FASB Is Still Trying to Get Hedge Accounting Right 20 Years Later


Since the inception of derivatives and hedge accounting, the standard setters have been challenged to provide the information investors need to make informed decisions. The Financial Accounting Standards Board (FASB) is trying once again, through ASU 2017-12: Targeted Improvements to Accounting for Hedging Activities to address concerns that current hedge accounting standards do not permit an entity to properly recognize the economic results of its hedging strategies.

Let us travel back in time to the beginning with Sherman and Mr. Peabody in their time machine. Set the dial back to 1998 when FASB issued Financial Accounting Statement (FAS) No. 133, Accounting for Derivative Instruments and Hedging Activities to establish accounting and reporting standards for derivative instruments. It required the fair value recognition of all derivatives as either assets or liabilities on the balance sheet.

Soon thereafter the use and complexity of derivative instruments and hedging activities increased significantly and it became apparent that the existing disclosure requirements in FAS 133 did not provide adequate information about how derivative and hedging activities affect an entity’s financial position, financial performance, and cash flows. This resulted in 2008 with the issuance of FAS 161 Disclosures about Derivative Instruments and Hedging Activities.

FAS 161 required additional disclosures about an entity’s derivative and hedging activities, thus improving the transparency of financial reporting. However, it still did not provide investors adequate information.

Back to the present, ASU 2017-12 will simplify the hedge accounting rules and create even more transparency in order for financial reporting to more closely reflect the entity’s risk management activities. The financial statements need to provide investors with a better understanding of an entity’s risk exposure and how hedging strategies help to mitigate them. There is a great deal of support among stakeholders for these long awaited changes. “Companies and investors alike have expressed overwhelming support for this long-awaited standard,” FASB Chairman Russell Golden said.

Banks and industrial companies in particular are welcoming these new rules on derivatives and hedge accounting. The rules may help prevent swings in earnings and are likely to provide significant new business for banks, Bloomberg BNA staff correspondent Steve Burkholder wrote in his article on the new rules. Click here to see the full story (subscription required).

FASB’s objective in issuing the new guidance is to improve the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. However, only time will tell if FASB achieves its objective and simplifies the application of hedge accounting guidance.

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