Derivatives, Contingencies, Business Segments, and Interim Reports

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2. 2 Understand the business and accounting concepts connected with derivatives and hedging activities. Identify the different types of risk faced by a business. Describe the characteristics of the following types of derivatives: swaps, forwards, futures, and options. Learning Objectives

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4. 4 Learning Objectives

5. 5 Types of Risk Price risk Credit risk Interest rate risk Exchange rate risk

6. 6 Types of Derivatives Swap Forward contract Futures contract Option

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11. 11 Call Option: Contract giving the owner the right, but not the obligation, to buy an asset at a specified price. Put Option: Contract giving the owner the right, but not the obligation, to sell an asset at a specified price.

12. 12 Types of Hedging Activities Hedging: Structuring of transactions to reduce risk. Fair value hedge: A derivative that offsets, at least partially, the change in the fair value of an asset or liability. Cash flow hedge: A derivative that offsets, at least partially, the variability in cash flows from forecasted transactions that are probable.

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14. 14 Accounting for Derivatives No hedge: All changes in the fair value of derivatives that are not designated as hedges are recognized as gains or losses in the income statement in the period in which the value changes. Fair value hedge: Changes in the fair value of derivatives designated as fair value hedges are recognized as gains or losses in the period of the value change.

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16. 16 Firms must disclose the gains and losses on derivatives, separated by category: Fair value hedges Cash flow hedges Other

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22. 22 Contingencies FASB Statement No. 5: “. . . an existing condition, situation, or set of circumstances involving uncertainty as to possible gain . . . or loss . . . to an enterprise that will ultimately be resolved when one or more future events occur or fail to occur.”

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24. 24 Accounting for Contingencies Likelihood Accounting Action

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27. 27 Accounting for Lawsuits For uninsured risks, a firm must decide when the liability for litigation becomes probable, and thus, a recorded loss. FASB Statement No. 5 identifies several key factors to consider:

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30. 30 Environmental Liabilities The SEC issued Staff Accounting Bulletin No. 92, its interpretation of GAAP regarding contingent liabilities, with particular applicability to companies with environmental liabilities.

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32. 32 Segment Reporting FASB Statement No. 14 disclosure requirements: Revenues, operating profit, and identifiable assets for each significant industry segment. A segment is significant if its sales, profits, or assets are 10% or more of total company amounts. A practical limit of 10 segments is suggested, and at least 75% of total company sales must be included in the reported segments.

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34. 34 FASB Statement No. 131 Disclosure Requirements Total segment operating profit or loss Amounts of certain income statement items such as operating revenues, depreciation, interest revenue, interest expense, tax expense, and significant noncash expenses. Total segment assets. Total capital expenditures.

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38. 38 Interim Reporting

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40. 40 APB Opinion No. 28 The interim period is an integral part of the annual period.

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