Accounting policies and internal control
The parties involved include the treasury, the federal reserve and the entity. The MLF LLC is financed using credit obtained from the FRBNY on the basis of recourse. The acquisition of debt involved purchase of debt on the LLC based on the financial status of the issuer and debt prepayment of the issuer to the SPV at any particular time. Because of the nature of prepayment options, one should perform an evaluation to determine whether the option for prepayment is embedded on the required derivative and if it is different from the accounting.
The impact of the derivative instrument being embedded forms a different type of contract called the “host contract”. This involves all or some cash flows or a certain exchange that may be required by the ‘host contract’ whether contingent or conditional upon the specified event occurring. It will be altered according to the stated underlying issues which in our case refers to the scheduled payments following the ASC 815-15-05-1 contract.
A derivative instrument which is embedded is separated from the contract of the host. It is accounted as a derivative instrument following the provision under the 815-10 after the following criteria are met. First, the economic risks and characteristics of the derivative embedded are not closely and clearly related to the economic risks and features of the host contract according to 815-15-25-1a paragraph.
The second criteria relates to hybrid instrument whereby both the host contract and the embedded instruments are taken into consideration otherwise generally known as GAAP with various alterations at fair value. The earnings are reported as they take place and as outlined under paragraph 815-15-25-1b and the last criteria follows the concept of separate instrument which consists of certain terms such as the embedded instruments would following section 815-10-15 of the subject derivative instrument and pursuant to requirements outlined under the 815-10 and paragraph of the subtopic 815-15-25-1c
Basic accounting policy constructs and considerations
Due to numerous debt features of the host contract, one should follow certain sequence as outlined in ASC 815-15-25-12. First step involves determining if the payoff or the amount paid on settlement is adjusted or altered based on index. If they are adjusted, follow the second step and if they are unadjusted, follow step 3. However, MLF LLC has no payoff and the amount is unrelated to the changes in the index. The second step involves determining if the payoff is indexed to other underlying other than credit risks or interest rate. if they are payoff is indexed to other underlying, then the embedded feature is not clearly/closely related to the host contract of debt and therefore doesn’t require further analysis in subsequent steps.
The third step involves determining if the debt is associated with significant discount or premium. If yes, follow the next step 4 and if no, it will require further analysis based on paragraph 815-25-26 if applicable. The debt is not involved with discount or premium. The 4th step involves determining if they are contingently exercisable put or call option to speed up the repayment for the principal amount under contract. If yes, the put/call option are not closely and clearly related to the instrument of dent. If they are not exercised contingently, the contract will require further analysis based on the paragraph 815-15-25-26 if required.
According to ACS 815-15-25-26, an embedded instrument derivative which is underlying refers to interest rate index or interest rate for example, interest rate collar or interest rate cap which changes net payment of interest that otherwise would be received or paid on a host contract with interest bearing host which is said to be debt instrument is refereed to as