Responding to widespread uncertainties about the implementation of Financial Accounting Statement 133, Accounting for Derivative Instruments and Hedging Activities, the Financial Accounting Standards Board has issued a proposed implementation issue intended to make it easier for companies to use the "shortcut method" in accounting for many hedging transactions.It should also help those companies' confidence.
Louis Fanzini, a FASB industry fellow serving as project manager, said that the amendments are intended as clarifications to questions that have been raised not only by the preparers of financial statements, but by auditors and regulators as well.
"These are several implementation issues that came up in practice where we felt it would make sense to clarify what was meant in Statement 133," he said. "Some are just basic transactions that most of us never would have thought would cause failure of the shortcut method, but because of the heightened scrutiny in recent years, people were having what we call 'interpretation risk.' They were afraid to make a call on what some of these issues meant."
The primary clarification allows the shortcut method to be applied even when a derivative's trade date, i.e., the commitment date, is different from the settlement date, i.e., the date the transaction is recorded.
ADVICE AND DISSENT
Three of the seven FASB members, however, dissented on the nature of the amendment. They supported the document generally, but felt that one proposed clarification actually conflicts with a common interpretation of Statement 133, and thus would disallow the common practice of applying the shortcut method to "late hedges."
A common late-hedge situation is one in which a swap is put in place after an asset is acquired or a debt is issued, perhaps a year or more later.
Clark Maxwell, director of accounting at Chatham Financial, said that most of the proposed amendments would be well received among statement preparers because the clarifications would increase the use of the shortcut method, because they would be confident that they were applying it appropriately.
Maxwell expected criticism of the restricted use of the shortcut method for late hedges, because those types of hedges are very common in practice. "Most of the clarifications are consistent with current interpretation and practice, but it is very significant that the proposal would restrict the use of the shortcut method for late hedging," he said. "That's where you're going to get the majority of the comments, and I think preparers that use shortcut in those situations should be encouraged to comment and share their viewpoints."
Opponents of that aspect of the proposal will find support in the three FASB members who dissented for the same reason. Though they supported the conclusions in the document generally, they did not see FAS 133 disallowing the use of the shortcut method in late hedges.
"[The dissenting members] disagree with the conclusion that a condition of the shortcut method is that the fair value of the hedged item has to equal its principal amount (which disqualifies hedge transactions that are entered into after the initial issuance or purchase of the debt instrument)," the proposal says in a statement of dissention.
Four board members felt that late hedging introduces more ineffectiveness than the shortcut method was intended to cover, and therefore accounting would have to be done by so-called "long-haul methods."
Maxwell said that long-haul methods are onerous and often beyond the capability of many small companies. He suspects that some companies may forego late hedging opportunities simply because of the complexity and cost of accounting.
He also questioned any need to disallow the shortcut method in late-hedge accounting. "I believe that the perception that there is abuse out there and a lot of ineffectiveness being hidden in late hedging is inaccurate," he said. "One of the things I will do in my comment letter is walk through the mathematical calculations to demonstrate that there are actually fairly immaterial differences between the long-haul and the shortcut methods with respect to late hedges."
The dissent notes that under FASB's mixed-measurement attribute model, derivatives are required to be carried at fair value, while most other instruments are not. The dissenting members would consider replacing the shortcut method with a principle that would apply more broadly to highly effective hedge transactions where the critical terms match as a different form of simplification.
Comments on the proposed implementation issue document are due by Sept. 21, 2007.
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