Derivatives Implementation Group

Statement 133 Implementation Issue No. J3

QUESTION

May a company that wishes to initially apply Statement 133 as of the beginning of a fiscal quarter (for example, January 1, 1999) for which it has not yet issued financial statements retroactively designate and document hedging relationships "as of" the beginning of the fiscal quarter?

RESPONSE

No. The designation and documentation of hedging relationships (such as that required by paragraphs 20(a) and 28(a)) must be concurrent with the date as of which Statement 133 is initially applied. For example, initial application of Statement 133 to the fiscal quarter ending March 31, 1999 requires designation and documentation of hedging relationships be completed no later than January 1, 1999 to qualify for hedge accounting for the value changes occurring after January 1. Paragraph 48 of Statement 133 states, "Initial application of this Statement shall be as of the beginning of an entity's fiscal quarter; on that date, hedging relationships shall be designated anew and documented pursuant to the provisions of this Statement" (emphasis added). The reference to designating hedging relationships in that paragraph includes the detailed requirements of paragraphs 20 and 28, that is, at inception of a fair value or cash flow hedge, there is formal documentation of the hedging relationship, the entity's risk management objective and strategy for undertaking the hedge, including identification of the hedging instrument, the hedged item, the nature of the risk being hedged, and the method of assessing the hedging instrument's effectiveness.

Because hedge accounting is based on management's intent, an entity is prohibited from reviewing transactions with hindsight and making retroactive decisions after hedge results are known. As stated in paragraph 385 of Statement 133's basis for conclusions, "The Board decided that concurrent designation and documentation of a hedge is critical; without it, an entity could retroactively identify a hedged item, a hedged transaction, or a method of measuring effectiveness to achieve a desired accounting result." Paragraph 515 states, "Because hedge accounting is based on an entity's intent at the time a hedging relationship is established, the Board decided that retroactive application of the provisions of this Statement was not appropriate." In addition, as explained in paragraph 459 of Statement 133, concerns about "after-the-fact" designation led the Board to require in paragraph 28(a)(2) of Statement 133 that documentation at inception of a cash flow hedge specify the date on, or period within which, a forecasted transaction is expected to occur.

Hedging relationships, if any, that existed and were the basis for the company's accounting under generally accepted accounting principles before the date of initial application of Statement 133 affect transition adjustments but are not relevant to hedge accounting after initial application. Unless a hedging relationship has been designated anew and has been fully documented by the date of initial application (that is, on the first day of the quarter in which the Statement is initially applied), a derivative must be accounted for as having no hedging designation. Accordingly, any gain or loss on the derivative must be recognized currently in earnings prospectively from the date of initial application. The designation and formal documentation of a hedging relationship after the date of initial application achieves hedge accounting only prospectively from the date that the hedging relationship is designated and fully documented.

In addition, reclassifications of certain securities accounted for under FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, that are permitted by paragraphs 54 and 55 of Statement 133, must also be made and documented at the date as of which Statement 133 is applied, rather than retroactively.

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.