FASB Exposure Draft on Hedge Accounting Sets U.S. on Diverging Path
In its public letter submitted last week to the Financial Accounting Standards Board (FASB) commenting on proposed accounting rules, Reval, a global derivative risk management and hedge accounting solutions provider to over 400 public companies, outlined what it believes to be the most significant areas of divergence from International Financial Reporting Standards (IFRS).
“Our commentary focuses on what the exposure draft doesn’t do for hedging, which, among other issues, introduces inconsistency on the path to convergence with IFRS,” says Joshua Cohen, Vice Chairman of Reval’s Hedge Accounting Technical Taskforce (HATT). Cohen submitted the letter and Reval’s responses to questions covering the hedge accounting portion of FASB’s exposure draft (ED), Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities. Public commentary on the ED closes September 30.
Cohen notes that, as public company financial reporting is expected to converge with IFRS, FASB activities “…should be focused on convergence rather than on introducing additional complexities that create new differences from IFRS.” This issue is also central to Reval’s public comment letter to the International Accounting Standards Board (IASB) on Fair Value Option for Financial Liabilities.
According to Reval, the following key areas of the ED depart from current IFRS literature and, if enacted, would lead to much larger problems when the standards do converge:
The “reasonably effective” threshold – A shift from “highly effective” to an undefined “reasonably effective” appears to move away from converging with current accounting guidance under IAS 39.
Hedge effectiveness assessment – The change to qualitatively assessing the effectiveness of a hedging relationship will not improve the quality or consistency of accounting for derivatives, nor will it comply with existing IFRS guidance on the subject.
Cash flow hedge measurement – The proposed method will result in more P&L volatility than the current method permits and will actually lead to more distorted financial statements, which is diametrically opposed to the stated objective of the Exposure Draft. The additional volatility may force companies to abandon the prudent use of derivatives to effectively manage their business risk.
Elimination of voluntary de-designation (ASC 815-20-55) – Companies will now have to “terminate” their derivatives if they wish to voluntarily de-designate their hedging relationship. If a company still wishes to hedge its risks but de-designate the hedging relationship, it must enter into an offsetting derivative, which will result in additional transaction costs and recordkeeping requirements.
Change to assessing and measuring the effectiveness of a purchased option (ASC 815-20-55) – This represents a hybrid model between the current ASC 815-20-55 (DIG G20) and the current guidance under IFRS, which would disallow the deferral of the time value completely. Due to the fact that the net periodic changes in time value and overall periodic reclassification amounts are likely to be small relative to the total time value and total periodic change in time value, it seems this proposed change adds an unnecessary element of complexity to the accounting treatment under ASC 815-20-55 (G20) while adding little additional transparency into the net effect of options on an entity’s financial position.
In addition to the above comments, Reval is seeking clarification from the FASB on hedging intercompany transactions, which in FASB’s 2008 Exposure Draft, effectively eliminated a company’s ability to hedge intercompany transactions unless an identifiable exposure survived consolidation. “We would like to confirm whether the Board intends to leave this topic unchanged or provide further clarification on the changes proposed in the 2008 Exposure Draft,” Cohen says.
Reval urges companies to post comments to the FASB regarding the areas that will impact them both positively and negatively. “Companies need to have a hand in shaping how they will account for the derivatives they use to hedge commercial risk and ensure that, in the end, users of their financial statements will have a clear picture of their corporate financial status,” Cohen says.
