Why CFOs Still Don’t Like Hedge Accounting

FASB's effort to make hedge accounting more palatable may not address the real reasons finance chiefs don't like it, including documentation headaches and the risk of restatements.

The study found that the “most explicit” and most frequent reason for not designating a derivative a hedge is the burden of documentation and ongoing monitoring of the hedge effectiveness, which was cited by a diverse set of companies, including ConocoPhillips, General Mills, Federal Home Loan Bank of New York, and Sara Lee. For companies like Aspen Technology, Netezza, and Residential Capital, natural hedges provided enough protection and there was little incentive to rack up the extra costs associated with designating the derivatives as hedges. Natural hedges result from situations in which companies have symmetrically opposite positions, such as accounts payable and receivables in euros.

The application of FAS 159, The Fair Value Option for Financial Assets and Liabilities, also contributes to the lack of hedge accounting. ConocoPhillips clearly stated that FAS 159 allows the company to use fair-value accounting without complying with “complex” accounting rules — a reference to hedge accounting, say the authors. Further, Wells Fargo pointed to two cases — mortgage-servicing rights and mortgages held for sale — in which economic hedges replaced fair value and cash-flow hedges, respectively. The term economic hedge is often used to describe a situation in which a derivative shields the company from the volatility in the price of the targeted commodities.

In addition, the study points out that companies including Federal Home Bank of New York, General Finance, and GeoEye said that qualifying hedges were not available, were too costly, or documentation was untimely, inadequate, or unavailable. For example, in its financial results dated December 31, 2007, GeoEye noted that adequate documentation did not exist at the inception of interest-rate swap agreements the company held.

The unspoken reason for shying away from FAS 133, according to the study, is the risk of restatements linked to hedge accounting, particularly related to the documentation and monitoring of the hedge effectiveness. The restatements, both intentional and unintentional, relate to the so-called short-cut method, which requires little or no documentation or ongoing monitoring of accounting hedges. This method allows companies to presume “perfect hedge effectiveness” if several FAS 133 criteria are met. Failure to meet the criteria results in restatements, as was the case with several financial-services companies, including AIG, Bank of America, Fannie Mae, Freddie Mac, Ford Motor Credit, and GE Capital, reports the study.

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