AICPA questions

AICPA's Common Sense Questions About Derivatives

Following are specific questions the AICPA has developed about derivatives activities. The AICPA hopes these questions can help top management and boards of directors of all types of enterprises gain a better understanding of their entities' derivatives activities.

1. Has the board established a dear and internally consistent risk management policy, including risk limits (as appropriate)?

Are our objectives and goals for derivatives activities clearly stated and communicated? To what extent are our operational objectives for derivatives being achieved? Are derivatives used to mitigate risk or do they create additional risk? If risk is being assumed, are trading limits established? Is the entity's strategy for derivatives use designed to further its economic, regulatory, industry and/or operating objectives?

2. Are management's strategies and implementation policies consistent with the board's authorization?

Management's philosophy and operating style create an environment that influences the actions of treasury and other personnel involved in derivatives activities. The assignment of authority and responsibility for derivatives transactions sends an important message. Is that message clear? Is compliance with these or related policies and procedures evaluated regularly? Does the treasury function view itself, or is it evaluated, as a profit center?

3. Do key controls exist to ensure that only authorized transactions take place and that unauthorized ions are quickly detected and appropriate action is taken?

Internal controls over derivatives activities should be monitored on an ongoing basis, and should also be subject to separate evaluations. Who is evaluating controls over derivatives activities? Do they bring the appropriate technical expertise to bear? Are deficiencies being identified and reported upstream? Are duties involving execution of derivatives transactions segregated from other duties (for example, the accounting and internal audit functions)?

4. Are the magnitude, complexity and risks of the entity's derivatives commensurate with the entity's objectives?

What are the entity's risk exposures, including derivatives? Internal analyses should include quantitative and qualitative information about the entity's derivatives activities. Analyses should address the risks associated with derivatives, which include:

Credit risk (the possible financial loss resulting from a counterparty's failure to meet its financial obligations)
Market risk (the possible financial loss resulting from adverse movements in the price of a financial asset or commodity)
Legal risk (the possible financial loss resulting from a legal or regulatory action that could invalidate a financial contract)
Control risk (the possible financial loss resulting from inadequate internal control structure)

Are our derivatives transactions standard for their class (that is, plain vanilla) or are they more complex? Is the complexity of derivatives transactions inconsistent with the risks being managed? The entity's risk assessment should result in a dekmination about how to man identified risks of derivatives activities. Has management anticipated how it will manage potential derivatives risk before assuming them?

5. Are personnel with authority to engage in and monitor derivative actions well qualified and appropriately trained?

Who are the key derivatives players within the entity? Is the knowledge vested only in one individual or a small group? The complexity of derivatives activities should be accompanied by development of personnel. For example, do employees involved in derivatives activities have the appropriate technical and professional expertise? Are other employees being appropriately educated before they become involved with derivatives transactions? Does the entity have personnel who have been cross-trained in case of the absence or departure of key personnel involved with derivatives activities? How do we ensure the integrity, ethical values and competence of personnel involved with derivatives activities?

6. Do the right people have the right information to make decisions?

What information about derivatives activities are we identifying and capturing, and how is it being communicated? The information should address both external and internal events, activities and conditions. For example, are we capturing and communicating information about market changes affecting derivatives transactions and about changes in our strategy for the mix of assets and liabilities that are the focus of risk management activities involving derivatives? Is this information being communicated to all affected parties?

Are the analysis and internal reporting of risks the company is managing and the effectiveness of its strategies comprehensive, reliable and well designed to facilitate oversight? The board should consider derivatives activities in the context of how related risks affect the achievement of the entity's objectives-economic, regulatory, industry or operating. For example, do derivatives activities increase the entity's exposure to risks that might frustrate, rather than further, achievement of these objectives?

Do we mark our derivatives transactions to market regularly (and, if not, why not)? Do we have good systems for marking transactions to market? Have the systems been tested by persons independent of the derivatives function? Do we know how the value of our derivatives will change under extreme market conditions? Is our published financial information about derivatives being prepared reliably and in conformity with generally accepted accounting principles?

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