Derivatives Implementation Group

Statement 133 Implementation Issue No. J11

QUESTION

If, prior to adopting Statement 133, an entity separately accounted for the discount or premium on a forward contract (or the premium on a purchased foreign currency option) designated as a hedge of a net investment in a foreign operation and included the discount or premium in the determination of net income over the life of the forward contract as permitted by paragraph 18 of FASB Statement No. 52, Foreign Currency Translation, how should the transition adjustment for net investment hedges be reported upon initial application of Statement 133 (that is, as a cumulative-effect-type adjustment of net income or other comprehensive income)?

BACKGROUND

Prior to Statement 133, paragraph 18 of Statement 52 set forth the accounting guidance for a foreign currency forward contract designated as a hedge of a net investment in a foreign operation. Under that guidance, the change in value of a forward contract designated as a net investment hedge would be computed based on the change in spot rates. Also, the discount or premium on the forward contract (determined by multiplying the foreign currency amount of the contract by the difference between the contracted forward rate and the spot rate at the date of inception of the contract) would be accounted for separately from the gain or loss on the contract and may either (a) be included in net income over the life of the forward contract or (b) be included with translation adjustments in other comprehensive income.

Statement 133 changed the accounting for derivatives designated as net investment hedges. Because Statement 133 requires all derivatives to be reported at fair value, the discount or premium on a forward contract that is used to hedge the foreign exchange exposure of the entity's net investment in foreign operations may not be accounted for separately. That guidance is explicit in Statement 133 Implementation Issue No. H6, "Accounting for Premium or Discount on a Forward Contract Used as the Hedging Instrument in a Net Investment Hedge."

Paragraph 52 of Statement 133 sets forth general guidance for reporting transition adjustments. It states, "…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." None of the subparagraphs of paragraph 52 explicitly address derivatives designated as net investment hedges. Paragraph 52(d) states, "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."

Paragraph 515 of Statement 133 states, "...changes in the fair value of derivatives that arose before initial application of this Statement and were previously recognized in net income, added to the carrying amount of hedged assets or liabilities, or included in other comprehensive income as part of a hedge of a net investment in a foreign entity are not to be included in transition adjustments."

RESPONSE

If, (a) prior to adopting Statement 133, an entity separately accounted for the discount or premium on a forward contract (or the premium on a purchased foreign currency option) designated as a hedge of a net investment in a foreign operation and included the discount or premium in the determination of net income over the life of the forward contract and (b) upon application of Statement 133, an entity designates changes in spot exchange rates for the measurement of ineffectiveness in a net investment hedge, the transition adjustment should be reported as a cumulative-effect-type adjustment of net income. If, (a) prior to adopting Statement 133, an entity separately accounted for the discount or premium on a forward contract (or the premium on a purchased foreign currency option) designated as a hedge of a net investment in a foreign operation and included the discount or premium in the determination of net income over the life of the forward contract and (b) upon initial application of Statement 133, an entity designates changes in forward exchange rates for the measurement of ineffectiveness in a net investment hedge, the transition adjustment should be reported as a cumulative-effect-type adjustment of the cumulative translation adjustment section of other comprehensive income (OCI). Therefore, if an entity had previously designated a forward contract as a net investment hedge and chose to amortize the discount or premium to net income over the life of the forward contract, the transition adjustment that would be recorded upon initial application of Statement 133 would be equal to the amount by which the fair value of the forward contract differs from the amount recorded on the entity's balance sheet as a result of applying Statement 52. Under Statement 52, the amount on the entity's balance sheet would be comprised of the amortized amount of discount or premium related to the forward contract and the cumulative change in value of the forward contract attributable to spot rate changes.

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.