Derivatives Implementation Group

Statement 133 Implementation Issue No. A10

QUESTION

Is an asset considered readily convertible to cash, as that phrase is used in paragraph 9(c), if the net amount of cash that would be received from a sale in an active market is not the equivalent amount of cash that an entity would typically have received under a net settlement provision? The net amount of cash that would be received from a sale in an active market may be impacted by various factors, such as sales commissions and costs to transport the asset (such as a commodity) to the delivery location specified for that active market.

BACKGROUND

Paragraph 9(c) of Statement 133 provides that a contract that requires delivery of the assets associated with the underlying has the characteristic of net settlement if those assets are readily convertible to cash. Footnote 5 to that paragraph makes explicit reference to the use of the phrase readily convertible to cash in paragraph 83(a) of FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises.

This issue addresses whether a contract has the net settlement characteristic described in paragraph 9(c). This issue presumes there is no net settlement provision in the contract and no market mechanism that facilitates net settlement that would cause the contract to meet the criteria in paragraphs 9(a) and 9(b). A contract that is a derivative solely because it has the net settlement characteristic described in paragraph 9(c) (since the asset to be delivered under the contract is readily convertible to cash) may yet qualify for the normal purchases and normal sales exception under paragraph 10(b) or the other exclusions provided in paragraph 10.

RESPONSE

It depends. An asset (whether financial or nonfinancial) can be considered to be readily convertible to cash, as that phrase is used in paragraph 9(c), only if the net amount of cash that would be received from a sale of the asset in an active market is either equal to or not significantly less than the amount an entity would typically have received under a net settlement provision. The net amount that would be received upon sale need not be equal to the amount typically received under a net settlement provision.

In describing net settlement, paragraph 6(c) of Statement 133 states, in part, that the contract "...provides for delivery of an asset that puts the recipient in a position not substantially different from net settlement" (emphasis added). The basis for conclusions also comments in paragraph 265 that "...the parties generally should be indifferent as to whether they exchange cash or the assets associated with the underlying," although the term indifferent was not intended to imply an approximate equivalence between net settlement and proceeds from sale in an active market. Based on the foregoing Statement 133 references, if an entity determines that the estimated costs that would be incurred to immediately convert the asset to cash are not significant, then receipt of that asset puts the entity in a position not substantially different from net settlement. Therefore, an entity must evaluate, in part, the significance of the estimated costs of converting the asset to cash in determining whether those assets are readily convertible to cash. For purposes of assessing significance of such costs, an entity should consider those estimated conversion costs to be significant only if they are 10 percent or more of the gross sales proceeds (based on the spot price at the inception of the contract) that would be received from the sale of those assets in the closest or most economical active market. The assessment of the significance of those conversion costs should be performed only at inception of the contract.

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.