Presented by Bill Brown

Accounting for Interest Rate Swaps

2009 Telergee CFO Conference

Newcastle, New HampshireOctober 15, 2009

Relationship of Audience Attention Span to Number of Accounting Standards References

Uninteresting professional standard references

Minutes

It’s all about the Hedging

Definitions

• Interest rate swap• Derivative• Hedge• Hedge Accounting• Fair Value Hedge• Cash Flow Hedge

Disclaimer on 15 Minute Primer

• Discussion of important practical considerations, not a structured study of the complex derivative accounting rules

• Accounting Standards Codification - 815 Derivatives and Hedging

• fka FAS 133 and 149

Executive Summary

• Cash settlements paid or received (quarterly) are recorded as an increase or decrease to interest expense

• The contract must be recorded at fair value, which is typically zero at inception

• Changes in fair value are recorded in earnings unless you can apply hedge accounting, in which case they are recorded in Other Comprehensive Income (equity)

2 Step Process to Apply Hedge Accounting

• Qualifying as a hedge (initial assessment)

• Assessing effectiveness/measuring ineffectiveness (ongoing)

Qualifying as a Hedge

• Documentation– Risk being hedged

– Reason for undertaking

– Method for assessing effectiveness

– Method for measuring ineffectiveness

• Expectation of highly effective– When financials prepared/at least every 3 months

– Prospective and retrospective

Highly Effective

• 80-125% correlation between cash flows associated with hedged risk and cash flows of the swap

• This applies to expected future cash flows as well as historical

• Regression analysis is sometimes used to make this assessment

Measuring Ineffectiveness

• Standards discuss 3 methods:

– Change in variable cash flows method

– Hypothetical derivative method

– Change-in-fair-value method

Shortcut Method

• Criteria for no ineffectiveness– Notional amount of swap matches principal amount

– Fair value of the swap at inception is zero.

– Formula for computing net settlements under the interest rate swap is the same for each net settlement. (fixed rate same throughout term and variable rate is based on same index.)

– Debt not pre-payable separately or without penalty. Other terms in the debt or swaps typical of those instruments and do not invalidate the assumption of no ineffectiveness.

–

Shortcut Method

• Criteria for no ineffectiveness (continued)– All interest payments on the variable-rate liability during

the term of the interest rate swap are designated as hedged

– If there is a floor or cap, it is comparable to the floor or cap on the variable rate liability

– Repricing dates for swap and underlying debt occur on same date and are calculated the same

– Quarterly assessments not required– Specific to interest rate swaps

Match of Critical Terms

• Permits an assumption of a highly effective relationship

• General – applies to different types of hedges

• Needs to be assessed on an ongoing basis

Disclosure

• Don’t forget that footnote disclosure is required

– Why

– How

– How much

– Where

– When

– Terms

Madness

Madness does not always howl.

Sometimes, it is the quiet voice at the end of the day saying,

"Hey, is there room in your head for one more?"

Enjoy New Hampshire!