The current rules on hedge accounting are among the most detailed and complex aspects of U.S. Generally Accepted Accounting Principles. The application of these rules has caused headaches for corporate risk managers and company accountants seeking to properly reflect the results of their company’s risk management activities while also ensuring compliance with accounting requirements. The Financial Accounting Standards Board plans to soon issue an exposure draft of a proposed standard intended to improve and simplify the requirements relating to hedge accounting and to more closely align them with companies’ risk management activities.
Specific rules on hedge accounting have been developed in order to enable companies to reflect in their financial statements the effects of transactions—usually involving the use of derivatives—designed to manage certain risks, such as interest rate, prepayment, credit, foreign currency, and commodity price risks. Accounting standards require derivatives to be carried at fair value, with unrealized and realized gains and losses included currently in reported earnings, unless they qualify for special hedge accounting rules. The special rules are needed in order to align the accounting for the effects of a hedging transaction with the accounting for the item being hedged.
