Derivatives Implementation Group

Statement 133 Implementation Issue No. H13

QUESTION

In instances where amounts in accumulated other comprehensive income (OCI) in the consolidated financial statements represent the effective portion of derivative gains and losses related to a cash flow hedge of a forecasted foreign-currency-denominated intercompany sale of an item that will be eventually resold to an unrelated third party, at what point should those amounts be reclassified into earnings? That is, should the amounts in OCI be reclassified into earnings when the hedged forecasted transaction-the intercompany sale-affects earnings of the hedging entity (that is, when the hedging subsidiary's intercompany sale occurs), or when consolidated earnings is affected by the eventual resale of the item to an unrelated third party occurs? Paragraph 31 of Statement 133 states, in part, "[a]mounts in accumulated other comprehensive income shall be reclassified into earnings in the same period or periods during which the hedged forecasted transaction affects earnings."

BACKGROUND

Parent A is a multinational corporation that has the U.S. dollar as its functional currency. Parent A has two subsidiaries: Subsidiary B, which has the Euro as its functional currency, and Subsidiary C, which has the Japanese yen as its functional currency. Subsidiary B manufactures a product and has a forecasted sale of the product to Subsidiary C that will be transacted in yen. Eventually, Subsidiary C will sell the product to an unrelated third party in yen. Subsidiary B enters into a forward contract with an unrelated third party to hedge the cash flow exposure of its forecasted intercompany sale in yen to changes in the Euro-JPY exchange rate.

Paragraph 40 of Statement 133 permits a derivative instrument to be designated as a hedge of the foreign currency exposure of variability in the functional-currency-equivalent cash flows associated with a forecasted intercompany foreign-currency-denominated transaction if certain criteria are met. The example transaction meets the hedge criteria of paragraph 40. Specifically, the operating unit having the foreign currency exposure (Subsidiary B) is a party to the hedging instrument; the hedged transaction is denominated in yen, which is a currency other than Subsidiary B's functional currency; and all other applicable criteria in paragraphs 28 and 29 of Statement 133 are satisfied. Subsidiary B measures the derivative instrument at fair value and records the effective portion of the gain or loss on the derivative instrument in accumulated OCI, with the ineffective portion, if any, recorded in current earnings.

RESPONSE

In the consolidated financial statements, the amount in OCI representing the effective portion of the gain or loss on a derivative designated as a cash flow hedge of a forecasted foreign-currency-denominated intercompany sale should be reclassified into earnings in the period that the revenue from the sale of the manufactured product to an unrelated third party is recognized. In the example in the Background section, the reclassification into earnings in the consolidated financial statements should occur when the forecasted sale affects the earnings of Parent A. Since the consolidated earnings of Parent A will not be affected until the sale of the product by Subsidiary C to the unrelated third party occurs, the reclassification of the amount of derivative gain or loss from OCI into earnings in the consolidated financial statements should occur upon the sale by Subsidiary C to an unrelated third party.

This guidance is relevant only with respect to the consolidated financial statements. In Subsidiary B's separate company financial statements, the reclassification of the amount of derivative gain or loss from OCI into earnings should occur in the period the forecasted intercompany sale is recorded since Subsidiary B's earnings are affected by the change in the Euro-JPY exchange rate when the sale to Subsidiary C occurs.

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.