Auditing Derivatives and Hedge Contracts Under ASC 815, 820 and Other Guidance Mastering Key Challenges and Analysis Techniques for Swaps, Options and Other Financial Instruments TUESDAY, FEBRUARY 25, 2014, 1:00-2:50 pm Eastern IMPORTANT INFORMATION This program is approved for 2 CPE credit hours . To earn credit you must: • Respond to verification codes presented throughout the seminar . If you have not printed out the “Official Record of Attendance”, please print it now. To earn Continuing Education credits, you must write down the verification codes in the corresponding spaces found on the Official Record of Attendance form . Complete and submit the “Official Record of Attendance for Continuing Education Credits,” which is available on the • program page along with the presentation materials. Instructions on how to return it are included on the form. • Remain on the line for the entire program. WHOM TO CONTACT For Additional Registrations : -Call Strafford Customer Service 1-800-926-7926 x10 (or 404-881-1141 x10) For Assistance During the Program : - On the web, use the chat box at the bottom left of the screen - On the phone, press *0 (“star” zero) If you get disconnected during the program, you can simply call or log in using your original instructions and PIN.
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Auditing Derivatives and Hedge Contracts Under ASC 815, 820 and Other Guidance Feb. 25, 2014 Elvis Candelario, Rothstein Kass, Michael Loritz, Mayer Hoffman McCann, ecandelario@rkco.com mloritz@cbiz.com
Today’s Program Basics of derivative instruments and hedge contracts Slide 7 – Slide 9 [Elvis Candelario] Slide 10 – Slide 24 Derivatives [ Elvis Candelario] Hedges Slide 25 – Slide 46 [Michael Loritz] Best practices Slide 47 – Slide 54 [Michael Loritz]
Auditing Derivatives and Hedge Contracts Under ASC 815, 820 and Other Guidance Elvis Candelario, Senior Manager Rothstein Kass, New York ecandelario@rkco.com 7
Rothstein Kass provides assurance, tax and advisory services to hedge funds, funds of funds, private equity and venture capital funds, broker-dealers and registered investment advisors. The firm is recognized internationally as a top service provider to the industry, and consults on a wide range of organizational, operational and regulatory issues. The firm also advises on fund structure, both inside and outside the United States, compliance and financial reporting, as well as tax issues from a federal, state, local and international compliance perspective. Rothstein Kass Business Advisory Services, LLC professionals provide value-added and results-oriented consulting services to clients across industries in the areas of strategy, operations, technology, risk, compliance, dispute resolution and investigations. Rothstein Kass Business Advisory Services, LLC is an affiliate of Rothstein Kass. Rothstein Kass has offices in California, Colorado, Massachusetts, New Jersey, New York, Texas and the Cayman Islands. 8
Accounting Guidance • ASC 815 – Derivatives and Hedging • Definition of a derivative instrument • Hedging vs Non-Hedging • Presentation in statement of financial position and operations • Disclosure requirements under ASC 815-10-50 • ASC 820 – Fair Value Measurement • ASC 210-20-50 – Offsetting of Derivatives, Financial Assets, and Financial Liabilities 9
Derivative instruments – Characteristics: • Financial instrument with an underlying or notional reference • No initial investment required • Payment provisions through netting of payments or delivery of asset – Examples: • Futures, Forwards, Options, Warrants, Total Return Swaps, Credit Default Swaps, Interest Rate Swaps, 10
Hedging vs Speculation • Hedging activity: – Risk management • Locking in interest rates • Foreign currency • Speculation: – Getting exposure in a position without directly investing in the underlying – Leveraged exposure to positions 11
Financial Statement Presentation – Required to be measured at fair value • Net equity in the position recorded as asset or liability • Balance sheet offsetting – Disclosure requirements • Additional transparency into exposure and risks • Additional transparency to net exposure by instrument or counterparty 12
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Fair value measurement & techniques The price that would be received to sell an asset or paid to transfer • a liability in an orderly transaction between market participants at the measurement date. – Level 1 – Exchange traded instruments: • Options & Futures contracts – Level 2 – Observable inputs in widely accepted models: • OTC Options, Interest Rate Swaps, Total Return Swaps, Credit Default Swaps. – Level 3 – Unobservable inputs used: • OTC Options, Warrants, Credit Default Swaps 14
Valuation techniques Options/Warrants – Strike price, Underlying price, Exercise date, • Volatility Credit Default Swaps – Likelihood of a credit event of underlying • debt. – Prepayment rates, Default rate, Recovery Rate, and Spread Interest Rate Swaps: • – Present value of Fixed and Variable legs Total Return Swaps: • – Change in fair value of underlying asset at measurement date and fair value of underlying at previous measurement date. 15
Balance sheet offsetting According to ASC 210-20: • – Assets an liabilities are should not be presented on a net basis unless a right of setoff exists Right of setoff: • – a. Each of two parties owes the other determinable amounts – b. The reporting party has the right to set off the amount owed with the amount owed by the other party. – c. The reporting party intends to set off. – d. The right of setoff is enforceable at law. 16
Additional disclosure requirements In March 2008 the FASB issued ASC 815-10-50 (formerly SFAS 161): • Provides enhanced disclosures about an entity’s derivative activities. – • Objectives and strategies for use of derivative activities • Exposure to market, interest rate, currency, credit, and other risks • Impact to balance sheet and income statement • Volume of derivative activities • Off-balance sheet risk from the use of leverage • Contingencies from credit events which can lead to termination of contracts or additional posting of collateral 17
Qualitative disclosures • Objectives and strategies: – Entities need are required to describe the objectives for derivative instruments. – Distinguish between risk management or other reasons – Entities are required to disclose the primary underlying risks of the derivative instruments – Descriptions of derivative instruments to achieve certain objectives 18
Qualitative disclosures Volume of derivative trading: • An entity is required to describe the volume of its derivative activities – Factors to consider in determining volume: – • Directional risk exposure • Notional value • Number of contracts An entity should disclose how volume is calculated – • Based on derivatives held at balance sheet date • Based on average held throughout the year 19
Qualitative disclosures Impact of derivatives to the financial statements: • – An entity should describe the location of derivatives in the statements of financial positions and statement of operations • Assets and liabilities by instrument type and primary underlying risk • Gains and losses by instrument type and primary underlying risks 20
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