FASB asks for more derivative disclosures.

Ending months of speculation following its issuance of an exposure draft on the thorny issue of derivative disclosures, the Financial Accounting Standards Board in October issued a final statement that requires more complete disclosures by businesses and not-for-profits about derivative financial instruments they hold.

Statement no. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments, is effective for calendar-year 1994 financial statements, although entities with less than $150 million in total assets have a one-year delay.

One of the objectives of the statement, according to Jeffrey Mahoney, FASB assistant project manager, is to improve yearend-1994 financial reporting. The standard won't resolve all the concerns voiced in past months about derivatives, he said, "but it is a step in the right direction. The disclosures should give investors a better picture of the nature of positions a particular organization is taking."

Statement no. 119 expands and amends the earlier Statements nos. 105, Disclosures of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk, and 107, Disclosures about Fair Value of Financial Instruments. Statement no. 119 requires disclosures about the amounts, nature and terms of derivatives that do not fall under Statement no. 105. For derivatives held for trading purposes, it requires disclosure of the average fair value balance of positions during the reporting period and the net gains or losses that resulted from trading activities. Identification of the derivatives from which the gains or losses arose and where those amounts are reported in the income statement also is required. For other instruments, the statement requires disclosure of the objectives for holding the derivatives, how they are reported in the financial statements and hedging of anticipated transactions.

Among other provisions, for derivatives held or issued for purposes other than trading, the FASB revised paragraph 11 of the April 1994 exposure draft of Statement no. 119 so that some of the required disclosures need not be by class of financial instrument. It also "encourages," rather than "requires," quantitative disclosures about interest rate or other market risks. Regarding Statement no. 107, Statement no. 119 requires the presentation of all fair value disclosures in a single note to the financial statements or in a summary table with references to other pertinent discussions in the notes; it prohibits the combination, aggregation or netting of derivative financial instruments with other financial instruments except to the extent permitted under FASB Interpretation no. 39.

"This statement is a timely response to the important question of derivative disclosure," said James A. Johnson, chairman of the American Institute of CPAs financial instruments task force. "It clears the way for the board to devote broader attention to the next step, its ongoing project on hedging, which will deal with how derivatives should be recognized and measured." Johnson is a partner of Deloitte & Touche, New York City, and a member of its financial instruments and strategies group.

Linda Bergen, a vice-president of J. P. Morgan & Co., New York City, agreed. The company "believes the disclosures required by Statement no. 119 represent a pragmatic first step [in responding] to the persistent calls for more information about derivatives. While many of the larger users of derivatives such as J. P. Morgan have voluntarily expanded such disclosures over the past few years, it is our view that Statement no. 119 will ensure all organizations that use derivatives provide adequate and consistent disclosures about their derivative activities until a broader disclosure framework can be developed for all financial instruments," she said. "The standard takes a significant step toward providing meaningful disclosures about derivatives by allowing many of the disclosures to be presented in a manner that reflects the way they are used in an entity's business activities, rather than focusing on instrument-type-based disclosures. As the economic risks are the same as for other financial instruments--credit, market and liquidity risks--disclosures about derivatives should be consistent and, when appropriate, integrated with disclosures about cash instruments."

Derivatives are financial agreements, such as forwards, futures, swaps and option contracts, whose returns are linked to, or derived from, the performance of an underlying asset, such as bonds, currencies or commodities. These volatile instruments are complex, and analysts and investors can misinterpret derivative disclosures (or the lack thereof) in financial statements. This year, the business press has reported numerous examples of investors that sustained large derivative-based losses. The sheer size of the derivative market, which is estimated to be around $14 trillion, ensures that any new regulations will have farreaching effects.

On the same date, the FASB also issued Statement no. 118, Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures, which made slight modifications to Statement no. 114, Accounting by Creditors for Impairment of a Loan, which was issued in May 1993.

Copies of Statements nos. 118 and 119 are available from the FASB order department, 401 Merritt 7, P.O. Box 5116, Norwalk, Connecticut 06856-5116; telephone: [phone], ext. 555.