NACUBO Derivatives ED Comment

Elsa.Greer

Description

• National Association of College and University Business Officers 1110 Vermont Avenue, NW Suite 800 Washington, DC 20005 T 202.861.2500 F 202.861.2583 www.nacubo.org October 26, 2007 Mr. David Bean Director of Research Governmental Accounting Standards Board 401 Merritt 7 PO Box 5116 Norwalk, CT 06856-5116 Re: Project No. 26-4 Dear David: The National Association of College and University Business Officers (NACUBO) appreciates the opportunity to provide input to the Board's Exposure Draft, “Accounting and Financial Reporting for Derivatives.” We value the considerable effort that the Board and the staff have invested in this project. NACUBO’s comments on the proposed statement were developed by members of our Accounting Principles Council (APC). The council consists of experienced volunteers from member institutions who, collectively, possess a thorough knowledge of higher education accounting and reporting issues and practices. NACUBO’s comments address the following: • Hedge accounting • Analyzing hedge effectiveness • Investment derivative instruments • ent derivative instrument disclosures • Inconsistency with FASB Statement of Accounting Standards No. 133 • The lack of lead time for implementation Hedge Accounting and Effectiveness Our understanding is that a hedging derivative instrument is a derivative instrument associated with a hedgeable item prior to the determination that it is effective ...

Informations

• Publié par: Onsa
• Nombre de lectures: 28
• Langue: English

Extrait

We mean business in higher education

National Association of College and University Business Officers

1110 Vermont Avenue, NW

Suite 800

Washington, DC 20005

T

202.861.2500

F

202.861.2583

www.nacubo.org

•

October 26, 2007

Mr. David Bean

Director of Research

Governmental Accounting Standards Board

401 Merritt 7

PO Box 5116

Norwalk, CT 06856-5116

Re: Project No. 26-4

Dear David:

The National Association of College and University Business Officers (NACUBO)

appreciates the opportunity to provide input to the Board's Exposure Draft, “Accounting

and Financial Reporting for Derivatives.”

We value the considerable effort that the

Board and the staff have invested in this project.

NACUBO’s comments on the proposed statement were developed by members of our

Accounting Principles Council (APC). The council consists of experienced volunteers

from member institutions who, collectively, possess a thorough knowledge of higher

education accounting and reporting issues and practices.

NACUBO’s comments address the following:

•

Hedge accounting

•

Analyzing hedge effectiveness

•

Investment derivative instruments

•

Investment derivative instrument disclosures

•

Inconsistency with FASB Statement of Accounting Standards No. 133

•

The lack of lead time for implementation

Hedge Accounting and Effectiveness

Our understanding is that a hedging derivative instrument is a derivative instrument

associated with a hedgeable item prior to the determination that it is effective in reducing

the identified financial risk.

Effectiveness is evaluated only at the end of each reporting period, using the consistent

critical terms method, one of three quantitative methods (synthetic instrument method,

dollar offset method or regression method) or another method that meets specified

requirements.

If the hedge is not effective first using the consistent critical terms method,

at least one quantitative method must be applied before concluding the potential hedging

derivative instrument is not effective.

The effectiveness of derivative instruments found

to be hedging derivative instruments must be re-evaluated at the end of each subsequent

reporting period using the method that was applied in the prior period.

We do not agree with the full hedge accounting and reporting requirement.

We agree that

the fair value of all derivative instruments should be consistently recognized and

measured at fair value in a government’s balance sheet and changes in the fair value of

derivative instruments should be reflected in a government’s change statements – without

the mandatory requirement of hedge accounting.

We think the balance sheet inflow and

outflow deferrals that are associated with hedge accounting will lead to clutter – resulting

in reduced understanding by readers and users.

There is also a burden associated with evaluating hedge effectiveness.

The proposed

methods for determining whether hedges are effective are very technical and complex, so

the significant time and resources involved in determining whether a hedge is effective

(and the extent of its ineffectiveness) is disproportionate to the benefits derived.

These

are complex issues that the GASB has spent years studying.

At the very least a phased

approach that allows the optional use of hedge accounting, experimentation with the

decision utility of reported deferrals, and begins with simpler alternatives for evaluating

hedge effectiveness over time should be considered.

Investment Derivative Instruments

In reading the Exposure Draft, it seems that derivative instruments used in investment

portfolios and/or strategies cannot be hedging derivative instruments.

However, except

for the note disclosure section at the end, the proposed statement does not clearly and

unambiguously distinguish between hedging derivative instruments and investment

derivative instruments.

It is becoming more common for colleges and university investment managers to use

derivatives in the endowment pool to hedge investment risk. Consequently we think

stronger language in the statement would prevent potential misinterpretation of the

statement’s requirements. For example, Section 17 could state that “Derivative

instruments associated with assets and liabilities measured at fair value, including those

held in the government’s investment portfolio or used by a government or the

government’s agents (external investment managers) in executing investment portfolio

strategies are not eligible for hedge accounting.

The changes in fair value of those

derivative instruments should always be reported as investment income on the change

statement.”

In addition, college and university endowment investment pools may also indirectly hold

derivative instruments as the underlying assets of a hedge fund or limited partnership. It

would be helpful if the proposed statement unequivocally established that derivative

instruments held indirectly in limited partnerships and other externally managed pools or

vehicles such as mutual funds are exempt from the requirements of this statement

including note disclosures.

Disclosure Requirements for Investment Derivative Instruments

As stated earlier, college and university endowments hold investment derivative

instruments.

The endowment managers also use such instruments to meet pricing and

purchasing strategies. Unlike interest rate swap agreements and other illiquid contracts

that will typically fall under hedging derivative instruments, many investment derivative

instruments have shorter maturities or are highly liquid (e.g., exchange traded), resulting

in less risk.

Accordingly, investment derivative instrument Note disclosures should be

flexible enough to explicitly permit the aggregation or netting of contract types at a high

level.

For example, without the type of aggregation permitted in paragraph 4 of GASB

Statement No. 40, “Deposit and Investment Risk disclosures,” NACUBO is concerned

that the disclosures per the proposed statement, by higher education institutions with

complex endowment investment pools, may provide a volume of information that

approximates transaction level detail.

Such laundry lists of detail will not serve to

improve financial reporting.

Inconsistency with FASB Statement of Accounting Standards No. 133

Because higher education is one industry with public institutions that follow

Governmental Accounting Standards Board (GASB) standards and independent

institutions that follow FASB standards, NACUBO is concerned about consistency

between public and independent institutions.

Currently independent institutions that

follow FASB statement 133, “Accounting for Derivative Instruments and Hedging

Activities,” lack an earnings statement, and the use of hedge accounting is prohibited

under the standard.

Implementation Time Concerns

The proposed effective date, of periods beginning after June 15, 2009, means that the

effective date for public institutions with June 30

th

fiscal year-ends is June 30, 2010 (or

June 30, 2009, if the institution plans to include a year of comparable information).

We

do not believe this provides enough time for affected entities to understand the

requirements, and change systems to enable acquisition of the information that will be

needed for testing hedge effectiveness and meeting disclosure requirements.

GASB issued an implementation guide for GASB Statement No. 40, and it would be

helpful if GASB did the same for this proposed statement.

The implementation guide

could include examples on how to apply the quantitative methods of evaluating hedge

effectiveness and provide examples on different types of Note disclosures.

The effective

date of the pronouncement should not occur less than six months prior to the first day of

the fiscal year covered by this pronouncement after the implementation guide is issued.

Changing the effective date will ensure that government entities have sufficient time to

digest the requirements and work with their agents (including external investment

managers) to capture all the required information.

As stated earlier, this statement is

highly complex.

For comparative financial statements the implementation time line as

proposed would be shorter than the Board’s derivatives project timeline.

Conclusion

In summary, we applaud the Board’s efforts concerning these complex financial

instruments.

NACUBO understands and agrees with the need to include such

instruments and related financial impact in the financial statements – balance sheet,

change statement and footnotes.

We believe management’s intent and risk assessment

are critical to a government’s decision to use derivatives.

We think such critical facts

should not be lost in confusing balance sheet deferrals, evaluation procedures that are

complex and burdensome, or in footnote disclosures so extensive that the meaning

becomes lost to statement users.

In closing, we again wish to express our appreciation for the opportunity to comment.

We look forward to answering any questions the Board or the staff may have about our

response. Please direct your questions to Sue Menditto at 202-861-2542 or

[e-mail].

Sincerely,

Susan M. Menditto

Director, Accounting Policy