Ernst & Young today announces its support for the International Accounting Standards Board’s (IASB) proposals on hedge accounting that will substantially simplify the current requirements under International Financial Reporting Standards (IFRS). The proposals, set out in the Board’s exposure draft released today, are designed to provide a better link between an entity’s risk management strategy, the rationale for hedging and the impact of hedging on the financial statements.
Tony Clifford, Ernst & Young’s Global IFRS Financial Instruments Leader says, “We welcome the IASB’s efforts to reduce complexity in hedge accounting and to provide a principles-based approach that can be consistently applied for both financial services entities and other entities. The proposals represent a fundamental shift from the way entities applied hedge accounting in the past. Financial reporting can now reflect more accurately how an entity manages its risk and the extent to which hedging practices mitigate those risks. The proposal is intended to address difficulties with the current hedge accounting under IFRS – arbitrary limits, complex rules and onerous hedge effectiveness testing, to name a few.”
Impact on non-financial services entities
Clifford adds, “Although the proposals are part of the financial instruments project, the most significant benefit will be for non-financial services entities. Hedge accounting will now be permitted for components of non-financial items (such as certain commodities), provided the entity can separately identify and measure the risk component (for example, commodity price risk) that is being hedged.
Impact on banks and other financial institutions
Tony Clifford says, “Although so called ‘macro hedging’ has not yet been addressed, which will be necessary to try to remove the European Union’s ‘carve out’ of sections of the current rules, banks and other financial institutions also stand to gain from the new proposals. Hedge effectiveness testing will be much simpler and will only be required on a prospective basis – previously, it was necessary to perform retrospective and prospective tests. Qualitative testing will be possible where appropriate and there will be no arbitrary bright lines in the new model.”
As well as reducing complexity, the proposed hedge accounting model will place a greater onus on entities to manage their hedge relationships in line with their risk management approach. It is important that all entities assess the impact of proposals and provide feedback to the IASB.
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