Derivatives Implementation Group

Statement 133 Implementation Issue No. J10

QUESTION

Should the transition adjustment resulting from adopting Statement 133 be reported in net income or other comprehensive income for a fixed-price purchase or sale contract that (1) was not previously accounted for as a derivative under generally accepted accounting principles before the date of initial application of Statement 133, (2) meets the definition of a derivative under Statement 133, (3) does not qualify for the normal purchases and normal sales exception in paragraph 10(b), and (4) qualifies as the hedging instrument in an "all-in-one" cash flow hedge pursuant to Statement 133 Implementation Issue No. G2, "Hedged Transactions That Arise from Gross Settlement of a Derivative ('All-in-One' Hedges)"?

For example, prior to adoption of Statement 133 Company A entered into a fixed-price purchase order to eliminate the fluctuation in the price of items to be purchased for inventory. Upon the initial application of Statement 133, that fixed price purchase order meets the definition of a derivative. Should Company A's transition adjustment resulting from adopting Statement 133 related to the fixed-price purchase order be reported in net income or other comprehensive income?

BACKGROUND

Statement 133 defines derivative instruments based on their characteristics; the resulting definition includes certain instruments that were not previously accounted for as derivatives. Therefore, prior to the initial application of Statement 133, those instruments were not designated in hedging relationships because they were not accounted for as derivatives. Those circumstances raise implementation questions regarding the application of paragraph 52 to the resultant transition adjustment.

Paragraph 52 of Statement 133 (as amended) states, in part, the following:

     The transition adjustment resulting from adopting this Statement shall be reported in net income or other comprehensive income, as appropriate, as the effect of a change in accounting principle and presented in a manner similar to the cumulative effect of a change in accounting principle as described in paragraph 20 of APB Opinion No. 20, Accounting Changes. Whether a transition adjustment related to a specific derivative instrument is reported in net income, reported in other comprehensive income, or allocated between both is based on the hedging relationships, if any, that had existed for that derivative instrument and that were the basis for accounting under generally accepted accounting principles before the date of initial application of this Statement.

1. If the transition adjustment relates to a derivative instrument that had been designated in a hedging relationship that addressed the variable cash flow exposure of a forecasted (anticipated) transaction, the transition adjustment shall be reported as a cumulative-effect-type adjustment of accumulated other comprehensive income.

    

2. If the transition adjustment relates to a derivative instrument that had been designated in a hedging relationship that addressed the fair value exposure of an asset, a liability, or a firm commitment, the transition adjustment for the derivative shall be reported as a cumulative-effect-type adjustment of net income. Concurrently, any gain or loss on the hedged item shall be recognized as an adjustment of the hedged item's carrying amount at the date of initial application, but only to the extent of an offsetting transition adjustment for the derivative. Only for purposes of applying the preceding sentence in determining the hedged item's transition adjustment, the gain or loss on the hedged item may be either (1) the overall gain or loss on the hedged item determined as the difference between the hedged item's fair value and its carrying amount on the date of initial application (that is, not limited to the portion attributable to the hedged risk nor limited to the gain or loss occurring during the period of the preexisting hedging relationship) or (2) the gain or loss on the hedged item attributable to the hedged risk (limited to the hedged risks that can be designated under paragraph 21 of this Statement) during the period of the preexisting hedging relationship. That adjustment of the hedged item's carrying amount shall also be reported as a cumulative-effect-type adjustment of net income....

3. Other transition adjustments not encompassed by paragraphs 52(a), 52(b) and 52(c) above shall be reported as part of the cumulative-effect-type adjustment of net income.

RESPONSE

Upon transition, a fixed-price purchase or sale contract that (1) was not previously accounted for as a derivative under generally accepted accounting principles before the date of initial application of Statement 133, (2) meets the definition of a derivative under Statement 133, (3) does not qualify for the normal purchases and normal sales exception in paragraph 10(b), and (4) qualifies as the hedging instrument in an "all-in-one" hedge pursuant to Issue G2 should be measured at fair value with the difference between its carrying amount and fair value reported as a cumulative-effect-type adjustment of accumulated other comprehensive income. Therefore, the guidance in paragraph 52(a) should be applied in arriving at the transition adjustment for that contract. If that contract qualifies for the normal purchases and normal sales exception in paragraph 10(b) (as amended by Statement 138), there would be no transition adjustment upon initial adoption of Statement 133.

If an "all-in-one" hedging relationship is not designated and fully documented upon the date of initial application (even though the contract qualifies for such a hedging relationship), the derivative must subsequently be accounted for as having no hedging designation, assuming the normal purchases and normal sales exception does not apply. Accordingly, any gain or loss on the derivative must be recognized currently in earnings prospectively from the date of initial application. In those circumstances, the transition adjustment should continue to be reported in accumulated other comprehensive income until it is reclassified into earnings pursuant to either paragraph 31 or paragraph 33. Conversely, if an "all-in-one" hedging relationship is designated and fully documented by the date of initial application, the derivative may continue to be accounted for as an "all-in-one" hedge in accordance with the guidance in Issue G2. Thus, in the example discussed above, upon transition Company A should measure the purchase order at fair value with the difference between its carrying amount and fair value reported as a cumulative-effect-type adjustment of accumulated other comprehensive income. The gain or loss recorded in other comprehensive income will be reclassified into earnings when the forecasted inventory purchase impacts earnings. The purchase order qualifies as the hedging instrument in an "all-in-one" hedge pursuant to the guidance in Issue G2. Issue G2 indicates that a derivative instrument involving gross settlement may be designated as the hedging instrument in a cash flow hedge of the consideration to be paid or received in the forecasted transaction that will occur upon gross settlement of the derivative contract itself.

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.