FASB Statement 133

1. Accounting for Derivative Instruments and Hedging Activities FASB Statement 133

2. ACCOUNTING FOR DERIVATIVESFASB Statement No. 133 Presentation by Bavan Holloway Robert Jensen Ira G. Kawaller

3. CASE 1 Cash Flow Hedge of Forecasted Inventory Sale ABC is hedging the risk of changes in cash flows related to a forecasted sale of 100,000 bushels of Commodity A to be sold at the end of period 1. The inventory carrying value is $1 million, and current market value is $1.1 million On the first day of period 1, ABC enters into Derivative Z to sell 100,000 bushels at $1.1 million at the end of period At hedge inception, the derivative is at-the-money (fair value is 0) All terms of the commodity and the derivative match (i.e., no expected ineffectiveness) On last day of Period 1, fair value of Derivative Z increased by $25,000 and expected sales price of 100,000 bushels of Commodity A decreased $25,000 From Example 4, Appendix B of Standard

4. CASE 1 Cash Flow Hedge of Forecasted Inventory Sale Journal entries at end of period 1 Derivative Z 25,000 OCI 25,000 To record Derivative Z at fair value Cash 25,000 Derivative Z 25,000 To record settlement of Derivative Z

5. CASE 1 Cash Flow Hedge of Forecasted Inventory Sale Journal entries at end of period 1 Cash 1,075,000 CGS 1,000,000 Revenue 1,075,000 Inventory 1,000,000 To record inventory sale OCI 25,000 Earnings 25,000 To reclassify amount in OCI to earnings upon inventory sale

6. CASE 1 Cash Flow Hedge of Forecasted Inventory Sale Forecasted cash flows: $1,100,000 Actual cash flows: Derivative $ 25,000 Sale of inventory 1,075,000 Total $1,100,000 The variability of cash flows related to the forecasted inventory sale is offset by change in value of derivative.

7. CASE 2Fair Value Hedge of Inventory ABC has 1,000 bushels of a Commodity with a fair value of $1.1 million and a carrying value of $1.0 million ABC wants to hedge overall fair value of the Commodity On 1/1/X1, ABC enters into an at-the-money �matching� derivative to hedge the changes in fair value of the 1,000 bushels of the Commodity This is example 1 from Appendix B of the Standard. Derivative is assumed to have no time value. In application, though, the derivative will have a time value component which must be accounted for. ABC expects no ineffectiveness because (a) the notional amount of Derivative Z matches the amount of the hedged inventory, and (b) the underlying of Derivative Z is the price of the same variety and grade of Commodity A as the inventory at the same location.This is example 1 from Appendix B of the Standard. Derivative is assumed to have no time value. In application, though, the derivative will have a time value component which must be accounted for. ABC expects no ineffectiveness because (a) the notional amount of Derivative Z matches the amount of the hedged inventory, and (b) the underlying of Derivative Z is the price of the same variety and grade of Commodity A as the inventory at the same location.

8. CASE 2 (Cont�d)Fair Value Hedge of Inventory Effectiveness will be assessed by comparing entire change in fair value of derivative to change in market price of inventory (time value will be ignored for illustration purposes only) On 1/31/X1, the fair value of the derivative has increased by $25,000 and the fair value of the inventory has decreased by $25,000

9. CASE 2Fair Value Hedge of Inventory Journal entries at end of period: Derivative 25,000 Earnings 25,000 To record derivative at fair value Earnings 25,000 Inventory 25,000 To record loss on hedged inventory In Case 2, it is assumed that there is no ineffectiveness.In Case 2, it is assumed that there is no ineffectiveness.