Standards body drafts new hedge accounting rules

Friday, 24 December 2010 00:04 -     - {{hitsCtrl.values.hits}}

LONDON (Reuters) - Companies from airlines to coffee makers will find it easier to account for strategies to mitigate risks such as currencies and commodity prices under draft rules published by a global accounting standards setter recently.

The International Accounting Standards Board (IASB), whose rules are used in over 100 countries including the European Union, unveiled its third and final leg of a reform of how the value of assets held by a company is shown in company accounts.

“These proposals sweep away the existing rule-based, complex and inflexible hedge accounting requirements and replace them with a simple, principle-based approach,” IASB Chairman David Tweedie said in a statement.

The new rules will end the current distinction in treatment between fair-value hedges, which limit exposure to changes in the value of an asset or liability, and cash flow hedges, which limit exposure to variability in cash flows such as future interest payments on a variable rate debt.

They will also, unlike the existing rules, allow hedge accounting to be used for net positions, where a company has offsetting assets and liabilities and only hedges the difference.

It will also end a distinction in the old rules that allows a company to hedge components of a financial item, such as the LIBOR risk component of a bond, but not components of a non-financial item, such as the oil price variability component of jet fuel prices.

Airlines are unable to directly hedge the price of jet fuel over a long period as there is not a large market for jet fuel derivatives. Instead, they use a proxy such as oil derivatives, which are an imperfect match, but cover a component of the risk of oil product price movements, while leaving some exposure to specific jet fuel price fluctuations.

Under the new rules, companies can specify to what extent the crude oil component of jet fuel is being hedged so that risks from adverse price moves are better quantified.

The rule change will also give investors more information on how hedging activities at a company could affect future cash flows.

After a public consultation, the board aims to make the changes optional for use from January 2013.

It will also introduce new requirements for companies to show how they manage which risks.

IASB officials expect tens of thousands of companies across the world to benefit from the new rules.

“If (the draft works) as expected, it will make quite a big difference, particularly for those companies that purchase or sell commodities,” said Tony Clifford, a partner at auditor Ernst & Young’s financial services practice.

“Anybody who hedges commodities should find it easier to reduce their profit and loss volatility. This should significantly reduce the bureaucratic cost of hedge accounting,” Clifford said.

The first part of replacing the IASB’s IAS 39 rule, on classification and measurement of financial instruments, has been completed. The second part, on impairment of financial assets, along with the third and final sector on hedge accounting will be completed next year with all three forming a new IFRS 9 standard.