What Are the FAS 161 Disclosure Requirements?

While originally known as Financial Accounting Standards Board (FASB) Statement No. 161, the rules for disclosing derivative instruments and hedging activities are now integrated into the FASB’s Accounting Standards Codification (ASC) under Topic 815. The primary objective of these rules is to provide users of financial statements, such as investors and creditors, with a clearer understanding of how and why an entity uses derivative instruments.

The guidance compels companies to provide a comprehensive picture of their derivative activities. This includes insight into their objectives for using these financial instruments, the volume of their activity, and the impact on their financial position, performance, and cash flows. By mandating detailed disclosures, the rules allow stakeholders to better assess the nature and extent of the risks an entity is managing and the effectiveness of its strategies.

## Qualitative Disclosure Requirements

Under the accounting guidance, entities must provide narrative disclosures that explain their objectives and strategies for using derivative instruments. This qualitative information provides the necessary context for financial statement users to understand the company’s risk management philosophy. The disclosures must be detailed enough to explain why the entity uses derivatives, distinguishing between instruments used for risk management purposes and those used for other reasons, such as trading.

The qualitative disclosures should be framed around the primary underlying risks the entity is seeking to manage. Common examples include:

• Interest rate risk
• Foreign currency exchange rate risk
• Commodity price risk
• Credit risk

For each type of risk, the company must describe its strategy for managing it and the role that derivative instruments play in that strategy. This provides a clear link between the company’s identified risks and the specific financial instruments it employs to mitigate them.

Furthermore, the entity must disclose its overall risk management policy. This involves a higher-level discussion of how the company approaches its hedging activities and the governance structure in place to oversee these strategies. This narrative helps to build a complete picture of the entity’s risk appetite and its approach to controlling financial exposures through derivatives.

These qualitative disclosures are important for interpreting the quantitative data presented elsewhere in the financial statements. Without this narrative context, the numerical disclosures about fair values and gains or losses would be less meaningful. By explaining the “how” and “why” behind its derivative activities, a company provides a more complete and transparent view of its financial risk management.

## Quantitative Disclosure Requirements by Category

A central requirement is the disclosure of quantitative information about derivative instruments, presented in a clear, tabular format. These tables are designed to provide a transparent summary of the fair value of derivative instruments and their precise location on the statement of financial position. The guidance requires that the fair values of derivative assets and liabilities be presented on a gross basis, even if they are subject to a master netting arrangement. This gross presentation ensures that users can see the full scale of an entity’s derivative activities. The disclosures are further broken down by the type of derivative contract, such as interest rate or foreign exchange contracts.

### Fair Value Hedges

For derivatives designated as fair value hedges, the quantitative disclosures focus on matching the gains and losses of the hedging instrument with the offsetting losses and gains on the hedged item. A tabular presentation is required showing the location and amount of gains and losses for both the derivative and the hedged item recognized in current earnings. For example, if an interest rate swap hedges the fair value of fixed-rate debt, the table would show the gain or loss on the swap alongside the corresponding loss or gain on the debt.

Entities must also disclose the cumulative amount of fair value hedging adjustments made to the carrying amount of the hedged assets and liabilities. This provides visibility into how the balance sheet values of hedged items have been modified over the life of the hedging relationship. For instance, the carrying value of a hedged fixed-rate loan would be adjusted for changes in fair value due to interest rate movements.

### Cash Flow Hedges

The quantitative disclosures for cash flow hedges center on the treatment of gains and losses deferred in other comprehensive income (OCI). Entities must disclose, in a tabular format, the gains and losses on these derivatives that were recognized in OCI during the period. The table must also detail the amount of gains and losses that were reclassified from accumulated other comprehensive income (AOCI) into earnings during the period.

This reclassification disclosure shows the impact of past hedges flowing through the income statement. For example, if a company used a forward contract to hedge a forecasted purchase of inventory, the gain or loss on that forward would initially be in OCI. The guidance also requires a description of the transactions being hedged and an estimate of the net amount in AOCI that is expected to be reclassified into earnings within the next 12 months.

### Net Investment Hedges

When an entity hedges its net investment in a foreign operation, the disclosure requirements focus on the impact on the cumulative translation adjustment (CTA), which is a component of OCI. Entities must separately disclose the gains and losses on instruments designated as net investment hedges that were recognized in CTA during the period. This allows users to see the extent to which the entity is mitigating the foreign currency risk associated with its international subsidiaries.

For example, a U.S. parent company with a European subsidiary might use a euro-denominated debt instrument to hedge its net investment in that subsidiary. As the euro exchange rate fluctuates, the translation of the subsidiary’s net assets creates a gain or loss in CTA. The offsetting gain or loss from remeasuring the euro-denominated debt is also recorded in CTA, and this amount must be disclosed.

### Derivatives Not Designated as Hedging Instruments

For derivatives that are not designated as hedging instruments, or do not qualify for hedge accounting, an entity must disclose the gains and losses from these instruments recognized in earnings. The disclosure must be presented in a table, broken down by the type of contract.

The table must also identify the specific line item(s) in the income statement where these gains and losses are reported, such as “Other income (expense).” For instance, if a company holds equity options for speculative purposes, any change in the fair value of those options would be recorded in earnings, and the total gain or loss for the period would be presented in this disclosure.

## Presentation and Location in Financial Statements

The procedural and presentational requirements are designed to ensure that derivative disclosures are clear, consistent, and easy for users to locate. A core component of this is the mandatory use of tabular formats for all quantitative data. This format prevents companies from obscuring derivative information in dense paragraphs of text.

These required tables, along with the accompanying qualitative narratives, are located within the footnotes to the financial statements. While the guidance does not mandate a single, all-encompassing derivative footnote, it does require clear organization. If an entity chooses to spread its derivative-related information across multiple footnotes, it must provide cross-references between them.

The presentation within the tables themselves is also highly specified. The table disclosing the fair value of derivatives on the balance sheet must separately present assets and liabilities. It must also segregate the instruments by their purpose (designated as a hedge versus not designated) and by the type of contract, and explicitly name the line item on the face of the balance sheet where these amounts are included.

Similarly, the tables for income statement impact must show the gains and losses on hedging instruments and identify the specific income statement line item where they are recorded. For fair value and cash flow hedges, the guidance requires the gain or loss on the hedging instrument to be presented in the same income statement line as the earnings effect of the hedged item. This matching presentation makes the economic relationship between the hedge and the hedged item transparent.