The Non-Designation of Derivatives as Hedges for Accounting Purposes

The FASB recently issued Proposed Statement of Financial Accounting Standards, Accounting for Hedging Activities: An Amendment of FASB Statement No. 133. The proposed standard simplifies the accounting for hedging activities and generally increases the appeal of hedge accounting. In this report we survey firms' reporting practices and examine hedges and hedge accounting generally and seek to determine why firms may decide not to designate derivatives as hedges for accounting purposes. In reviewing the reports of a large sample of firms, we find the following four explicit reasons why companies may decide not to designate derivatives as accounting hedges: (1) the substantial cost of documentation and ongoing monitoring of designated hedges; (2) the availability of natural hedges that can be highly effective; (3) a new accounting standard that broadens the applicability of natural or economic hedges; and (4) qualifying hedges are not available or are too costly or documentation is untimely, inadequate, or unavailable. In addition, a fifth reason, not offered as such by the surveyed firms, is the increased risk of restatement that accompanies hedge accounting. The proposed standard combined with the recently-released SFAS 159, The Fair Value Option for Financial Assets and Liabilities, offer companies a welcome relief to the onerous accounting and reporting requirements of SFAS 133