INTERNATIONAL STANDARDS governing hedge accounting have been overhauled by the IASB to provide a more principles-based approach that better reflects companies’ risk management strategies.
As a result of the changes, which include a loosening eligibility rules for what can be hedged and dealing with the so-called “own credit” accounting anomaly, users of the financial statements will be provided with better information about risk management and about the effect of hedge accounting on the financial statements.
Entities can now change the accounting for liabilities they have elected to measure at fair value, before applying any of the other requirements in IFRS 9. Gains caused by a worsening in an entity’s own credit risk on such liabilities are no longer recognised in profit or loss.
“This had meant that companies in trouble were paradoxically seen to be recording gains in profit or loss, which was counter-intuitive and looked distinctly odd,” said Andrew Spooner, Deloitte’s lead financial instruments partner. “Companies are now allowed to adopt this fix early without adopting the rest of IFRS 9, though it will still be subject to EU endorsement for EU reporters.”
The changes are part of a package of amendments to the accounting requirements for financial instruments, known as IFRS 9, which will replace IAS 39, the accounting standard heavily criticised in the wake of the financial crisis.
However, the current rules only apply to entities that hedge non-financial risk, As such, banks – whose application of IAS 39 was cited as a contributing factor of the financial crisis – are unlikely to see much change to the status quo.
According to Enrique Tejerina, KPMG’s global IFRS financial instruments deputy leader, companies with significant commodity price exposure are most likely to welcome changes.
“Airlines, manufacturers and others that have to manage significant commodity price exposures will have the most to gain from the new ability to apply hedge accounting for risk components of non-financial items,” Tejerina said. “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.”
Because it is more principles-based the new standard will require more disclosures, which will hinder efforts to reduce the length of IFRS financial statements.
“More judgement means an increased need for disclosures. That may be a challenge for some. What is critical is that the longer disclosures don’t result in key information becoming obscured,” said Nigel Sleigh-Johnson, head of ICAEW’s Financial Reporting Faculty.
The impairment phase of IFRS 9 is still to be completed. As a result the IASB scrapped the original mandatory effective date of 1 January 2015 and said a new date should be decided upon when the entire IFRS 9 project is closer to completion.
“Replacing IAS 39 has proved a much slower and tougher task for the standard setters than originally thought. That has been a source of huge frustration,” said Sleigh-Johnson. “They are not there yet, but the hedge accounting standard is an important strand of what has become a rather tangled and complex web of much-needed financial reporting reforms”.
A high level summary of the amendments can be downloaded here.