Accounting rulemakers voted to give favorable bookkeeping treatment to companies that use derivatives as insurance against losses, easing concern that using them will cause unwanted fluctuations in corporate earnings.
The seven-member Financial Accounting Standards Board unanimously decided that under certain circumstances so-called hedge accounting will be applied to net written options-non-exchange traded options designed specifically to hedge changes in the value of an asset, such as currencies or commodities. Hedge accounting is considered favorable because it allows companies to avoid booking fluctuations in the value of derivatives until the contracts are sold or mature.
The ruling changes current accounting, which doesn't permit hedge accounting treatment for net written options.
The decision is part of the FASB's larger project on accounting for derivatives, which was prompted by losses at companies including Procter & Gamble Co. that weren't reported on the face of financial statements.
Under current accounting, gains and losses from most derivatives don't have to be acknowledged on the balance sheet, a situation the FASB is expected to change.
"This broadens slightly the use of written items as hedging instruments," said Scott Marcello, a FASB practice fellow.
Hedge accounting can be used if the combination of the hedge item and the option provides at least as much potential for gains as it does for potential losses, said Halsey Bullen, a senior FASB project manager. Today's ruling is intended to give favorable treatment to companies that use derivatives as insurance against losses, rather than as a speculation on the direction of currencies, interest rates, or the price of commodities.
The FASB, which sets accounting standards under authority of the Securities and Exchange Commission, hopes to complete its derivatives project by yearend and start applying it for quarters that begin after Dec. 15, 1998.
Companies are watching the process closely because they are concerned that placing a value for derivatives on the balance sheet will increase earnings volatility.
Some derivatives dealers are concerned about the pace of creating a new derivatives standard.
"It's a worthwhile goal to increase consistency," said Paul Salfi, a senior financial policy analyst at the American Bankers Association. Derivatives dealers said that the document has changed so much since its inception that the proposal should be reissued in its entirety, providing dealers and end-users with the opportunity to comment.
"We believe that the proper procedure is to go through the normal process of reexposure," said Gay Evans, chairman of the International Swaps and Derivatives Association.
Mr. Marcello said the FASB voted last week against reexposure and that there would have to be a compelling reason for the board to reconsider it.
"The Securities and Exchange Commission has asked us to do this as quickly as we can," he said. "This has always been a high priority for the board."
