Analysis of Derivatives' Unrealized Gains/losses from Pre-SFAS 133 Disclosures: Banking Industry

Article excerpt

ABSTRACT

Accounting for derivative instruments has had tremendous attention in the financial press due to far-reaching and complex problems. The impact of SFAS 133 will not be fully reported in annual reports until well into the year 2002. It is imperative that the potential impacts be anticipated. This article presents the results of an empirical study of the measurement and reporting practices of United States (US)-based banks for their financial derivatives instruments and hedging activities during the year 1998 before the Statement of Financial Accounting Standards (SFAS) Number 133 Accounting for Financial Derivatives Instruments and Hedging Activities became mandatory. The authors analyzed the 1998 annual reports of the largest twenty-five US-based banks. The pre-SFAS 133 measurement and reporting practices were adjusted to anticipate the impact of the SFAS 133 requirements. The impact was imputed and revealed that SFAS 133 has the potential of significantly changing financial results.

INTRODUCTION

Early in the year 2001, Bank of America's stock price declined. The decline was blamed on financial derivatives instruments. The material impact of derivatives on stock prices and other financial reports of banks and other entities substantiated the wisdom of the Financial Accounting Standards Board's (FASB's) requiring the implementation of Statement of Financial Accounting Standards (SFAS) Number 133 Accounting for Financial Derivatives Instruments and Hedging Activities for fiscal years beginning after May 2000. Corporations, such as Bank of America, reporting on an annual basis had to implement SFAS133 on January 1, 2001. Results of this accounting change should appear in annual reports with a year-end of December 31, 2001. These reports are typically published in the second (February) or third (March) month of the following year (2002). The need to anticipate the impact of this accounting change motivated the research that is reported in this article.

This article provides empirical evidence regarding the potential impact of SFAS 133 on the measuring and reporting practices of the largest twenty-five United States (US)-based banks. These banks are subject to SFAS 133 for fiscal years that began June 2000. The research reported in this article examines accounting disclosures under SFAS 107 and SFAS 119, which were superseded by SFAS 133. These actual practices are compiled and analyzed to provide insight on the potential impact that SFAS 133 will have on the banks' reported performance. Relevant past studies are briefly discussed next, followed by the motivation for this study and then a description of the sample and methodology with findings as used in this study. An analysis of unrealized gains and losses are presented next followed by a brief discussion of SFAS 133 as amended by SFAS 138. This is followed by research conclusions and limitations.

PAST STUDIES

Prior studies indicated that the impact of fair-value changes on the derivative financial instruments has not been transparent. Disclosure of derivatives has been diverse. Part of this diversity was due to the Financial Accounting Standards Board (FASB) pronouncements such as SFAS 52 and SFAS 80. They addressed recognition and measurement issues, but provided conflicting guidance. For example, the conceptual conflict where SFAS 52 restricted hedge accounting to the hedging of "firm" commitments of a net investment nature. On the other hand, SFAS 80 allowed hedge accounting for "anticipatory" transactions. SFAS 105, 107, and 119 addressed footnote disclosures in a piecemeal approach.

In 1995, the FASB staff conducted a review of disclosure practices about derivative financial instruments and fair value of financial instruments in the 1994 annual reports of 75 corporations selected from the Fortune 1000 entities. Their findings suggested that (due to inconsistent disclosure practices) users have a difficult time in measuring the magnitude of gains and losses from the changes in fair values of the derivative financial instruments. …