Financial Accounting Standards Board

1. IASB MEETING JUNE 2008 OBSERVER NOTE 5 Financial Accounting Standards Board Hedging Project IASB Education Session June 18, 2008 Kevin Stoklosa

2. Hedging Project • Project Objectives • Simplify accounting for hedging activities • Improve the financial reporting of hedging activities to make the accounting model and the associated disclosures easier to understand for financial statement users • Resolve hedge accounting practice issues that have arisen under Statement No. 133 • Address differences in the accounting for derivative instruments and hedged items or transactions

3. Hedging Project • The hedge accounting approach would establish a fair value methodology to hedge accounting. The approach would eliminate many elements that exist under the current hedge accounting model, including bifurcation-by-risk, the shortcut method, critical terms match, and the requirement to quantitatively assess effectiveness in order to qualify for hedge accounting • The items and transactions currently eligible for hedge accounting would continue to be eligible under this approach.

4. Hedging ProjectMajor Changes • Hedge Effectiveness • Qualitative instead of Quantitative • Reasonably effective • No ongoing effectiveness testing unless circumstances suggest no longer reasonably effective • No effectiveness testing at all was considered

5. Hedging ProjectMajor Changes • Dedesignation • Discontinuation of hedge accounting only if hedging relationship is terminated • Discontinuation of hedging relationship by merely dedesignating is not permitted

6. Hedging ProjectMajor Changes • Hedged Risk • General model is that the designated hedged risk must be all changes in fair value or variability in cash flows (bifurcation-by-risk not permitted) • Two exceptions: • Foreign exchange rate risk can be designated as the hedged risk • Interest rate risk can be designated as the headed risk in a hedge of an entity’s own debt at inception of the debt

7. Hedging ProjectMajor Changes • Measurement of Hedged Item in Fair Value Hedges • Hedged item and derivative hedging instrument must be independently measured for changes in fair value • Not permitted to take the change in fair value of the derivative, change the sign and apply it to the hedged item • All of contractual cash flows of the entire hedged item must be included in calculating the fair value • Adjust the carrying value of hedged item for changes in fair value during the hedge period

8. Hedging ProjectMajor Changes • Measuring and Reporting Ineffectiveness in Cash Flow Hedges • Compare change in fair value of the actual derivative and the present value of the cumulative change in expected future cash flows on the hedged transaction • For example, an entity could compare the change in fair value of the actual derivative with the change in fair value of a derivative that would mature on the date of the forecasted transaction, be priced at market, and provide cash flows that would exactly offset the hedged cash flows • The difference would be reported in earnings as ineffectiveness • Nonperformance risk must be considered when calculating the fair value of the derivative hedging instrument • Permitted to use the same credit adjustment in the derivative that would exactly offset the hedged cash flows as used in the actual derivative

9. Hedging ProjectMajor Changes • Measuring and Reporting Ineffectiveness in Cash Flow Hedges • Hedging with purchased options • When a purchased option contract is used as the hedging instrument to provide only one-sided protection, a purchased option derivative that would mature on the date of the forecasted transaction and provide cash flows that would exactly offset the one-sided change in the hedged cash flows could be used for calculating ineffectiveness. • Ineffectiveness can be measured using all changes in the option’s cash flows

10. Hedging ProjectMajor Changes • Measuring and Reporting Ineffectiveness in Cash Flow Hedges • Hedging groups of transactions – first 100M in sales for January • Compare actual derivative to derivative that settles within a reasonable period of time of cash flows on forecasted transactions • Reasonable if the difference in forward rates between that derivative and derivative(s) that would exactly offset cash flows is minimal

11. Hedging ProjectMajor Changes • Disclosures • For hedged items in fair value hedges - table showing amount reported in balance sheet, Statement 133 adjustment, Other fair value adjustments, amount excluding those adjustments • Hedging interest rate risk in issued debt – how hedging derivative(s) changes maturity and interest rate on debt