-148-
On July 23, 1993, FNBC’s Control Department issued FAPM 396,
entitled “Nonperforming Variable Exposure Product
Transactions”.53 In relevant part, this document established the
policies for dealing with a swap (or other variable exposure
product) if the counterparty had not made a payment which FNBC
had an unqualified right to receive. According to FAPM 396,
FNBC’s policy was to account for swaps with a past due periodic
payment using a “‘modified’ lower of cost or market”. FAPM 396
stated further that changes in the value were recognized in the
applicable trading profits account currently as losses or gains
(only to the extent of prior losses). FAPM 396 further stated
that the modified lower of cost or market accounting treatment
might occur when (1) payment that FNBC had an unqualified right
to receive had not been made when due and (2) it had been
determined that the contract is nonperforming.
XIII. FNBC Had No Schedule M Adjustments
There were no Schedule M adjustments on FNBC’s tax returns
with respect to swaps booked through FNBC.
XIV. Nature and Amount of the Proposed Disallowances
The audit of FNBC’s 1990 and 1991 taxable years commenced in
December 1992. The assigned agent’s focus during the audit was
53 A contract was considered “nonperforming” if it was
determined that a counterparty would probably not fulfill its
cashflow (or other exchange) obligation under the terms of the
contract.
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