commodity Contracts |
| Paragraph
references: |
6(a), 7, 251, 540 |
| Date cleared by
Board: |
November 23, 1999
(Revised December 6, 2000) |
QUESTION
How does the lack of specification of a fixed number
of units of a commodity to be bought or sold affect whether a
commodity contract has a notional amount? Specifically, do each of
the illustrative contracts below have a notional amount as
discussed in paragraph 6(a) to meet Statement 133's definition of
derivative instrument?
BACKGROUND
Paragraph 540 of Statement 133 defines notional
amount as:
A number of currency
units, shares, bushels, pounds, or other units specified in a
derivative instrument.
Many commodity contracts specify a fixed number of
units of a commodity to be bought or sold under the pricing terms
of the contract (for example, a fixed price). However, some
contracts do not specify a fixed number of units. For example,
consider the following four contracts that require one party to buy
the following indicated quantities:
Contract 1: As many units as
required to satisfy its actual needs (that is, to be utilized or
consumed) for the commodity during the period of the contract (a
requirements contract). The party is not permitted to buy more than
its actual needs (for example, the party cannot buy excess units
for resale).
Contract 2: Only as many units as needed to satisfy
its actual needs up to a maximum of 100 units. The party is not
permitted to buy more than its actual needs (for example, the party
cannot buy excess units for resale).
Contract 3: A minimum of 60 units and as many units
needed to satisfy its actual needs in excess of 60 units. The party
is not permitted to buy more than its actual needs (for example,
the party cannot buy excess units for resale).
Contract 4: A minimum of 60 units and as many units
needed to satisfy its actual needs in excess of 60 units up to a
maximum of 100 units. The party is not permitted to buy more than
its actual needs (for example, the party cannot buy excess units
for resale).
This issue solely focuses on whether the contracts
under consideration have a notional amount pursuant to the
definition in Statement 133. These types of contracts may not
satisfy certain of the other required criteria in Statement 133 in
order for them to meet the definition of a derivative
instrument.
RESPONSE
Generally, the anticipated number of units covered by
a requirements contract is equal to the buyer's needs. When a
requirements contract is negotiated between the seller and buyer,
both parties typically have the same general understanding of the
buyer's estimated needs. Given the buyer's often exclusive reliance
on the seller to supply all its needs of the commodity, it is
imperative from the buyer's perspective that the supplier be
knowledgeable with respect to anticipated volumes. In fact, the
pricing provisions within requirements contracts are directly
influenced by the estimated volumes. The conclusion that a
requirements contract has a notional amount as defined in Statement
133 can be reached only if a reliable means to determine such a
quantity exists. Application of this guidance to specific contracts
is provided below.
Contract 1-Requirements Contract
It depends. If the requirements contract contains
explicit provisions that support the calculation of a determinable
amount reflecting the buyer's needs, then that contract has a
notional amount pursuant to the definition in Statement 133. One
technique to quantify and validate the notional amount in a
requirements contract is to base the estimated volumes on the
contract's settlement and default provisions. Often the default
provisions of requirements contracts will specifically refer to
anticipated quantities to utilize in the calculation of penalty
amounts in the event of nonperformance. Other default provisions
stipulate penalty amounts in the event of nonperformance based on
average historical usage quantities of the buyer. If those amounts
are determinable, they should be considered the notional amount of
the contract. The identification of a requirements contract's
notional amount may require the consideration of volumes or
formulas contained in attachments or appendices to the contract or
other legally binding side agreements. The determination of a
requirements contract's notional amount must be performed over the
life of the contract and could result in the fluctuation of the
notional amount if, for instance, the default provisions reference
a rolling cumulative average of historical usage. In circumstances
where the notional amount is not determinable, making the
quantification of such an amount highly subjective and relatively
unreliable (for example, if a contract does not contain settlement
and default provisions that explicitly reference quantities or
provide a formula based on historical usage), such contracts are
considered not to contain a notional amount as that term is used in
Statement 133.
Contract 2-Requirements Contract with a Specified
Maximum Quantity
It depends. The same considerations discussed above
with respect to Contract 1 also apply to Contract 2; however, the
notional amount cannot exceed 100 units.
Contract 3-Requirements Contract with a Specified
Minimum Quantity
Yes. The same considerations discussed above
with respect to Contract 1 also apply to Contract 3; however, the
notional amount of Contract 3 cannot be less than 60 units. A
contract that specifies a minimum number of units always has a
notional amount at least equal to the required minimum number of
units. Only that portion of the requirements contract with a
determinable notional amount would be accounted for as a derivative
instrument under Statement 133.
Contract 4-Requirements Contract with a Specified
Minimum and Maximum Quantities
Yes. The same considerations discussed above with
respect to Contract 1 also apply to Contract 4; however, the
notional amount of Contract 4 cannot be less than 60 units or
greater than 100 units. A contract that specifies a minimum number
of units always has a notional amount at least equal to the
required minimum number of units. Only that portion of the
requirements contract with a determinable notional amount would be
accounted for as a derivative instrument under Statement 133.
The above response has been authored by the FASB
staff and represents the staff's views, although the Board has
discussed the above response at a public meeting and chosen not to
object to dissemination of that response. Official positions of the
FASB are determined only after extensive due process and
deliberation.
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