Derivatives Implementation Group

Statement 133 Implementation Issue No. K4

QUESTION

May an entity classify as part of interest income or interest expense in its income statement (a) the amount of hedge ineffectiveness and (b) the component of the derivative instrument's gain or loss, if any, excluded from the assessment of hedge effectiveness arising from qualifying fair value hedges of its existing interest-bearing assets and interest-bearing liabilities or qualifying cash flow hedges of the forecasted receipt or payment of interest or forecasted acquisitions of debt securities or forecasted borrowings?

BACKGROUND

In defining how hedge effectiveness will be assessed, an entity may specify whether it will include in that assessment all of the gain or loss on a hedging instrument. Paragraph 63 of Statement 133 permits an entity to exclude all or a part of the hedging instrument's time value from the assessment of hedge effectiveness. When an entity excludes all or a part of the hedging instrument's time value from the assessment of hedge effectiveness, changes in the excluded component of the hedging instrument's value are recorded in earnings. In addition, any hedge ineffectiveness that results under the entity's defined method of assessing effectiveness is recognized in current earnings.

With respect to financial institutions, analysis of the financial statements of those institutions considers various measures of performance that take into account the institutions' reported interest income and interest expense. In addition, certain financial institutions are subject to regulatory disclosure requirements that include the average yield for each major category of interest-bearing asset, the average rate paid for each major category of interest-bearing liability, the average yield on all interest-earning assets, the average effective rate paid on all interest-bearing liabilities, and the net yield on interest-earning assets. This suggests that there should be comparability in the income statement category in which financial institutions report the amount of their hedges' ineffectiveness and the excluded component of their derivative instruments' gains or losses.

RESPONSE

Statement 133 does not provide guidance on the required income statement classification of the amount of hedge ineffectiveness and the component of a derivative instrument's gain or loss, if any, excluded from the assessment of hedge effectiveness. While Statement 133 does not specify whether certain income statement categories are either permitted or appropriate, the Statement does contain specific disclosure requirements for those items.

Paragraph 44C of Statement 133 states, in part:

    An entity that holds or issues derivative instruments (and nonderivative instruments that are designated and qualify as hedging instruments pursuant to paragraphs 37 and 42)^12a2 shall disclose for every annual and interim reporting period for which a statement of financial position and statement of financial performance are presented:...

1. The location and amount of the gains and losses reported in the statement of financial performance (or when applicable, the statement of financial position, for example, gains and losses initially recognized in other comprehensive income [OCI]) on derivative instruments and related hedged items. Gains and losses shall be presented separately for:

   (1)  Derivative instruments designated and qualifying as hedging instruments in fair value hedges and related hedged items designated and qualifying in fair value hedges.

   (2)  The effective portion of gains and losses on derivative instruments designated and qualifying in cash flow hedges and net investment hedges that was recognized in OCI during the current period.

   (3)  The effective portion of gains and losses on derivative instruments designated and qualifying in cash flow hedges and net investment hedges recorded in accumulated other comprehensive income during the term of the hedging relationship and reclassified into earnings during the current period.

   (4)  The portion of gains and losses on derivative instruments designated and qualifying in cash flow hedges and net investment hedges representing (a) the amount of the hedges’ ineffectiveness and (b) the amount, if any, excluded from the assessment of hedge effectiveness....

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.