FASB 133
Encyclopedia
Statements of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, commonly known as FAS 133, is an accounting standard issued in June 1998 by the Financial Accounting Standards Board
(FASB) that requires companies to measure all assets and liabilities on their balance sheet
at “fair value
”. This standard was created in response to significant hedging
losses involving derivatives years ago and the attempt to control and manage corporate hedging as risk management not earnings management.
All derivatives within the scope of FAS133 must be recorded at fair value as an asset or liability. Hedge accounting may be applied if there is hedge documentation and gains and losses in the value of the derivative with gains and losses in the value of the underlying transaction.
To be designated and qualify for FAS 133 hedge accounting, a commodity (hedged item) and its hedging instrument must have a correlation ratio between 80% and 125%, and the reporting enterprise must have hedge documentation in place at the inception of the hedge. If these criteria are not met, hedge accounting cannot be applied. The non-applicability of hedge accounting can lead to significant volatility in corporate earnings. Now, the financial community has had enough experience with FAS 133 that companies and constituents better understand this process and are less critical of the volatile impact on earnings.
Creating forward commodity values to determine correlation, required by FAS 133, is not perfect due to the nature of different OTC derivative commodities and the fact that they are not quoted in exchanges like NYMEX and ICE. Many companies outsource this data collection to ensure that industry methods and standards are achieved. As important as FASB 133 is in risk management and hedging, this reporting system has limited some creative hedges solely based on the potential negative impact on the companies’ earnings.
This FAS was most recently amended in March 2008 by FAS 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133 which requires enhanced disclosures about derivative (finance)
contracts and hedging activities to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. Further, in September 2008, FASB Staff Position (FSP) FAS 133-1 and FASB Interpretation (FIN) 45-4 was issued, entitled Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161. Some provisions of the amendment to FAS 133 became effective sooner than the requirements of FAS 161. The quirkiness of the effective date and its 'earlier' implementation requirements caught some practitioners and impacted financial statement preparers a bit off-guard. In light of recent financial market turmoil linked to the mortgage and banking crisis that reached new degrees of severity in 2008, FASB was concerned new required disclosures for sellers of credit protection (such as institutional investors opening sell protection credit default swaps ("CDS") contracts) needed to be quickly implemented as financial statement readers needed to know more about the risks associated with those types of arrangements, which were associated with and/or contributed toward the recent failure of Lehman Brothers
and AIG
.
Financial Accounting Standards Board
The Financial Accounting Standards Board is a private, not-for-profit organization whose primary purpose is to develop generally accepted accounting principles within the United States in the public's interest...
(FASB) that requires companies to measure all assets and liabilities on their balance sheet
Balance sheet
In financial accounting, a balance sheet or statement of financial position is a summary of the financial balances of a sole proprietorship, a business partnership or a company. Assets, liabilities and ownership equity are listed as of a specific date, such as the end of its financial year. A...
at “fair value
Fair value
Fair value, also called fair price , is a concept used in accounting and economics, defined as a rational and unbiased estimate of the potential market price of a good, service, or asset, taking into account such objective factors as:* acquisition/production/distribution costs, replacement costs,...
”. This standard was created in response to significant hedging
Hedge (finance)
A hedge is an investment position intended to offset potential losses that may be incurred by a companion investment.A hedge can be constructed from many types of financial instruments, including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of...
losses involving derivatives years ago and the attempt to control and manage corporate hedging as risk management not earnings management.
All derivatives within the scope of FAS133 must be recorded at fair value as an asset or liability. Hedge accounting may be applied if there is hedge documentation and gains and losses in the value of the derivative with gains and losses in the value of the underlying transaction.
To be designated and qualify for FAS 133 hedge accounting, a commodity (hedged item) and its hedging instrument must have a correlation ratio between 80% and 125%, and the reporting enterprise must have hedge documentation in place at the inception of the hedge. If these criteria are not met, hedge accounting cannot be applied. The non-applicability of hedge accounting can lead to significant volatility in corporate earnings. Now, the financial community has had enough experience with FAS 133 that companies and constituents better understand this process and are less critical of the volatile impact on earnings.
Creating forward commodity values to determine correlation, required by FAS 133, is not perfect due to the nature of different OTC derivative commodities and the fact that they are not quoted in exchanges like NYMEX and ICE. Many companies outsource this data collection to ensure that industry methods and standards are achieved. As important as FASB 133 is in risk management and hedging, this reporting system has limited some creative hedges solely based on the potential negative impact on the companies’ earnings.
This FAS was most recently amended in March 2008 by FAS 161, Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133 which requires enhanced disclosures about derivative (finance)
Derivative (finance)
A derivative instrument is a contract between two parties that specifies conditions—in particular, dates and the resulting values of the underlying variables—under which payments, or payoffs, are to be made between the parties.Under U.S...
contracts and hedging activities to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. Further, in September 2008, FASB Staff Position (FSP) FAS 133-1 and FASB Interpretation (FIN) 45-4 was issued, entitled Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161. Some provisions of the amendment to FAS 133 became effective sooner than the requirements of FAS 161. The quirkiness of the effective date and its 'earlier' implementation requirements caught some practitioners and impacted financial statement preparers a bit off-guard. In light of recent financial market turmoil linked to the mortgage and banking crisis that reached new degrees of severity in 2008, FASB was concerned new required disclosures for sellers of credit protection (such as institutional investors opening sell protection credit default swaps ("CDS") contracts) needed to be quickly implemented as financial statement readers needed to know more about the risks associated with those types of arrangements, which were associated with and/or contributed toward the recent failure of Lehman Brothers
Lehman Brothers
Lehman Brothers Holdings Inc. was a global financial services firm. Before declaring bankruptcy in 2008, Lehman was the fourth largest investment bank in the USA , doing business in investment banking, equity and fixed-income sales and trading Lehman Brothers Holdings Inc. (former NYSE ticker...
and AIG
AIG
AIG is American International Group, a major American insurance corporation.AIG may also refer to:* And-inverter graph, a concept in computer theory* Answers in Genesis, a creationist organization in the U.S.* Arta Industrial Group in Iran...
.
See also
- FASB
- List of FASB Pronouncements
- IAS 39IAS 39IAS 39: Financial Instruments: Recognition and Measurement is a measure of instrument of the International Accounting Standards Board ....
- Cash flow hedgeCash flow hedgeA cash flow hedge is a hedge of the exposure to the variability of cash flow that# is attributable to a particular risk associated with a recognized asset or liability...
- Foreign Exchange HedgeForeign exchange hedgeA foreign exchange hedge is a method used by companies to eliminate or hedge foreign exchange risk resulting from transactions in foreign currencies . This is done using either the cash flow or the fair value method...
- Hedge accountingHedge AccountingHedge accounting is an accountancy practice.-Why is hedge accounting necessary?:Many financial institutions and corporate businesses use derivative financial instruments to hedge their exposure to different risks .Accounting for derivative financial instruments under International Accounting...