GASB issues preliminary view on derivatives.

Publication: CPA Government & Nonprofit Report

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COPYRIGHT 2006 Aspen Publishers, Inc.

The use of derivatives has skyrocketed in recent years, as more governments determine the benefits of using derivative-type financial arrangements. Many of these financial arrangements have been developed by financial advisors and brokerage houses to lower borrowing rates and to increase investment income. Unfortunately, many government-finance officials and their auditors may not understand the complexities of these derivative financial arrangements. And it is a sure bet that the external users may not understand the complexities and risks brought about by the use of derivatives. Hence the need for more guidance in this area.

Preliminary View

GASB has issued a Preliminary View (PV) "Accounting and Financial Reporting for Derivatives" document to provide input before issuing an Exposure Draft. PVs are used by GASB in more complicated accounting issues to assist in getting public input before it establishes a more formal position on financial accounting and reporting. The PV document can be downloaded free of charge from the GASB's Web site at: www.gasb.org. The PV describes what GASB is proposing and also provides considerable background information about derivatives and explains the rationale behind the GASB's proposals.

The GASB also has published a plain-language supplement to the document. The supplement is a non-technical summary written for external users and others that would like an overview without getting into the more complex areas of the PV. It can be downloaded for free at the GASB's Web site.

The Derivatives Issue

As indicated, derivatives are complex transactions because in essence, the cash flows or the value of derivative instrument is derived from what happens in a separate transaction, agreement, or rate. In other words, its value is derived from some external event that is not always transparent to the reader of the financial statements.

According to GASB, "a derivative is often a complex financial arrangement in which two parties agree to make payments to each other. Each party has a different obligation. Derivatives are leveraged and are entered into with no or a small initial investment. Most derivatives are entered into with the intent to lower the costs of borrowing, lock-in prices, or lower price volatility."...

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