Question

topic is on FAS 133 “Reporting for Derivatives.” While derivatives are fairly complex, they have become increasingly popular over the last decade and it is very important that you have a working knowledge of what they are and why people use them. What makes something a derivative? A derivative’s underlying value is based on or tied to something else. Investors use stock options (a very common derivative instrument) to reduce the risk of investing. A stock option gives its owner the right, but not the obligation, to buy (call) or sell (put) shares of stock at a stated price before the option’s expiration date. Companies, especially those highly dependent on commodities such as wheat or gold, use derivatives to “hedge” their risk through futures and forward contracts that allow them to “lock” into specific commodity prices.

While derivatives have the potential to significantly reduce risk, they are also highly volatile—their values can fluctuate significantly. The FASB has issued new regulations for how public companies must report their derivatives. Review the links in the Web Resources section below that summarize FAS 133, and write a discussion forum entry on why you think some companies are opposed to FAS 133. Do you see FASB 133 as a protection for investors?

Answer 1

Some companies are opposed to FAS 133 due to various practical difficulties that they are facing and will potentially face while implementing FAS 133. First of all implementation of provisions of FAS 133 requires companies to have specialized industry risk management practices and skills. This is beyond the accounting and financial analysis skills of its employees. Thus companies will have to invest more towards the development of the skill sets of its employees. Secondly the success of Statement no. 133 depends on how entities document their hedging activities. Not only has this but the results had to be communicated properly to its constituents. Thirdly companies will have to, to qualify for hedge accounting, demonstrate a hedging relationship to be highly effective in achieving offsetting changes in fair value or cash flows for the risk being hedged. The biggest point of contention for companies opposes to FAS 133 is that as per the provisions of FAS 133 purchase orders for commodities will be regarded as derivatives even if the companies do not intend to use these purchase contracts as derivatives.

The companies are opposed to FAS 133 because they are of the opinion that the standards are not easy to implement and can sometimes be unfair as well.

Yes, I do see FASB 133 as a protection for investors. This is because the investors will benefit from reporting by companies that has to be done in greater detail with regards to their derivatives strategies and hedges. Accurate accounting and good regulation will be the result of implementation of FASB 133 and investors will stand to gain from this.