WASHINGTON - The Financial Accounting Standards Board is considering extending to derivatives some of the accounting methods that apply to investments in debt and equity, a staff member of the board said yesterday.
Currently, the board's Statement 115, "Accounting for Investments in Debt and Equity Securities," sets forth the accounting methods that apply to investments in debt and equity.
The board is debating whether to draft standards for derivatives that incorporate some of the accounting methods in Statement 115.
"We thought maybe we could use that as a different approach to hedge accounting," Halsey Bullen, a staff member and consultant to the board, said this week. "We're trying it on for size."
The private sector standards-setting board has been trying to develop hedge accounting standards for about two and a half years.
In hedge accounting, income gains and losses can be deferred rather than recognized quarterly or annually by a financial institution engaged in hedging.
But the board has been stumped by how to treat hedging of "anticipated" or "forecasted" transactions, such as a futures contract on Treasury bonds that is intended to hedge the future purchase of a municipal bond issue.
In addition, end-users of derivatives who use options to hedge foreign currency transactions have complained that traditional hedge accounting is too restrictive.
The board began considering extending some of the accounting methods in Statement 115 to derivatives at an accountant's suggestion, Bullen said.
"Right now it just applies to debt and equity, but we're looking to see if that same approach could be extended to derivatives," he said.
"That would be a way of accommodating the concerns about hedge accounting in an indirect way," he said.
If the accounting methods in Statement 115 were applied to derivatives:
* the gains and losses from derivatives used for risk management purposes would be deferred on firms' balance sheets in equity outside of earnings;
* firms would mark to market derivatives involved in trading, with the gains and losses taken into account account in earnings;
The board has been discussing these ideas in a series of public meetings, Bullen said.
"We're exploring some of the ramifications of his proposal, but there are a lot of things that would need to be resolved before we know whether it can really work," he said.
One potential problem is that while these, accounting methods would probably please heavily capitalized, lightly-leveraged manufacturing and industrial firms, they might not be welcomed by lightly-capitalized, highly-leveraged financial institutions, Bullen said.
The reason for this, he said, is that a deferral of a loss in equity outside of earnings would result in a reduction of equity and could affect the capital standing of financial institutions that must meet federal capital requirements, he said.
If the board can resolve this and other issues, it would like to release a draft standard for derivatives sometime this year, Bullen said.