Lost in the Maze

Problems with hedge accounting caused a wave of restatements in 2005. Are FASB's rules too hard to follow, or are companies simply too lax?

“The risks are real,” agrees Jeff Wallace, managing partner of Greenwich Treasury Advisors LLC, a consultancy in Naperville, Illinois. “You need to be tracking them.”

Linda Corman is a freelance writer based in New York.

Disclosing Derivatives

In its 2004 study of how companies implemented FAS 133, Fitch Ratings recommended the addition of numerous new disclosure requirements that would assist analysts in understanding and assessing companies’ hedging activities. In particular, Fitch said that more disclosure was necessary so that investors and analysts could appropriately adjust the effects of hedge accounting on credit ratios. At times, analysts and investors could choose to ignore the effects of hedge accounting, as volatility that can create confusion about a company’s true financial condition is shifted from the earnings statement to the balance sheet. Among the disclosures Fitch recommended was a roll-forward of the fair-value balance-sheet values of derivative positions.

Largely in response to Fitch’s critique, the Financial Accounting Standards Board formed a “Derivatives Disclosure Project” last fall to consider and ultimately recommend changes in the required disclosures under FAS 133. Those recommendations, to be developed by representatives of accounting firms, companies, and financial institutions, as well as by academics and analysts, should be ready for public consideration by the end of June, says Stanley Stuart Moss, manager of the project.

Comments Raja Akram, senior director in credit policy at Fitch: “While there seems to be no light at the end of the tunnel in terms of making accounting for these instruments less complex than brain surgery, maybe help is on the way through better disclosures that can help investors understand the risk better.” But even if there are changes in disclosure requirements, they are unlikely to have any impact on restatements. For companies to get the accounting right, either the rules will have to change or companies will have to learn how to comply with the rules. — L.C.

Take It Back
Hedge Accounting Restatements in 2005*
Company Reasons
for Restating
Effect on Earnings
Abington Community
Bancorp
Requirements for hedge accounting
not met
Decrease by $0.4M
Allied Defense
Group
Improper documentation Decrease by $23M
American International
Group
Improper documentation Increase of $500M
Ameritrade Improper documentation Decrease by $10M
Bay View Capital Derivative instrument not accounted for as derivative Increase of $0.4M
Cardinal Financial Incorrect valuation Not disclosed
Celgene Derivative instrument not accounted for as derivative Increase of $22M
Center Financial Improper application of shortcut method Increase of $0.2M
Ceridian Requirements for hedge accounting not met Increase of $38M
CIT Group Improper application of shortcut method Increase of $37.5M
CT Communications Requirements for hedge accounting not met Decrease by $0.1M
ECC Capital Incorrect valuation Increase of
$6M to $8M
General Electric Improper application of shortcut method Increase of $538M
Glenborough Realty Trust Improper documentation and recording of derivative fair value Increase of $4K
Hersha Hospitality Instrument not timely designated as hedge Decrease by $0.1M
Impac Mortgage Holdings Improper documentation Decrease by $85M
Interpool Improper documentation Increase of $0.1M
Kilroy Realty Requirements for hedge accounting not met Increase of $4.2M
Liberty Media Embedded derivative not separately accounted for Increase of $14M
MBIA Improper application of shortcut method Increase of $6.8M
MortgageIT Holdings Improper documentation Decrease by $0.1M
New York Mortgage Trust Not disclosed Increase of $0.1M
Northeast Utilities Requirements for hedge accounting not met Decrease by $46M
OM Group Improper documentation Increase of $0.1M
Petroleum Development Requirements for hedge accounting not met Decrease by $2M
Provident Bankshares Improper application of shortcut method Decrease by $0.7M
Pulaski Financial Improper application of shortcut method Decrease by $0.5M
Banking Corp. of Florida Requirements for hedge accounting not met Decrease by $0.2M
South Financial Group Improper application of shortcut method Decrease by $15M
SWS Group Incorrect valuation Increase of $3M
Taylor Capital Group Improper application of shortcut method Decrease by $1M
US Airways/America West Airlines Requirements for hedge accounting not met No impact
United Mobile Home Improper documentation Decrease by $0.3M
Western Gas Resources Instruments do not meet definition for derivative classification Decrease by $20M
* Companies listed are with market cap greater than $100 million. A total of 57 U.S. companies restated in 2005 due to hedge accounting.

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