GASB proposes to modify swap accounting.

• Author: Gauthier, Stephen J.
• Position: The Accounting Angle

In February 2011, the Governmental Accounting Standards Board (GASB) issued an exposure draft (ED) on Derivative Instruments: Application of Hedge Accounting Termination Provisions. The changes proposed in the ED apply solely to interest rate swaps and commodity swaps. The proposed change, if approved, would take effect starting with the fiscal year that ends June 30, 2012 (earlier application encouraged).

GENERAL BACKGROUND

As a rule, derivative instruments are reported at fair value in the financial statements. Likewise, changes in fair value are reported as part of investment income when they occur. Hedge accounting constitutes an important exception to this general rule.

Hedging involves the use of a derivative instrument (e.g., an interest-rate swap) to offset the effect of market changes on a given asset, liability, or future cash flow (e.g., the anticipated future purchase of commodities). The hedging derivative and the hedged item are "matched" precisely because market changes are expected to effect the two items in opposite ways (e.g., if the fair value of the hedging derivative increased, the fair value of the hedged item would decrease). Thus, changes in the one would be expected to offset changes in the other.

No specialized accounting is necessary if both the hedging derivative and the hedged item are reported at fair value. However, derivatives (always reported at fair value) are often used to hedge items that are not reported at fair value (e.g., debt). If so, changes in the fair value of the hedging derivative would not be offset by corresponding changes in the fair value of the hedged item. To avoid the unsettling effect such a "mismatch" could have on investment income, specialized hedge accounting is used in such situations. Specifically, changes in the fair value of the hedging derivative are reported as deferred items on the statement of position rather than as a component of investment income.

All hedging arrangements must eventually come to an end. Sometimes they do so as the result of a default or some other event that legally terminates the contract (termination event). When a hedge comes to an end, any amounts that have been deferred must be removed from the statement of position and included in investment income of the period.

ISSUE: TERMINATION EVENTS

Some governments have been involved in interest-rate swap agreements or commodity swap agreements that have come to an end because the counterparty (or the...