1. 1-0 Accounting for Derivative Instruments and Hedging Activities FASB Statement 133 October 12-13, 2000 Chicago, IL

2. 1-1 ACCOUNTING FOR DERIVATIVES FASB Statement No. 133 Presentation by Bavan Holloway Robert Jensen Ira G. Kawaller

3. 1-2 CASE 1 Cash Flow Hedge of Forecasted Inventory Sale n 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 n 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 n At hedge inception, the derivative is at-the-money (fair value is 0) n All terms of the commodity and the derivative match (i.e., no expected ineffectiveness) n 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 n From Example 4, Appendix B of Standard

4. 1-3 CASE 1 Cash Flow Hedge of Forecasted Inventory Sale Journal entries at end of period 1 Derivative Z25,000 OCI 25,000 To record Derivative Z at fair value Cash 25,000 Derivative Z 25,000 To record settlement of Derivative Z

5. 1-4 CASE 1 Cash Flow Hedge of Forecasted Inventory Sale Journal entries at end of period 1 Cash1,075,000 CGS1,000,000 Revenue1,075,000 Inventory1,000,000 To record inventory sale OCI 25,000 Earnings 25,000 To reclassify amount in OCI to earnings upon inventory sale

6. 1-5 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. 1-6 CASE 2 Fair Value Hedge of Inventory n ABC has 1,000 bushels of a Commodity with a fair value of $1.1 million and a carrying value of $1.0 million n ABC wants to hedge overall fair value of the Commodity n 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

8. 1-7 CASE 2 (Contd) Fair Value Hedge of Inventory n 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) n 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. 1-8 CASE 2 Fair Value Hedge of Inventory Journal entries at end of period: Derivative 25,000 Earnings25,000 To record derivative at fair value Earnings 25,000 Inventory25,000 To record loss on hedged inventory