Derivatives Implementation Group

Statement 133 Implementation Issue No. E17

QUESTION

If an entity has entered into a purchase contract that is a derivative instrument but, as a normal purchase, that contract is not subject to Statement 133 pursuant to the normal purchases and normal sales exception in paragraph 10(b) (as amended), may that contract be the hedged item in a fair value hedge or may the purchase under that contract be the hedged transaction in a cash flow hedge?

BACKGROUND

An entity enters into a purchase contract that is a derivative instrument under the criteria in paragraphs 6-9. However, the contract meets the conditions for the normal purchases and normal sales exception in paragraph 10(b). The introduction to paragraph 10 states that "notwithstanding the conditions in paragraphs 6-9, the following contracts are not subject to the requirements of this Statement...."

Footnote 8 to paragraph 21 states that "a firm commitment that represents an asset or liability that a specific accounting standard prohibits recognizing…may nevertheless be designated as the hedged item in a fair value hedge."

RESPONSE

Yes. A contract that is not subject to the requirements of Statement 133 because it qualifies for the normal purchases and normal sales exception may be designated as a hedged item in a fair value hedge, provided that the provisions of paragraph 21 are met. Similarly, the purchase under that contract may be the hedged transaction in a cash flow hedge, provided that the provisions of paragraph 29 are met. As the hedged item, the contract would be accounted for under fair value hedge accounting as specified in Statement 133. (For cash flow hedges, the special accounting applies to the hedging instrument, not to the purchase contract that is related to the hedged forecasted transaction.) In emphasizing the conditions in the definition of a derivative instrument in paragraphs 6-9, paragraph 10 essentially exempts contracts that meet the definition of a derivative from the requirements of Statement 133 applicable to derivative instruments. However, paragraph 10 is not intended to preclude such contracts from being subject to the requirements of Statement 133 applicable to the hedged item in a fair value hedge.

A contract that qualifies for the normal purchases and normal sales exception will typically satisfy the criteria for a firm commitment and will not be recognized on an entity's financial statements because of the exclusion from recognition under Statement 133 or other accounting literature. Footnote 8 to paragraph 21 acknowledges such unrecognized firm commitments may be the hedged item in a fair value hedge. The transaction under a contract that qualifies for the normal purchases and normal sales exception but does not satisfy the criteria for a firm commitment because the contract does not contain a fixed price may be the hedged transaction in a cash flow 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.