Derivatives Implementation Group

Statement 133 Implementation Issue No. J19

QUESTION

In initially adopting Statement 133, may an entity bifurcate and separately account for the forward component and the option component that comprise a compound commodity contract that meets the definition of a derivative and exists at the date of initial application of Statement 133?

BACKGROUND

Many commodity contracts are structured to contain both a forward component and an option component. Typically there is a minimum volume to be delivered (the forward component) as well as an option to purchase an additional volume (an option component) to ensure that the buyer has a sufficient supply to meet production demands. In its entirety, that compound contract cannot qualify for the normal purchases and normal sales exception in paragraph 10(b) of Statement 133, as discussed in Statement 133 Implementation Issue No. C16, "Applying the Normal Purchases and Normal Sales Exception to Contracts That Combine a Forward Contract and a Purchased Option Contract." Statement 133 Implementation Issue No. C10, "Can Option Contracts and Forward Contracts with Optionality Features Qualify for the Normal Purchases and Normal Sales Exception?" also points out that freestanding option contracts cannot qualify for the normal purchases and normal sales exception in paragraph 10(b).

Some constituents have desired to bifurcate the compound contract into its components, a forward contract and an option contract, in order to apply paragraph 10(b) solely to the forward component. However, paragraph 18 and Statement 133 Implementation Issue No. B15, "Separate Accounting for Multiple Derivative Features Embedded in a Single Hybrid Instrument," preclude a company from bifurcating a derivative instrument by risk. Thus, under the ongoing application of Statement 133, a company cannot bifurcate a compound commodity contract into a forward contract and an option contract. Paragraph 523 indicates that the prohibition to bifurcating a compound derivative instrument is not considered to be unduly burdensome on an ongoing basis. However, for the initial adoption of Statement 133, footnote 13 to paragraph 49 specifies one single exception to the general rule in paragraph 18 for a compound derivative that has a foreign currency exchange risk component. That exception permits an entity, at the date of initial application of Statement 133, to separate the compound derivative into two parts: the foreign currency derivative and the remaining derivative. FASB Statement No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, did not rescind that single exception even though the reasons cited in paragraph 524 for that exception were nullified when Statement 138 amended the provisions of Statement 133 for foreign currency hedges.

RESPONSE

No, in initially adopting Statement 133, an entity may not bifurcate and separately account for the forward component and the option component that comprise a compound commodity contract that meets the definition of a derivative and exists at the date of initial application of Statement 133. Statement 133 does not permit such bifurcation.

In stating that a compound contract composed of a forward component and an option component cannot qualify for the normal purchases and normal sales exception in paragraph 10(b) of Statement 133, Implementation Issue C16 provides some relief in its transition provisions. Its guidance does not retroactively affect the accounting for the compound contract if that compound contract was negated and replaced by two separate contracts (a forward contract and an option contract) prior to the effective date of Implementation Issue C16. (The effective date of that Implementation Issue for each reporting entity is the first day of its second fiscal quarter beginning after October 10, 2001.)

EFFECTIVE DATE

The effective date of the implementation guidance in this Issue for each reporting entity is the date of its initial adoption of Statement 133.

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.