FASB Drops Mark-to-Market Plan for Derivatives Accounting; New Approach

The Financial Accounting Standards Board last week took a step back from a mark-to-market approach to derivatives accounting that had alarmed bankers.

But the accounting board's new plan, which will allow corporations to link derivatives to the financial instruments or transactions they are hedging, isn't winning rave reviews either.

"We're glad they're rethinking their previous mark-to-market approach, and this seems to be a tiny step in the right direction," said Donna Fisher, director of tax and accounting for the American Bankers Association.

However, she added, "What the FASB is doing is still fair value, they've simply limited the amount of fair value that you recognize. And it's still going through the income statement and we have for a very long time objected to that."

In October, the standards board - under pressure from the Securities and Exchange Commission to move derivatives from the footnotes to the balance sheets of corporate financial statements - endorsed a simple but controversial approach to derivatives accounting.

That is, corporations would have been required to mark all their derivatives to market and account for unrealized gains or losses in earnings if the derivatives were held for trading, and in equity if they were not.

The board recognized that this would cause problems for banks and other companies that use derivatives to hedge their risks on financial instruments that aren't marked to market, such as loans. So it also gave companies the option to mark all their financial instruments to market.

The problem with the latter approach is that there are still a lot of things - leases, for example, and core deposit intangibles - that nobody has yet figured out how to mark to market. Also, some bankers fear that marking all their assets and liabilities to market would add volatility to their financial statements that would confuse investors.

So on Thursday, the accounting board voted 5-2 for a less-encompassing derivatives standard.

Derivatives being used to hedge assets or liabilities would have to be marked to market, with unrealized gains or losses accounted for in earnings. But corporations would be allowed to offset changes in the derivatives' value with changes in the value of whatever financial instrument the derivatives are being used to hedge.

When used to hedge future transactions, derivatives would also be marked to market, but unrealized gains or losses would be accounted for in equity until the transaction takes place, when they would go into earnings.

"This is somewhat of an interim solution," said Bob Conklin, a FASB practice fellow working on the derivatives project. "The ultimate vision is marking all financial instruments to market."

The accounting board hopes to issue a formal proposal on derivatives accounting by June 30.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER