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IASB and FASB Convergence
The International Accounting Standards Board and its U.S. counterpart the Financial Accounting Standards Board have been talking about compatible standards for years. As companies increasingly become global entities, disparate accounting standards complicate things for both corporations and investors. As it currently stands, a U.S. subsidiary of a foreign corporation is essentially running two sets of financial disclosures, one according to U.S. GAAP (Generally Accepted Accounting Principles) and one according to IFRS (International Financial Reporting Standards). The benefits of applying a single standard should be obvious in terms of cost and clarity. Both boards recognize this, and since 2002 they’ve been engaged in a dialog to bring the two standards together.
Less talk more action
Let’s fast forward a bit to 2004. The FASB and the IASB issue a Memorandum of Understanding (MoU), and it is apparent that the two organizations are taking this commitment seriously. The MoU not only reiterates the need for a single standard, but also cites specific convergence topics as well as expected timeframes. The hope is that it will all come together by the end of 2011. In fact the G-20 (Group of Twenty nations) has recently turned the heat up for a 2011 project completion. The G-20 hopes that a single standard will revitalize global economies. (We could sure use a little boost here.)
Ok, so this is no cakewalk, and there has been bickering along the way, particularly with respect to the issues related to the recent economic crisis. That alone sparked a highly charged dialog on how to cope with toxic assets. At times it seemed almost as if the process was destined to stall. When the IASB issued an exposure draft in December of 2010 on hedge accounting, the document posed a very different approach to hedge accounting than that offered by FASB’s May 2010 exposure draft. So just when it looked like we would achieve confluence, a whole new batch of differences was introduced. I presume that many hoped that the IASB would offer proposals more in line with those of the FASB. I can also presume that many were ecstatic that the proposals were not.
Some of the Key Differences
|Both financial and non-financial instruments may be used as hedging instruments, with the exception of certain written options.||Non-derivative financial instruments may not be used for hedging purposes unless they are used for foreign exchange or net investment risk.|
|In hedges where an option’s intrinsic value is the designated hedging instrument, the initial time value may be amortized over the time period related to the hedge.||In hedges where an option’s intrinsic value is the designated hedging instrument, the initial time value is immediately recognized in earnings.|
|Component risks are allowed to be hedged.||The hedging of component risks is not allowed.|
|Aggregated exposures (a combination of an exposure and a derivative) may be designated as a hedged item.||Not allowed.|
|To qualify for hedge accounting, a hedging relationship is required to both (a) meet the objective of the hedge effectiveness assessment (that is, to ensure that the hedging relationship will produce an unbiased result and minimize expected hedge ineffectiveness) and (b) be expected to achieve other-than-accidental offsetting.||
To qualify for hedge accounting, current U.S. GAAP requires that the hedging relationship be expected to be highly effective in achieving offsetting of the changes in fair values or cash flows.
Under proposed U.S. GAAP, the “highly effective” requirement would be changed to “reasonably effective.”
|After inception of a hedge, an entity must reassess hedge effectiveness on a prospective basis in an ongoing manner. A retrospective assessment is not required for qualification purposes. The proposed guidance does not specify whether an entity would perform a qualitative or quantitative analysis when determining whether a hedging relationship meets the hedge effectiveness requirements.||
Proposed U.S. GAAP would require that, after inception, an entity assess hedge effectiveness after inception of a hedge on a prospective basis and retrospective basis only if changes in circumstances suggest that the hedging relationship may no longer be reasonably effective
|An entity may adjust an existing hedging relationship (referred to as “rebalancing”) and account for the revised hedging relationship as a continuation of the existing hedge rather than as a discontinuation when any of the following occur:
a. A hedged item changes.
b. A hedging instrument changes.
c. The expectation of hedge effectiveness changes.
d. Any combination of the above.
The part of the hedging relationship that remains after the rebalancing would be reported as a continuing hedge, with the part that is no longer hedged after rebalancing reported as a discontinued hedge.
Under proposed U.S. GAAP, an entity may modify the hedging instrument by adding a derivative to an existing hedging relationship that would not offset fully the existing hedging derivative and would not reduce the effectiveness of the hedging relationship. That modification would not result in the termination of the hedging relationship.
|For fair value hedges, the gain or loss on the hedging instrument and hedged item (excluding the ineffective portion) would be recognized in other comprehensive income.||
For fair value hedges, the gain or loss on the hedging instrument and hedged item (for changes in the hedged risk) are presented in profit or loss.
|For fair value hedges, fair value changes attributable to the hedged risk would be presented as a separate line item in the statement of financial position. That separate line item should be presented next to the line item that includes the hedged asset or liability.||
For fair value hedges, the carrying amount of the hedged item is adjusted for the change in its fair value attributable to the hedged risk.
Finding Middle Ground
While it’s too early to break into a chorus of “What a Wonderful World”, progress is being made. This month, the FASB issued a discussion paper on hedge accounting that actually included the IASB’s exposure draft. This could be an indication that the FASB may be leaning towards IASB’s proposals. At least that’s the way it looks. Both organizations are keen to simplify the hedge accounting rules, so I view the FASB’s issuance of this document as a positive step towards a single standard.
As things stand today, multi-national corporations need to constantly look to multiple sources for guidance on every accounting and disclosure issue. This is an important issue. Adhering to a mixed set of standards for global entities benefits no one – neither corporations nor investors.
The comment deadline for the IASB’s exposure draft for hedge accounting is March 9, 2011, while the comment period for FASB’s discussion paper ends April 25, 2011.