Final proposals on accounting for risk management activities

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Monday, 10 September 2012 - EY have welcomed the International Accounting Standards Board’s (IASB) release of a review draft on new proposals for hedge accounting that will allow many entities to better reflect their risk management activities in financial statements.

The proposals are designed to provide a stronger link between an organisation’s risk management activities, the rationale for hedging, and the impact on financial statements.

Lynda Tomkins, EY’s National IFRS leader says the new hedge accounting model is more principle-based, less complex, more linked to an entity’s risk management activities, and can be consistently applied by all industry sectors.

“The current hedge accounting model includes complex rules and prescriptive hedge effectiveness testing that often result in an entity not being able to apply hedge accounting to its economic hedging relationships resulting in additional ‘volatility’ in profit or loss,” Ms Tomkins said.

 “We expect Australian entities to significantly benefit from a number of aspects of the proposals. For example, the proposals would make hedge accounting easier to achieve, implement and manage for Australian entities that enter into foreign currency denominated debt financing or foreign currency denominated commodity contracts.”

Ms Tomkins said it was also expected corporate entities particularly those in the agricultural, resources and airlines industry will benefit most from the proposals.

“These entities typically enter into contracts to buy or sell non-financial items such as commodities that are subject to various types of risks such as, foreign exchange risk and price risk. Hedge accounting will now be permitted for individual risk components of non-financial items provided the entity can separately identify and reliably measure the risk component that is actually hedged.”

Australian entities such as those in the airlines, energy and resources industry that use option-based strategies will also benefit from the proposals Ms Tomkins said.

“Under the current hedge accounting requirements, option-based hedging strategies results in significantly more profit or loss volatility even if hedge accounting is applied. The Board has proposed a change to the treatment of options under hedge accounting such that profit or loss volatility from option-based strategies can be reduced.” 

Ms Tomkins said although many financial institutions are waiting for the IASB to develop a separate proposal on the so called ‘macro hedging’ model, they will also benefit from the proposals.

“Many financial institutions hedge the credit risk arising from loans, bonds or loan commitments using credit derivatives. However, under the current rules hedge accounting cannot normally be applied. Under the new proposals, an entity may, at any time, elect to account for a loan or loan commitment at fair value through profit or loss in circumstances where credit risk hedging is undertaken.”

The review draft will remain on the IASB's website until early December 2012 and the Board then intends to finalise the draft document. The final standard is due to be issued by the end of 2012, with an effective date for reporting periods beginning 1 January 2015.

Ms Tomkins encouraged organisations to analyse the proposals in detail to understand the impact the new hedge accounting model would have on their financial positions and results and provide comments to the IASB where appropriate.

“This is the last opportunity to provide any comments and outline any concerns or negative consequences to the Board before the hedge accounting model is finalised. We encourage organisations to carefully consider the impact of these proposals. ”
In light of the transition requirements and interaction with other phases of the IASB’s financial instrument project, implementation of the new requirements will also bring its own challenges.

“Early planning will be essential, and this document will give organisations a head-start,” Ms Tomkins said.

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