GASB mandates immediate expanded disclosure for derivatives: the GASB's new guidance on derivatives disclosure is designed to increase the public's understanding of the significance of derivatives to a government's financial position.(The Accounting Angle)(Governmental Accounting Standards Board)(Technical Bulletin 2003-1)

The Governmental Accounting Standards Board in June issued Technical Bulletin 2003-1, Disclosure Requirements for Derivatives Not Reported at Fair Value on the Statement of Net Assets. The new guidance on derivatives disclosure was first proposed in draft form earlier this spring (April). The provisions of GASB 2003-1 will become effective almost immediately, starting with financial statements for periods ending after June 15, 2003. The following questions summarize key aspects of the new guidance.

Why did the GASB choose to address the issue of disclosure for derivatives at this time? State and local governments have become increasingly involved with derivatives in recent years. Some of the more common examples encountered in practice include interest-rate swaps (exchanging fixed-rate interest payments for variable-rate interest payments or vice versa), basis swaps (exchanging a variable interest rate based on one index for a variable interest rate based on a different index), and swaptions (the option to participate in an interest-rate swap at some future date). Governments also sometimes use derivatives to protect themselves from swings in the price of commodities and foreign-exchange rates. In light of the increased use of derivatives in the public sector, the GASB became convinced that existing disclosure requirements for derivatives were too narrow in scope and inconsistently applied in practice.

What specific disclosure will the newTB require? GASB TB 2003-1 mandates five categories of disclosure for derivatives outstanding as of the end of the fiscal period if the derivatives are not reported at fair value on the face of the financial statements:

1. Objectives. A government will need to explain why it is has entered into a derivative. In doing so, it will need to provide whatever context is necessary to explain the government's objectives and strategies in using derivatives. The government also will need to indicate the specific types of derivatives used, including options purchased or sold.

2. Significant Terms. The significant terms of a derivative that will need to be disclosed include (1) the notional, face, or contract amount; (2) interest rates, including terms such as caps, floors, or collars; (3) embedded options (a call option written into a bond contract); (4) the date when the derivative became effective and when it is scheduled to terminate or mature: and (5) cash paid or received when the derivative was initiated.

3. Fair Value. The government will have to disclose the fair value of derivatives, along with information on the method used to make this calculation and any significant assumptions made if estimates are used (in the absence of quoted market prices). Acceptable methods for estimation include both the zero-coupon method and the par-value method. Embedded options could be valued using an option-pricing model.

4. Associated Debt. When the intended effect of a derivative is to create a synthetic interest rate (e.g., a variable-to-fixed interest rate swap), a government will need to disclose both the derivative's net cash flow and the debt service requirements of the associated debt.