The Hindu Business Line : The metamorphosis of Standards

It would be a practical idea for entities to disclose the net effect of their hedging transactions during the quarterly report in order that investors, shareholders and the public would at least be aware if there is a storm ahead.

Mohan R. Lavi

There is a saying, “Old accountants never die, they just get out of balance.” One could probably tweak that a bit and say: “Old accounting standards never die, they are changed with the changing times.”

Statement No. 161

A series of proposed and pronounced announcements from the Financial Accounting Standards Board (FASB) in the US reflect the gargantuan task at hand to get to a single set of global accounting standards. Against the run of play, the FASB recently issued Statement No. 161 — Disclosures about Derivative Instruments and Hedging Activities.

The Statement requires that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. This disclosure better conveys the purpose of derivative use in terms of the risks that the entity is intending to manage.

Disclosing the fair values of derivative instruments and their gains and losses in a tabular format should provide a more complete picture of the location in an entity’s financial statements of both the derivative positions existing at the period end and the effect of using derivatives during the reporting period.

Disclosing information about credit-risk-related contingent features should provide information on the potential effect on an entity’s liquidity from using derivatives. Finally, this Statement requires cross-referencing within the footnotes, which should help users of financial statements locate important information about derivative instruments.

The Statement clarifies that although IFRS-7 on disclosures in financial statements does state elaborate disclosure norms for all types of financial instruments, Statement No. 161 has been specifically drafted for derivative transactions considering their significance at the present point in time.

AS 32 issued by the Institute of Chartered Accountants of India (ICAI) recently also prescribes elaborate disclosures of all financial instruments, including their significance and nature and extent of exposure to risks. Hedging transactions are quantitative finance and it would be well-nigh impossible for the shareholder to comprehend binomial models, random behaviour of assets, barrier options, Black-Scholes formula, credit risk and value at risk.

At the same time, getting to know about these transactions after the horse has fled — annual results — would hardly help the ordinary shareholder. It would probably be a practical idea for entities to disclose the net effect of their hedging transactions during the quarterly report in order that investors, shareholders and the ordinary public would at least be aware if there is a storm ahead.

This Statement No 159 talks about the fair value option for all financial assets and liabilities. Some exceptions apart, it encourages embracing fair value for all recognised financial assets and financial liabilities

Off-balance-sheet vehicles

For years, accounting standards have allowed US banks to keep certain loans, such as those linked to subprime mortgages, in off-balance-sheet vehicles (OBSVs). Enron specialised in creating OBSVs at will and putting assets they didn’t need into them and withdrawing them when needed. It is surprising that the FASB and the SEC have kept mum till now about issuing a standard on this.

But now FASB is revamping FAS 140 — Accounting for Transfers and Servicing of Financial Assets — as it believes that the rule hid the true risks banks faced. Although this move has met with a whale of protest from the industry stating that the present gory times are hardly conducive to issue such radical standards, it does remain a fact that we are only postponing the inevitable.

(The author is a Hyderabad-based chartered accountant.)

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