Derivatives Implementation Group

Statement 133 Implementation Issue No. G5

QUESTION

In a contract that requires the buyer to pay $100 per unit adjusted for a portion of the change in the average market price of sugar, a major ingredient in the item purchased, may the buyer use a derivative whose underlying is the price of sugar in a cash flow hedge of its purchases under the contract in a hedge of its exposure to changes in the price of sugar? Assume the purchase contract does not meet the definition of a freestanding derivative and does not contain an embedded derivative that warrants separate accounting under Statement 133.

BACKGROUND

Statement 133 permits an entity to use hedge accounting in a hedge of the variability of cash flows in a forecasted transaction provided the transaction is probable of occurring and all hedging criteria are met.

Paragraph 29(g) requires that if the hedged transaction is the forecasted purchase or sale of a nonfinancial asset (as in the above example), the designated risk being hedged must be the risk of changes in the cash flows relating to all changes in the purchase or sales price of the asset, not the risk of changes in the cash flows relating to the purchase or sale of a major ingredient.

RESPONSE

Because of the limitations in paragraph 29(g), the buyer must designate as the risk being hedged the risk of changes in the cash flows relating to all changes in the purchase price of the items being acquired under the contract. If the only variability in the items' purchase price under this peculiar contract relates to changes in the average market price of sugar, the buyer may use a derivative whose underlying is the price of sugar in a cash flow hedge of its purchases under the contract. The buyer must determine that all the criteria for cash flow hedges are satisfied, including that the hedging relationship is highly effective in achieving offsetting cash flows attributable to the hedged risk during the term of the hedge.

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.