Impact of FASB Proposed Statement on Corporate Hedging Strategies: A Case Study of BMS, Lecture notes of Accounting

Download Impact of FASB Proposed Statement on Corporate Hedging Strategies: A Case Study of BMS and more Lecture notes Accounting in PDF only on Docsity! August 15, 2008 Mr. Russell G. Golden Technical Director Financial Accounting Standards Board 401 Merritt 7 PO Box 5116 Norwalk, TC 06856-5116 RE: File Reference No. 1590-100 Dear Mr. Golden, • Bristol-Myers Squibb Company 11111111111 1 5 90- 1 00* LEITER OF COMMENT NO. !.f {p On behalf of Bristol-Myers Squibb Company ("BMS"), I would like to provide the Company's response to the FASB's recently issued Exposure Draft ("ED") on the amendment ofF ASB Statement No. 133, Accounting jor Hedging Activities. BMS commends the Board's efforts of attempting to simplifY the hedging requirements prescribed by F ASB 133. Even though BMS is typical of most corporate hedgers in that all executed hedging instnunents are usually plain vanilla in their structure, it does require an extraordinary amount of time and effort to properly document the hedge relationship, assess effectiveness, measure ineffectiveness, dedesignate hedging relationships where applicable, etc. This effort is time consuming and requires a unique level oftechnical specialization, to understand both the hedging instnunents and strategies and the related accounting rules, even for the most basic derivative financial instnunents. It is for this reason that BMS is compelled to respond to the exposure draft because we believe that for companies like BMS, the ED if adopted as proposed will require additional work, and additional costs will be incurred, without a benefit to the company's shareholders. We believe that the ED adds complexity, particularly as it relates to the impact it will have on the previously acceptable hedging of interest rate risk related to our own issued debt using plain vanilla interest rate swaps. The company's responses to the issues indicated in the ED are as follows: Hedged Risk Issue 1: For the reasons stated in paragraph A16 of this proposed Statement, the Board decided to eliminate (with two exceptions) the ability of an entity to designate individual risks as the hedged risk in a fair value or cash flow hedge. As a result of that change, the financial statements would reflect information about the risks in the hedged item or transaction that an entity both chooses to manage and not to manage as part of a particular hedging relationship. Do you believe that tbe. proposed Statement would improve or impair the usefulness of financial statements by eliminating the ability of an entity to designate individual risks and requiring the reporting of the risks inherent in the hedged item or transaction? -1- It is the company's opinion that the elimination of the ability to designate individual risks as the hedged risk in a fair value or cash flow hedge will impair the usefulness of financial statements. By eliminating the company's ability to designate the benchmark interest rate risk only as the hedged item, an otherwise highly effective hedge of our debt may become ineffective due to changes in credit risk. In addition, the company has, from time to time, entered into pre-issuance forward starting swaps on its probable issuance of long-term debt in order to lock-in an interest rate. Eliminating the company's ability to hedge just interest rate risk on the pre-issuance of debt will require the company to consider its own credit risk as part of its hedging strategy. Currently, there are no provisions in the company's risk management policy that allow taking a hedge position on its own credit risk, nor do we believe it prudent to do so. In summary, the company believes that the ability to designate individual risks as the hedged item in a hedging relationship should continue to be allowed, or at the very least expand the exceptions for more commonly hedged risks. Issue 2: For the reasons stated in paragraphs AIB-AlD, the Board decided to continue to permit an entity the ability to desiguate the following individual risks as the hedged risk in a fair value or cash flow hedge: (a) interest rate risk related to its own issued debt (that is, its liability for funds borrowed), if hedged at inception, and (b) foreign currency exchange risk. For those two exceptions, the financial statements would not reflect information about the risks that an entity chooses not to manage as part of a particular hedging relationship. Do you believe the Board should continue to permit an entity to desiguate those individual risks as a hedged risk? Yes, BMS believes that the Board should continue to pennit an entity to designate interest rate risk and foreign currency risk as the hedged risk. The company also believes the exceptions should be expanded to include more commonly hedged risks such as price risk in a commodity hedge when that price risk is tied to an exchange traded commodity by contract. Hedge Effectiveness Issue 3: This proposed Statement would eliminate the shortcut method and critical terms matching. Therefore, an entity would no longer have the ability upon compliance with strict criteria to assume a hedging relationship is highly effective and recoguize no ineffectiveness in earnings during the term of the hedge. As a result, when accounting for the hedging relationship, an entity would be required, in aU cases, to independently determine the chauges in fair value of the hedged item for fair value hedges and the present value of the cumulative change in expected furure cash flows on the hedged transaction. Do you foresee any significant operational concerns or constraints in calculating ineffectiveness for fair value hedging relationships and cash flow hedging -2. Issue 7: In the statement of operations, Statement 133 does not prescribe the presentation of gains and losses associated with hedging instruments, inclnding the effective portion, the ineffective portion, and any amounts excluded from the evaluation of effectiveness, such as forward points. Some have suggested that such a prescription would improve financial reporting by creating consistency in the presentation of these amounts across all entities. Others observe that F ASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities, requires disclosure about that information, and they question whether a prescriptive approach is appropriate given the diverse hedge accounting strategies employed by entities. Do you believe that Statement 133 should be amended to prescribe the presentation of these amounts? For example, the Statement could require that the effective portion of derivatives bedgiug the interest rate risk in issued debt be classified within interest expense and that the ineffective portion and any amounts excluded from the evaluation of effectiveness be presented within other income or loss. BMS believes that additional guidance on presentation of ineffectiveness and the effects of dedesignated hedges in the financial statements would eliminate diversity in practice. Effective Date and Transition Issue 8: The Board's goal is to issue a final Statement by December 31, 2008. The proposed Statement would require application of the amended hedging requirements for financial statements issued for fiscal years beginning after June 15, 2009, and interim periods within those fiscal years. Do you believe that the proposed effective date would provide enough time for entities to adopt the proposed Statement? Why or wby not? BMS believes the proposed effective date of the requirements of the ED would provide enough time to adopt the proposed statement. Issne 9: The Board did not prescribe any specific transition disclosures upon the adoption oftbis Statement. Do you believe that there are specific disclosures that should be required during transition? If so, what? Please be specific as to how any suggested disclosures would be used. BMS does not believe additional transition disclosure requirements are necessary. Issue 10: The Board decided to permit an entity a one-time fair value option election under FASB Statements No. 156,Accounting/or Servicing 0/ Financial Assets, and No. 159, The Fair Value Option/or Financial Assets and Financial -5- Liabilities, for (a) servicing assets and servicing liabilities designated as a hedged item on the date immediately preceding initial application and (b) eligible financial instruments designated as a hedged item on the date immediately preceding initial application of this proposed Statement. Do you agree with the Board's decision to allow a one-time fair value option at the initial adoption of this proposed Statement? Do you agree with the Board's decision to limit the option to assets and liabilities that are currently designated as hedged items under Statement l33? BMS agrees with the Board's decision to allow a one-time fair value option at the initial adoption of the proposed amendment. Many companies did not elect the fair value option, because they were receiving reasonable accounting treatment under the shortcut method. This one-time fair value option will give companies the ability to reconsider that decision. Benefit-Cost Considerations Issue 11: The objective of financial reporting is to provide information that is useful to present and potential investors, creditors, donors, and other capital market participants in making rational investment, credit, and similar resource allocation decisions. However, tbe benefits of providing information for tbat purpose should justify the related costs. Tbe benefit-cost considerations considered by the Board are provided in paragraphs A43-ASO in Appendix B of tbis proposed Statement. Do you believe the Board identified tbe appropriate benefits and costs related to this proposed Statement? If not, what additional benefits or costs sbould tbe Board consider? BMS believes the Board should consider the pending convergence to IFRS and the costs associated with adopting the proposed amendment and then in the near future, having to adopt the requirements ofIAS 39. The company believes that the Board should wait for the convergence to IFRS. Other Issues: BMS would like further clarification to the changes proposed in paragraph 40 of the amendment. Per F ASB 52, paragraph 20, there are only two types of transaction gains and losses to be excluded from the determination of net income, 1) foreign currency transactions that are designated as, and are effective as, economic hedges of a net investment, and 2) intercompany foreign currency transactions that are of a long-term investment nature. All other foreign currency denominated transactions, regardless of whether it's a third party transaction or an intercompany transaction, will generate a foreign currency gain or loss that will survive consolidation. The proposed addition to this paragraph is not clear as to the Board's intentions to permit hedging intercompany transaction or not and which transactions it believes would be eligible versus those that would not be under the ED. -6- We appreciate this opportunity to provide comments, and would be pleased to discuss this further at your convenience. HenryHus y Technical Accounting and Policy CC: Joseph Caldarella Vice President and Corporate Controller David Levi Director Technical Accounting and Policy -7-