As companies prepare for their 2011 year-end, we will review and highlight key audit issues. Using auditors’ reactions through 2011, we will discuss current concern areas and review appropriate control environments for derivative programs. For more information visit www.hedgetrackers.com or 408-350-8580

1. 2011 Audit Readiness
December 16, 2011
Presented by:
Helen Kane, President
hkane@hedgetrackers.com

2. Agenda Audit Environment
Key Controls
• All Derivatives
• At Fair Value
• Correct OCI
• Accurate Disclosures
Control Considerations
Quick Update on FASB/IASB Developments
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the
rendering of accounting advice and is not a substitute for such professional advice or services.

3. Shifts
Away from documentation minutia
Increased focus
• Eliminating short-cut/matched terms
assumptions
• Valuation
• Probability
• Increased scrutiny of 3rd party events
• Measurement of ineffectiveness
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 3
rendering of accounting advice and is not a substitute for such professional advice or services.

4. Documentation
In place (can locate)
Meets ASC 815-20-25 requirements
• Clarity in layering
• Clarity in definition
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rendering of accounting advice and is not a substitute for such professional advice or services.

5. Matched Terms Assumptions
Preparation for FASB ED direction (IASB
convergence)
• SEC standard comment letter
• Please provide a copy of the analysis prepared to
support the assumption of perfect effectiveness using
the short-cut method
• No longer accepting “de minimis” testing
• Moving all to long-haul (regression)
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 5
rendering of accounting advice and is not a substitute for such professional advice or services.

6. Valuations
Questioning:
• Models (appropriateness)
• Input Type designation (I, II, III)
• Conflict with Counterparty statements
• OIS vs. LIBOR
• Credit
• Static
• Potential
• Own credit by collateral?
• Bank of Ireland/European Banking Counterparties
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 6
rendering of accounting advice and is not a substitute for such professional advice or services.

7. Probability
Increased scrutiny of “probability” of anticipated
transactions
• Historical Experience with actuals vs. forecast
• Experience with over hedging over past year
• “Three strikes”
• Increase of tenor decrease in confidence
• Pro-active probable, possible, remote
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rendering of accounting advice and is not a substitute for such professional advice or services.

8. Timing of OCI Reclass
• Releases follow 3rd party event, not interco
• “…the amount in OCI representing
• the effective portion
• of the gain or loss on a derivative
• designated as a cash flow hedge
• of a forecasted foreign-currency-denominated
intercompany sale
• should be reclassified into earnings in the
period that the revenue from the sale of the
manufactured product to an unrelated third
party is recognized.”
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 8
rendering of accounting advice and is not a substitute for such professional advice or services.

9. Measurement of Ineffectiveness
Scrutiny of the Hypothetical Derivative
• Updating the “Expected Date”
• Worst case vs. most likely case
• Calculation of ineffectiveness
• No assumption of immateriality
• When is recasting of the inception value of the
hypothetical derivative required (IR)
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 9
rendering of accounting advice and is not a substitute for such professional advice or services.

10. SEC Comment Letters
• What is the period over which company
forecasting probable cash flows
• How assessing the probability of cash flows
• How frequently have probable cash flows failed
to occur
• What is impact in earnings of changes in hedge
accounting approach
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 10
rendering of accounting advice and is not a substitute for such professional advice or services.

11. Key Controls

12. All Derivatives
All derivatives identified at month end
• Treasury Traded
• Disclose volume of all trading in quarter
• Trade date vs. settlement date accounting on
compensating contracts over quarter end
• Segregation of duties: confirms sent directly to
accounting/electronically confirmed by acctg.
• Validate # and notional outstanding
• Best Practice: acctg. informed at or before
execution
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 12
rendering of accounting advice and is not a substitute for such professional advice or services.

13. All Derivatives
All derivatives identified at month end
• Traded Outside of Treasury
• Contracts that meet the definition of a derivative
• fixed price/rate
• fixed quantity
• small or no cash up front
• Commodity or highly brokered goods
• Natural gas, electricity
• Steel, aluminum
• Avoid derivative accounting with Normal Purchase/
Normal Sale election if taking/making physical
delivery: ASC 815-10-15-22
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 13
rendering of accounting advice and is not a substitute for such professional advice or services.

14. All Derivatives
All derivatives identified at month end
• Traded Outside of Treasury
• Contracts in a 3rd currency = FX forwards
• Not functional currency of substantial party to the
contract
• Not local currency of delivery point to/from
• Not currency of international commerce for that
good
• Watch for leases in Mexico, Russia, etc.
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 14
rendering of accounting advice and is not a substitute for such professional advice or services.

15. Third Currency Contracts
Examples:
• Eastern European sales with US Corp in Euro
• USD sales between local currency functional sub
and 3rd party client
Requirement
• Bifurcate the “currency forward contract” and
mark to market through income
ASC 815-15-15-10
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 15
rendering of accounting advice and is not a substitute for such professional advice or services.

16. All Derivatives at Fair Value
Are all derivatives on the books at fair value
• Hierarchy of Inputs: Types I, II, III
Beware of inefficient markets (prices) at year end
Beware of thin markets at year end
• Independent valuations
• Use counterparty to validate, not set values
• You own the inputs!
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 16
rendering of accounting advice and is not a substitute for such professional advice or services.

17. ASC 820-10 (old FAS 157)
Market Price Considerations
• Counterparty credit quality
• Consider impact of master netting arrangements
• Consider impact of new ISDA/debt terms that make
derivative positions callable every 6 months
• Own Credit
• Two approaches: discounting current position,
discounting possible future positions
• Absence of “efficient markets” creates basis risk
• IR: 1M vs. 3M
• FX/IR: Cross currency swaps
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 17
rendering of accounting advice and is not a substitute for such professional advice or services.

18. CDS Rates – 2011 - US
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 18
rendering of accounting advice and is not a substitute for such professional advice or services.

19. CDS Rates – 2011 - Europe
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 19
rendering of accounting advice and is not a substitute for such professional advice or services.

20. CDS Rates – 2011 - Global
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 20
rendering of accounting advice and is not a substitute for such professional advice or services.

21. 3M vs 1M LIBOR
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 21
rendering of accounting advice and is not a substitute for such professional advice or services.

22. Value in OCI
Audit focus shifting from assessments to
measurement
Appropriate documentation
All values in OCI associated with anticipated,
possible transactions
• Reclass follows hedged item NOT cash
• Credit effects
• Any element of hindsight to determine hedged item is
problematic
•
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 22
rendering of accounting advice and is not a substitute for such professional advice or services.

23. Documentation
• Testing:
• Correct assumptions on sources of ineffectiveness
• Testing those sources
• Similarity of items hedged together in pool
• Validation of data points
• Insufficient specificity
• Debt: what layer, which accrual
• FX: Which Euro entity revenue first?
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 23
rendering of accounting advice and is not a substitute for such professional advice or services.

24. Qualification buster
Failure to produce inception documentation
Renewals of credit arrangements
• Floors on debt are forcing mark to market
treatment of swaps: ineffectiveness and lack of
“variability in cash flows”
• Violation of reset election commitment (depends on
firm)
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 24
rendering of accounting advice and is not a substitute for such professional advice or services.

25. Effectiveness
Does your regression support the hedge objective
• How are you calculating (input verification)
• How modeling underlying variances
• Constant tenor vs. constant derivative
• R2, Slope, A Nova statistic (T, P, F)
Probability Issues?
• Possible
• Probable not to occur
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 25
rendering of accounting advice and is not a substitute for such professional advice or services.

26. Disclosures
Tables:
Income Statement tables (including OCI) are
current year values for unrealized AND realized
gains/losses
Volumes
Information about the volume of trade and trade
activity
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 26
rendering of accounting advice and is not a substitute for such professional advice or services.

27. Control Considerations
• Segregation of duties (avoid fraud/rogues)
• Independent confirmation & reconciliation
• Independent valuation
• Limits: Trade, Instrument, Coverage, Credit,
Trader
• Systems controls
• Accounting vs. Treasury roles
• Conflicts of interest
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 27
rendering of accounting advice and is not a substitute for such professional advice or services.

28. FASB/IASB Update

29. FASB/IASB Update
Convergence:
• Decision to converge or not to converge due in
2010 postponed
• “Condorsement”: vocabulary introduced in SEC
speech addressing variation on convergence
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 29
rendering of accounting advice and is not a substitute for such professional advice or services.

30. Condorsement or Condoresement
Mr. Beswick stated, "So what would be a
reasonable approach for the U.S.? In our
October (2010) update we highlighted that
the majority of jurisdictions are following
either a convergence or an endorsement
approach. In my opinion, if the U.S. were to
move to IFRS, somewhere in between could
be the right approach. I will call it a
'condoresement' approach. Yes, I admit I just
made up a word.
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 30
rendering of accounting advice and is not a substitute for such professional advice or services.

31. Condorsement
Mr. Beswick continued, "So how would this
approach work? Well, to begin, U.S. GAAP
would continue to exist. The IASB and the
FASB would finish the major projects…The
FASB would not begin work on any major new
projects … Rather, …the FASB would work to
converge existing U.S. GAAP to IFRS over a
period of time for standards that are not on
the IASB's agenda. This …would entail
making sure on a standard by standard basis,
existing IFRS standards are suitable for our
capital markets."
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 31
rendering of accounting advice and is not a substitute for such professional advice or services.

32. Hedging Projects
FASB:
• 2/11 Request for feedback on IASB proposal
• 11/11 Education Session—Discussions about the
IASB’s hedge accounting model, presented by
the IASB staff.
• Nothing on project schedule through 6/12
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 32
rendering of accounting advice and is not a substitute for such professional advice or services.

33. Hedging Projects
FASB:
• 5/10 Issued Hedge Acctounting ED as part of
Financial Instruments ED
• 2/11 Requested feedback on IASB proposal
• 11/11 Education Session—Discussions about
the IASB’s hedge accounting model, presented
by the IASB staff.
• Nothing on project schedule through 6/12
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 33
rendering of accounting advice and is not a substitute for such professional advice or services.

34. Hedge Accounting Projects
IASB
• New derivative guidance fatal flaw draft in
circulation
• Pre-release expected early 2012
• Implementation date 2015, perhaps 2016
© 2011 Hedge Trackers, LLC This publication contains general information and does not represent the 34
rendering of accounting advice and is not a substitute for such professional advice or services.

35. Answers
hkane@hedgetrackers.com
www.hedgetrackers.com
408.350.8580
Silicon Valley | Chicago | Los Angeles
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