EITF ABSTRACTS
Issue No. 02-3
Title: Issues Involved in Accounting for Derivative Contracts Held for Trading
Purposes and Contracts Involved in Energy Trading and Risk Management
Activities
Dates Discussed: June 19–20, 2002; September 11–12, 2002; October 25, 2002;
November 21, 2002; March 20, 2003
References:
FASB Statement No. 107, Disclosures about Fair Value of Financial
Instruments
FASB Statement No. 125, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities
FASB Statement No. 133, Accounting for Derivative Instruments and
Hedging Activities
FASB Statement No. 157, Fair Value Measurements
FASB Concepts Statement No. 5, Recognition and Measurement in
Financial Statements of Business Enterprises
APB Opinion No. 20, Accounting Changes
APB Opinion No. 22, Disclosure of Accounting Policies
Accounting Research Bulletin No. 43, Chapter 4, Inventory Pricing
AICPA Statement of Position 94-6, Disclosure of Certain Significant
Risks and Uncertainties
AICPA Audit and Accounting Guide, Brokers and Dealers in Securities
SEC Staff Accounting Bulletin No. 101, Revenue Recognition in
Financial Statements
SEC Financial Reporting Release No. 61, Disclosure in Management's
Discussion and Analysis about the Application of Critical Accounting
Policies
ISSUE
1.
Issue No. 98-10, “Accounting for Contracts Involved in Energy Trading and Risk
Management Activities,” Issue No. 00-17, “Measuring the Fair Value of Energy-Related
Contracts in Applying Issue No. 98-10,” and Topic No. D-105, “Accounting in
Consolidation for Energy Trading Contracts between Affiliated Entities When the
Activities of One but Not Both Affiliates Are within the Scope of Issue No. 98-10,”
address various aspects of the accounting for contracts involved in energy trading and
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risk management activities. The purpose of this Issue is to address certain issues related
to energy trading activities, including (a) gross versus net presentation in the income
statement, (b) whether the initial fair value of an energy trading contract can be other
than the price at which it was exchanged, and (c) additional disclosure requirements for
energy trading activities.
Reporting Gains and Losses on Energy Trading Contracts
2.
In Issue 98-10, the Task Force reached a consensus that energy trading contracts
should be marked-to-market (that is, measured at fair value determined as of the balance
sheet date) and that gains and losses (realized and unrealized) related to energy trading
contracts could be shown either gross or net in the income statement. The Task Force
had previously reached a tentative conclusion that gains and losses on energy trading
contracts should be reported net in the income statement. However, in reversing that
tentative conclusion on income statement presentation, the Task Force considered
comment letters from several energy trading companies contending that a gross
presentation was appropriate in certain circumstances in which settlement of energy
trading contracts required physical delivery of the underlying commodity (instead of net
cash settlement). The Task Force was asked to reconsider the consensus in Issue 98-10
that allows companies to use either the gross or the net method of presentation for
reporting gains and losses on energy trading activities in the income statement.
Recognition of Unrealized Gains and Losses at Inception of an Energy Trading
Contract
3.
Issue 98-10 defines the fair value of an energy contract in footnote 2 (consistent
with Statements 107, 125, and 133) as “the amount at which that contract could be
bought or sold in a current transaction between willing parties, that is, other than in a
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forced or liquidation sale” (emphasis added). For some energy contracts that are required
to be recorded at fair value, no quoted market prices or similar current transactions exist
on which to base a fair value measurement. In Issue 00-17, the Task Force reiterated this
point by stating that “the price at which an energy contract is exchanged normally is its
initial fair value.”
The Task Force further noted that “valuation models, including
option-pricing models, should be used only when market transactions are not available to
evidence fair values” (emphasis added).
4.
Questions have been raised about whether unrealized gains or losses may be
reported at inception of energy trading contracts, absent evidence from quoted market
prices or other current market transactions with similar terms and counterparties. The
FASB staff questions the appropriateness of such gains, in light of the guidance in Issue
00-17, in transactions for which fair value is determined in a manner other than by
reference to quoted market prices or current market transactions for similar contracts. In
particular, the FASB staff notes that while the Task Force observed that fair value should
be based on the best information available in the circumstances, the consensus also notes
that “current market transactions also may provide evidence for recognition of ‘dealer
profit. . . .’” The FASB staff interprets the Task Force’s consensus to indicate that a
dealer profit, or unrealized gain or loss at inception of the contract, may not be
recognized unless it is evidenced by quoted market prices or other current market
transactions.
Disclosure
5.
Issue 98-10 does not address disclosure, other than an SEC Observer comment
requiring registrants to disclose their policy for presentation of gains and losses in the
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income statement, including presentation on a gross or net basis.
However, other
accounting literature provides guidance that should be followed by entities involved in
energy trading activities.
For example, Opinion 22 requires a description of all
significant accounting policies of the reporting entity, and SOP 94-6 requires disclosures
about estimates used in the determination of the carrying amounts of assets and liabilities
if those estimates are particularly sensitive to change in the near term. The Task Force
was asked to clarify the application of Opinion 22 and SOP 94-6 to an entity's energy
trading operations and provide for any other disclosures that may be useful to financial
statement users.
6.
The issues are:
Issue 1—Whether gains and losses on energy trading contracts should be reported gross
or net in the income statement
Issue 2—Whether recognition of unrealized gains and losses at inception of an energy
trading contract is appropriate in the absence of quoted market prices or
current market transactions for contracts with similar terms
Issue 3—What disclosure requirements of energy trading activities should be.
EITF DISCUSSION
7.
At the June 19–20, 2002 meeting, the SEC Observer requested that the Task Force
address additional issues relating to the application of Issue 98-10, Issue 00-17, and
Topic D-105, including the use of mark-to-market accounting for contracts that
physically settle and the recognition of revenues from changes in fair value when fair
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value is estimated based solely on internal valuation models (that is, where the inputs are
not observable in the market place). The SEC Observer recommended that a working
group be formed to assist the Task Force in resolving those issues and emphasized the
need for resolution prior to the end of the calendar year. The Task Force agreed to form a
working group.
8.
On Issue 1, the Task Force reached a consensus that all gains and losses (realized
and unrealized) on energy trading contracts should be shown net in the income statement
whether or not settled physically.
An entity should disclose the gross transaction
volumes for those energy trading contracts that are physically settled.
9.
The Task Force did not reach a consensus on Issue 2. Rather, the Task Force
referred that Issue to the working group. The FASB staff indicated that until such time
that the working group recommendations on Issue 2 are considered by the Task Force,
the FASB staff will continue to hold the view that Issues 98-10 and 00-17 do not allow
for recognition of dealer profit, or unrealized gain or loss at inception, unless evidenced
by quoted market prices or other current market transactions for energy trading contracts
with similar terms and counterparties.
10.
The Task Force reached a consensus on Issue 3 that entities involved in energy
trading activities also should disclose all of the following:
a.
b.
c.
d.
The applicability of Issue 98-10
The types of contracts that are accounted for as energy trading contracts
The fair values of its energy trading contracts, aggregated by source or
method of estimating fair value and by maturity dates of the contracts
A description of the methods and significant assumptions used to estimate the
fair value of its various classes of energy trading contracts
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e.
f.
11.
A reconciliation of the beginning and ending carrying values of its energy
trading contracts, aggregated by source or method of estimating fair value,
showing separately the changes attributable to (1) unrealized gains and losses
recognized at inception of a contract, (2) unrealized gains and losses
recognized as a result of changes in valuation techniques and assumptions, (3)
other unrealized gains and losses recognized during the period, and (4)
realized gains and losses recognized during the period
The sensitivity of its estimates to changes in the near term. 1
The consensus on Issue 1 is effective for financial statements issued for periods
ending after July 15, 2002. Upon application of the consensus, comparative financial
statements for prior periods should be reclassified to conform to the consensus. The
consensus on Issue 3 is effective for financial statements issued for fiscal years ending
after July 15, 2002. The disclosures required by the consensus should be provided for all
periods presented. Early application of the consensuses is permitted.
12.
At the September 11–12, 2002 meeting, the Task Force was provided with an
update of Working Group discussions to date. The Task Force discussed some of the
issues being deliberated by the Working Group, including whether Issue 98-10 should be
retained given that Statement 133 addresses the accounting for most energy trading
contracts.
The Task Force requested that the Working Group further explore the
implications of rescinding Issue 98-10 and addressing any residual energy trading issues
within the context of Statement 133. The Task Force also requested that the Working
Group continue its efforts to provide guidance for measuring the fair value of energy
trading contracts in the absence of quoted market prices or current market transactions
with similar terms and counterparties.
1
Paragraph 14 of SOP 94-6 provides that “the disclosure should indicate the nature of the uncertainty and
include an indication that it is at least reasonably possible that a change in the estimate will occur in the
near term” (footnote references omitted).
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13.
Additionally, the Task Force discussed the transition requirements relating to its
consensus reached at the June 19–20, 2002 meeting that all gains and losses (realized and
unrealized) on energy trading contracts should be shown net in the income statement
whether or not settled physically. The Task Force did not change its prior consensus
including the transition requirements.
However, the Task Force clarified that that
consensus applies to all energy trading contracts subject to the consensus in Issue 98-10,
including those contracts that are also derivatives subject to Statement 133. The Task
Force declined to discuss the issue of whether gains and losses (realized and unrealized)
should be shown gross or net in the income statement for contracts that are not subject to
the consensuses in Issue 98-10 but are derivatives subject to Statement 133.
14.
At the October 25, 2002 meeting, the Task Force reached a consensus to rescind
Issue 98-10 (and related interpretive guidance of Issue 00-17 and Topic D-105) and
preclude mark-to-market accounting for energy trading contracts that are not derivatives
pursuant to Statement 133.
15.
The Task Force discussed physical inventories included in energy trading activities
and noted that those inventories are often carried at fair value based on current industry
practice. The Task Force agreed that its decision to rescind Issue 98-10 will eliminate
any basis for recognizing physical inventories at fair value, except as provided by other
guidance under higher categories of the GAAP hierarchy.
16.
The Task Force chairman noted that the consensus to rescind Issue 98-10
effectively supersedes the Task Force consensuses reached at the June 19–20, 2002
meeting on Issues 1 and 3. The Task Force discussed the income statement presentation
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of gains and losses on derivative instruments subject to Statement 133 when the gains or
losses are realized by physically settling the derivative instrument. The Task Force
reached a consensus that gains and losses (realized and unrealized) on all derivative
instruments within the scope of Statement 133 should be shown net when recognized in
the income statement, whether or not settled physically, if the derivative instruments are
held for trading purposes. 2 A derivative held for trading purposes may be designated as
a hedging instrument, prospectively, if all of the applicable criteria in Statement 133 have
been met. The Task Force also generally agreed that additional guidance from the Board
is needed with respect to measuring fair value in the absence of quoted market prices or
current market transactions with similar terms and counterparties. 3
17.
The SEC Observer noted (and the FASB staff concurred) that this consensus
prohibiting mark-to-market accounting for nonderivative energy trading contracts is
equally applicable to brokers and dealers, as the Guide for brokers and dealers in
securities does not afford brokers and dealers special treatment in that regard.
18.
The SEC Observer also reminded registrants of the requirements to provide
disclosures identified in Item 303 (Management's Discussion and Analysis) of
Regulations S-K and S-B and in guidance provided by FRR 61.
19.
The consensus to rescind Issue 98-10 is effective for all new contracts entered into
(and physical inventory purchased or produced) after October 25, 2002. The consensus
2
The determination of what constitutes “trading purposes” is based on the intent of the issuer or holder and
shall be consistent with paragraph 12(a) of Statement 115 which characterizes trading as “active and
frequent buying and selling . . . with the objective of generating profits on short-term differences in price.”
On an ongoing basis, reclassifications into and out of trading should be rare.
3
[Deleted 9/06 because of Statement 157. See STATUS section.]
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is effective for fiscal periods beginning after December 15, 2002, for energy trading and
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energy-related contracts that existed on or before October 25, 2002, that remain in effect
at the date this consensus is initially applied. The effect of this consensus shall be
reported in a manner similar to a cumulative effect of a change in accounting principle in
accordance with Opinion 20 (the pro forma disclosures described in paragraph 21 of
Opinion 20 are not required). Application of the consensus, as it relates to restating the
carrying value of physical inventories, may be applied prospectively 4 if there is
insufficient information to report the change in accounting for physical inventories in a
manner similar to a cumulative effect of a change in accounting principle, as described in
the preceding sentence.
Early application of the consensus is permitted as of the
beginning of periods for which financial statements have not been issued. 5
20.
The consensus relating to the presentation of gains and losses on derivative
instruments held for trading purposes is effective for financial statements issued for
periods beginning after December 15, 2002. 6
Upon application of the consensus,
comparative financial statements for prior periods should be reclassified to conform to
the consensus. 7 For gains and losses on energy trading activities that are not derivatives
pursuant to Statement 133 (for example, spot market purchases and sales), entities are
encouraged to reclassify prior periods presented for gross presentation in the income
4
The carrying value of physical inventories on the effective date becomes the new cost basis and other
applicable generally accepted accounting principles apply going forward.
5
Statement 133 precludes retroactively designating a derivative as a hedging instrument in a fair value or
cash flow hedge.
6
At the June 19–20, 2002 meeting, the Task Force reached a consensus that all gains and losses (realized
and unrealized) on energy trading contracts should be shown net in the income statement. That consensus
was effective for financial statements issued for periods ending after July 15, 2002.
7
Derivative instruments previously included in energy trading activities pursuant to Issue 98-10 are
presumed to have been held for trading purposes.
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statement if that presentation is consistent with the guidance provided in Issue No. 99-19,
"Reporting Revenue Gross as a Principal versus Net as an Agent." Early application of
the consensus is permitted as of the beginning of periods for which financial statements
have not been issued.
STATUS
21.
A related issue was discussed in Issue No. 03-11, “Reporting Realized Gains and
Losses on Derivative Instruments That Are Subject to FASB Statement No. 133 and Not
‘Held for Trading Purposes’ as Defined in Issue No. 02-3.”
22.
Statement 157 was issued in September 2006. The guidance in Statement 157
applies for derivatives and other financial instruments measured at fair value under
Statement 133 at initial recognition and in all subsequent periods and, therefore, nullifies
the guidance previously included in footnote 3 of this Issue. Statement 157 shall be
applied retrospectively to the following financial instrument as of the beginning of the
fiscal year in which Statement 157 is initially applied (a limited form of retrospective
application): A financial instrument that was measured at fair value at initial recognition
under Statement 133 using the transaction price in accordance with the guidance in
footnote 3 of this Issue prior to initial application of Statement 157.
23.
No further EITF discussion is planned.
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Suggested Index Entries for Issue No. 02-3, “Issues Involved in Accounting for
Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy
Trading and Risk Management Activities”
DERIVATIVE INSTRUMENTS
Energy Trading
. . Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and
Contracts Involved in Energy Trading and Risk Management Activities 02-3
FAIR VALUE
Energy Trading
. . Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and
Contracts Involved in Energy Trading and Risk Management Activities 02-3
FINANCIAL INSTRUMENTS
Energy Trading
. . Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and
Contracts Involved in Energy Trading and Risk Management Activities 02-3
HEDGES
Energy Trading
. . Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and
Contracts Involved in Energy Trading and Risk Management Activities 02-3
OPTIONS
Energy Trading
. . Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and
Contracts Involved in Energy Trading and Risk Management Activities 02-3
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