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The International Accounting Standards Board (IASB) has published for public comment an exposure draft on the accounting for hedging activities. The exposure draft proposes requirements that will enable companies to reflect their risk management activities better in their financial statements, and, in turn, help investors to understand the effect of those activities on future cash flows.

The proposed model is principle-based, and will more closely align hedge accounting with risk management activities undertaken by companies when hedging their financial and non-financial risk exposures. The proposals also include enhanced presentation and new disclosure requirements.

"These proposals sweep away the existing rule-based, complex and inflexible hedge accounting requirements and replace them with a simple, principle-based approach," says David Tweedie, Chairman of the IASB. "The result, if adopted, will be a much simpler model that better reflects risk management practices whilst providing more useful information to investors."

The exposure draft builds on proposals contained in the IASB’s discussion paper Reducing Complexity when Reporting Financial Instruments published in March 2008. The exposure draft forms part of the IASB’s project to replace IAS 39 Financial Instruments: Recognition and Measurement, and when its proposals are confirmed they will be incorporated into IFRS 9 Financial Instruments.

The changes regarding non-financial risks, which may make hedge accounting possible for some commodity components of operating exposures (such as the oil component of jet fuel purchases), will be of particular importance to entities outside the financial sector. Other changes that will make the use of purchased options as hedging instruments more attractive and broaden the scope of eligible hedging instruments and hedged items will be equally important to financial and non-financial institutions alike.

“The proposals in the ED alleviate some of the more operationally onerous requirements, such as the quantitative threshold and retrospective assessment for hedge effectiveness testing. An additional proposed simplification will allow entities to rebalance and continue certain existing hedging relationships that have fallen out of alignment instead of having to restart the hedge in a new relationship.  However, voluntarily stopping hedging relationships in certain circumstances would be prohibited,” says Enrique Tejerina, the deputy leader of KPMG’s global IFRS Financial Instruments practice and partner in the US firm.

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