IASB release new hedge accounting proposals

LONG-AWAITED hedge accounting proposals aimed at freeing up companies to explain how they balance risk, received tentative support after being released this morning.

The repeatedly-delayed proposals will likely please investors and companies, frustrated by existing rules which can distort published finances.

The proposals will be closely watched by corporations which routinely deal with raw materials, in particular, major airlines which employ complex hedging strategies to offset the volatile price of jet fuel.

Hedge accounting allows companies to link two ordinarily seperate transactions, where one is designed to offset the risk of the other. The aim is to communicate to investors how risk is being managed. But strict accounting rules has meant while many companies practice hedging, a large proportion are not able to communicate their strategies in their published accounts.

This has led corporates to simply explain their hedging strategies outside of their statutory accounts, which can make it difficult to make comparisons between companies.




New hedge accounting proposals will allow companies to hedge individual components of complex products

The International Accounting Standards Board (IASB) which authored the proposals is attempting to free up the rules including allowing corporates to hedge individual elements of complex products.

The major components of jet fuel include jet kerosene, gas oil and crude oil. Under the new proposals airlines will be able to pluck out the crude oil component, and hedge the associated risk, rather than attempting the tricky task of hedging the entire product.

Frustration at existing rules has run high in the past. In 2006, engine manufacturer Rolls Royce signaled its disdain for hedge accounting when it publicly refused to alter “its hedging activities in order to achieve a particular accounting presentation”.

The proposals is the last of a suite of three major financial standards released in the wake of the crisis. However, unlike the first two standards – classification and measurement, and impairment – this standard will affect close to all corporates who deal in raw materials.

The standard was repeatedly delayed due, in part, to staffing changes at the IASB. The organisation hopes to finalise the standard in the first half of 2011.

Tony Clifford, senior partner with Ernst & Young, said current rules included “arbitrary limits, complex rules and onerous hedge effectiveness testing.”

“The proposals represent a fundamental shift from the way entities applied hedge accounting in the past. Financial reporting can now reflect more accurately how an entity manages its risk and the extent to which hedging practices mitigate those risks,” he said.

Liz Murrell, corporate governance and reporting director with the Investment Management Association, said she agreed with the aim of the proposals.

“We will be reviewing the proposals during the course of the consultation period but we welcome the intended purpose of increasing comparability of accounts,” she said.

“We welcome proposals which allows better alignment with a company’s risk strategy.”

Nigel Sleigh-Johnson, Head of ICAEW’s financial reporting faculty, described the area as one of the most “complex and debated areas of accounting”.

“The very detailed and specific rules in the current standard made hedge accounting very difficult,” he said.

“The IASB’s hedge accounting proposals will require careful consideration but could represent a significant improvement on current requirements.”


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Fiona Westwood of Smith and Williamson.