WASHINGTON -- A Financial Accounting Standards Board panel has cleared a major hurdle in its attempt to draft accounting guidelines for derivatives that are used as a hedge against loans and investments.
The move came last week when the standards board approved the panel's use of a simple modeling technique that would separate derivatives used for trading from derivatives used for all other purposes.
"Many of the models we've considered started off with recognizing and measuring derivatives instruments at their fair value," said Jane Adams, the hedge accounting panel's project manager.
One of the reasons for hedge accounting is to provide for income of items that are related or that have counterbalancing changes in value, Adams said. "We wouldn't resolve that solely by saying you mark these derivatives to market and everything goes to earnings when it happens."
There are a wide variety of objectives that individuals and organizations have in terms of risk management strategies. "I believe the one that we've proposed would, while not satisfying everyone, certainly provide for a form of special accounting for a vast range of those objectives," Adams said.
The panel had to find some way of deferring certain gains and losses into future periods. This was accomplished by placing derivatives investments into the two categories, Adams said.
Derivatives used in tracking would be marked to market with the changes in values recognized in earnings.
Those derivatives used in all other areas, including risk management, would be marked to market with changes in values reflected in equity. Once realized, the derivatives would have to be recorded in earnings.
The newly approved method has some great advantages, Adams said.
"One benefit is that it's very simple," Adams said. Although some industry sources would say it's too simple, "it has the benefit of increasing the visibility of derivative instruments and increasing the comparability in which they are reflected in financial statements."
Now that the accounting panel has determined what model will be used for the hedge accounting guidelines, the hedge project group will be going back to the board to debate other issues including different tax treatments, a clarification of fair value, and a definition of derivative instruments.
Adams said her panel will meet with the accounting board at the end of this month and hopes to draft a proposal early in the second quarter of 1995.
Once an exposure draft is released, the accounting board will most likely keep the public comment period open for 90 to 100 days. After that it will review the comments and probably conduct public hearings.
"If we came out with a document in early second quarter then we likely couldn't have a final statement out in 1995," Adams said.