Will the FASB clip the hedges?

• Author: Herz, Robert H.
• Position: Regulation of hedging strategies - Corporate Reporting

Do you use hedging strategies to manage risk? Are you confused about the rules on accounting for derivatives? If you answered yes to either question, tread carefully -- the FASB may be bringing big changes your way.

If you've got hedging headaches, you're not alone. CFOs and corporate treasurers are continually barraged with a myriad of financial instruments and techniques for managing the risk in their businesses. But accounting rule makers also have been hard-pressed to keep up with new hedging products and techniques. As a result, accounting rules in this area are piecemeal, often internally inconsistent and sometimes counterproductive to sound economic management. This has made the going tough for financial executives trying to adopt sound economic hedging strategies without undesirable financial-statement results.

Controversial accounting procedures for hedging anticipated future exposures vividly demonstrate the rampant confusion. While one accounting regulation permits companies to defer gains and losses on futures contracts hedging anticipated interest-rate and commodity price risks, another prohibits deferrals on foreign-currency forwards and swaps for hedging anticipated foreign-currency transactions. This is just one example of the regulatory hodgepodge.

After years of prodding by a somewhat frustrated business community, the Financial Accounting Standards Board in 1992 launched a project on hedge accounting and accounting for derivatives and synthetic instruments. Most recently, the FASB staff prepared a "Preliminary Views" document containing tentative conclusions that could significantly change the current rules and practices. Because individual FASB members are divided on certain key issues, and because two of the seven ended their term in June and were replaced with two new members, this document was not released publicly. Rather, the FASB recently released "A Report on Deliberations" on its discussions and tentative conclusions to date and plans to hold meetings in the fall with interested parties.

The existing authoritative accounting rules are spelled out in Statements of Financial Accounting Standards 52 and 80. SFAS 52 deals with foreign currency transactions, including accounting for foreign-currency forwards and currency swaps, and SFAS 80 addresses the accounting for regulated interest-rate and commodity futures contracts. A 1986 issues paper from the American Institute of Certified Public Accountants contains nonauthoritative accounting guidance for options. While no promulgated guidance for interest-rate swaps and other derivatives exists, generally accepted practices have emerged. Finally, the FASB's Emerging Issues Task Force and the Securities and Exchange Commission's Office of the Chief Accountant have occasionally addressed specific issues prompted by regulatory...