Netting Credit Collateral Against Derivative Assets and Liabilities
By Linda Cavanaugh, CPA - The FASB issued FSP FIN 39-1 in April of 2007,which amends FIN 39: Offsetting of Amounts Related to Certain Contracts and is effective for fiscal years beginning after November 15, 2007 (January 1, 2008 for calendar year companies). FIN 39 allows an entity that has several open positions with a counterparty to present the assets and liabilities on a netted basis if there is a master netting arrangement between the two parties.
Per paragraph 5 of FIN 39, there are a four criteria to be able to offset contracts under a master netting arrangement:
1. Each of two parties owes the other determinable amounts.
2. The reporting party hs teh right to set off the amount owed with the amount owed by the other party.
3. The reporting party intends to set off.
4. The right of setoff is enforceable at law.
Paragraph 10 of FIN 39 states "fair value amounts recognized for forward, interest rate swap, currency swap, option and other conditional or exchange contracts executed with the same counterparty under a master netting arrangement may be offset."
FSP FIN 39-1 amends paragraph 10 of FIN 39 to “permit a reporting entity to offset fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) against fair value amounts recognized for derivative instruments executed with the same counterparty under the same master netting arrangement that have been offset in accordance with that paragraph.” This allows the derivative asset or liability to present the true commitment under any outstanding contracts.
If an entity makes an accounting policy decision to net derivative assets and liabilities, it must also net any cash collateral received or payable for those derivative counterparties that are recorded at fair value. A reporting entity’s decision to offset or not offset must be disclosed and if the entity is offsetting the fair value of collateral posted or received the amounts must be disclosed.
The important thing to note here is that the collateral must be recognized at fair value (think FAS 157) and must be recorded in the financial statements before it can be offset against the asset or liability. At my company we only have letters of credit or parental guarantees, which are not recorded in the financial statements because there hasn't been any transfer of assets. Therefore, FSP FIN 39-1 will not have an impact.
Linda is a CPA living in Southwestern Ohio, working as a research accountant for an investor-owned publicly traded utility company. She specializes in implementing new FASB and SEC requirements and FAS 133 derivative issues. In her role at the utility she has encountered many issues and written many memos, so send in your implementation and derivative issues and Linda will help figure out an answer.