The Financial Accounting Standards Board came under fire last week as 22 of the nation's leading executives protested new derivatives rules. Responding to the likes of Citicorp's John S. Reed, FASB chairman Edmund L. Jenkins wrote Aug. 1:
In your letter of July 31, you state that over the last few weeks the board has developed a new proposal on accounting for derivatives and hedging and has not exposed it for public comment. You also state that the board has not adequately considered the proposal's impact on capital markets or the difficulties that companies will have in implementing the proposal. These assertions are not correct.
The board has followed an extensive process during the development of this project and that process continues as described later in this letter. Constituents have been consulted regularly during the development of the proposal leading up to the exposure draft, including the holding of public hearings. Over 300 organizations provided written comments to the exposure draft and these were each carefully analyzed and considered in arriving at the revised proposal that will soon be issued for further comment.
Changes from the exposure draft. The board has changed its proposed standard in some ways since the exposure draft, Accounting for Derivative and Similar Financial Instruments and for Hedging Activities, was issued for comment in June 1996. However, collectively these changes have not resulted in a fundamentally new proposal, and all interested parties will have an opportunity to comment on the proposal as it stands today. The basic requirement is still to report derivatives in financial statements at fair value. Like the exposure draft, the revised proposal also permits deferral of gains or losses on derivatives used as hedges, if the derivative is effective in offsetting changes in the fair value of the hedged item or the cash flows of the hedged transaction.
It is important to recognize that:
The changes largely involve matters that were highlighted as potential issues on which respondents to the exposure draft were asked to comment.
Almost all of the changes were in response to constituent comments to make accounting for derivatives and hedging activities easier and more like current reporting practices.
The changes were not developed over the last few weeks; rather, they were developed over the last six months or more and involved the active participation of numerous constituents including in particular representatives from many of the companies signing the July 31 letter. As these changes were developed, weekly public updates were made available and many interested constituents responded to those changes at the time.
The board has attempted to be as responsive as possible to the competing demands of the various constituencies, while still achieving the primary goal of making financial reports more transparent, understandable, and useful to investors. Let me assure you that all comments were carefully considered, and all aspects of the proposal in the exposure draft were thoroughly reconsidered.
Further opportunities to comment. The board has gone to significant lengths to assure that constituents will have an adequate opportunity to comment on the proposed revised standard. As announced, a revised draft standard with examples will be distributed in about a month for comments within a 45-day period. The normal period for comments on a draft of this type is 30 days or less.
In addition, all constituents who commented on the exposure draft will receive a letter notifying them that the new draft is available and can be received either in printed form or from the FASB Web site. Thus, comments will be solicited from several hundred constituents rather than the usual limited number.
The primary objective of the review is to determine whether the proposed standard is clearly communicated and would be operational. However, we believe that the word "operational" is broad enough to encompass any concerns on which you might wish to comment. The board and staff will read all of the comments received, and any new information will be carefully considered and could cause the board to change some of its decisions.
The approach to soliciting comments on this draft and the comment period were designed to be responsive to implementation concerns while maintaining an effective date of Jan. 1, 1999. We are very conscious that systems changes can be difficult and time-consuming.
We also understand that companies have other concerns, including the year-2000 problem and a single European currency. We do not see how re- exposure would help. Many knowledgeable constituents have told us that their systems departments do not consider exposure drafts but wait for a final statement to initiate changes. For that reason, the board wanted to give affected companies as long as possible-about twelve months-consistent with maintaining the effective date to implement the new standard.
Capital markets. A fundamental objective of financial reporting is to provide information to capital markets, and in this case the board has carefully considered how to present information about derivatives in a transparent, understandable, and useful manner.
Companies currently omit from their financial statements billions of dollars of transactions in derivative instruments each year. That makes it difficult for investors to properly evaluate those companies' financial position and risks. The requirements in the board's proposal would remedy that lack of information.
We appreciate your participation in the FASB's process and we believe that our comments are responsive to your concerns.
Edmund L. Jenkins