GASB 53 Derivatives

The Governmental Accounting Standards Board (GASB) Statement No. 53, Accounting and Financial Reporting for Derivative Instruments, requires that the fair value of financial arrangements called “derivatives” or “derivative instruments” be part of the reporting in the financial statements of state and local governments. If a derivative effectively hedges an identified risk of rising or falling cash flows or fair values, then its annual fair value changes are deferred until the hedged transaction occurs or the derivative ceases to be effective.

A derivative is often a complex financial arrangement that a government may enter into with another party. The value of a derivative or the cash it provides the governmental entity (or that it requires that entity to pay) is based on changes in the market prices of an item that is being hedged, such as interest rates on long term bonds or commodity prices. In other words, the value or cash flows of a derivative are obtained from (are determined by) changes in the market price of the hedged item.

DerivActiv performs valuations on hedging derivative instruments that meet the rigorous standards in today’s market. In addition we perform all of the GASB 53 calculations and provide a report to the governmental entity that can be used to prove the hedging relationship to the auditors.

Information about derivatives is disclosed in the notes to the financial statements, including identification of the risks to which hedging derivative instruments themselves expose a government. Governments are required to implement Statement 53 no later than the first fiscal year beginning after June 15, 2009 (in most cases this would be fiscal year 2010).

For more information, contact a DerivActiv representative to discuss your particular requirements at 866-200-9012.

Governments enter into derivatives for at least four reasons:

• Governments often intend derivatives to be hedges. This type of derivative attempts to significantly reduce a specific financial risk that a government identifies, such as the risk of increasing commodity costs.
• Some governments find that they can lower their borrowing costs by entering into a derivative in connection with debt they issue, often this is an interest rate swap.
• Some governments engage in derivatives that are investments—governments are trying to generate income, as they would by buying other financial instruments.
• Some governments enter into derivatives to manage their cash flows. These derivatives may include an up-front cash payment to the government from the other party as part of the agreement. The payment arrangements or terms of the derivative agreement provide for the repayment of the up-front cash.