IASB Proposals Align Hedge Accounting Closer with Risk Management

Michelle Remo, “Big 4″ observer
September 10, 2012 /

The International Accounting Standards Board (IASB) released over the weekend a draft final standard with revised proposals on hedge accounting that will allow many entities better to reflect their risk management activities in the financial statements.

The proposals are designed to provide a stronger link between an organization’s risk management activities, the rationale for hedging, and the impact on the financial statements.

Enrique Tejerina, KPMG’s global IFRS Financial Instruments deputy leader, said: “Many preparers will support these revised proposals. It appears that in redeliberating the December 2010 Exposure Draft, the IASB has responded to stakeholder requests for conceptual clarifications and more ‘meat on the bone’ for the new concepts. It has done this without losing the more principles-based approach that aligns hedge accounting more closely with risk management that many constituents viewed as a positive step forward.”

Many financial institutions are waiting for the IASB to develop a separate proposal on so called “portfolio” or “macro hedging,” that is expected to be issued as a separate standard in 2014. Some of the existing macro hedge accounting provisions have been carried forward into this final draft standard, but banks will need to review it carefully to ensure that when applying IFRS 9 they can continue with their existing hedge accounting policies until the macro hedging project is completed. But banks will benefit from the new standard.

KPMG said some industries (e.g. banking and insurance) may believe that these proposals will not significantly change the ‘status quo’ from their perspective, as they keenly await the IASB’s macro hedging discussion paper later this year. However, other industries may be keen to seize the opportunity to further align their hedge accounting with how they actually manage risk.

Tejerina commented: “Airlines, manufacturers and others that have to manage significant commodity price exposures will have the most to gain from the proposals to permit hedge accounting for risk components of non-financial items. A company will be able to reflect in its financial statements an outcome that is more consistent with how management assesses and mitigates risks for key inputs into its core business.”

The proposals also remove the rigid ‘bright line’ for assessing hedge effectiveness, which will allow for a more flexible principles-based approach to hedge accounting.

Tony Clifford, Ernst & Young’s Global IFRS Financial Instruments Leader, said: “We expect that the most significant benefit of the proposals will be for non-financial services entities. These entities typically enter into contracts to buy or sell non-financial items that contain various risk components, such as, foreign exchange risk, commodity price risk and basis risk. Hedge accounting will now be permitted for individual risk components of non-financial items, provided the entity can separately identify and reliably measure the risk component that is actually hedged. One example commonly used is the hedge of the crude oil component of a jet fuel purchase.”

However, Tejerina cautioned: “Although the principles in the draft will provide welcome relief, the application guidance in some areas remains complex. Significant effort may be needed to analyse the requirements and determine how best to apply them to a company’s particular circumstances. While some entities may be eager to implement the proposals, they may need to apply a greater degree of judgement to comply with them. In addition, to complement a more principles-based approach, additional disclosures will be required to inform users of how an entity is managing its risks.”

The draft will be available until early December 2012, after which time the IASB intends to proceed to finalise the draft.


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