Perspective on Hedge Accounting - Striking the Right Balance

There are markedly different views about hedge accounting.

Some believe that hedge accounting is an exception to the principle that derivative instruments should be marked to fair value with changes in fair value reflected in earnings. Others believe that hedge accounting properly reflects the role derivative instruments play in the risk management processes of entities.

Holders of the former view would call for rules that are strictly applied to "earn" the use of hedge accounting. Some argue that this view is a main reason for the complexity of the current hedge accounting rules under U.S. GAAP and IFRS. They also argue that this view has caused a disconnect between what accountants do to “earn” hedge accounting and what entities do to manage risk.

Holders of the latter view would call for a more holistic approach to allowing hedge accounting. Consistency between what an entity does for risk management would be very important. However, some argue that this view does not provide enough discipline for what is after all an exception and that hedge accounting may be used to manage earnings.

Striking the right balance between the two views is key. In other words, allow hedge accounting to reflect what an entity does for risk management while at the same time provide enough discipline in its application.

This will require the application of judgment since detailed rules would be done away with. Striking the right balance is the challenge for the accounting standard setters.

It is expected that the IASB will issue its standard on hedge accounting in the next few months. The FASB is yet to begin re-deliberating its hedge accounting proposals; thus the timing of the finalization of its standard is not clear.