IFRS hedge accounting: Long-awaited standard looks to common sense

28 Nov 2013

The International Accounting Standards board has published its final standard on hedge accounting, issuing a replacement of IAS 39 that it hopes will align hedge accounting with risk management more closely.

Applying the new standard should result in more 'decision-useful' information to users of financial statements and also establishes a more principles-based approach to hedge accounting, addressing a number of weaknesses in the prior model, IAS 39.

Put simply, the new accounting model should allow companies to better demonstrate their risk management activities in the financial statements. Investors and others had described the old ‘rules based’ IAS 39 provisions as too arbitrary, and the model had been broadly criticised as not permitting hedge accounting for some valid economic hedges. For example, IAS 39 did not allow hedge accounting to be applied to components of non-financial items, a major concern for those companies hedging non-financial risk.

Investors fed back to the IASB that they had been using non-audited information to better understand entities’ risk management practices and that the disclosure requirements in IFRS did not generally lead to "sufficient information" in the financial statements about an entity’s risk management activities.

IFRS 9 takes a common sense "principles based" approach. For example, it removes the previous 'bright line' requirement that a hedge has to be 80-125% effective in order to qualify for hedge accounting. And it looks at whether a risk component can be separately identified and reliably measured” rather than prohibiting certain risk components from qualifying for hedge accounting.

As well as removing restrictions on economically rational hedging strategies and relaxing the rules on the use of some hedging instruments, the new model also allows an entity to use "information produced internally for risk management purposes" as a basis for hedge accounting.

Hans Hoogervorst, Chairman of the IASB called the reforms "long-awaited" and "a significant change in accounting" that “has received strong support from corporates around the world”.

The European Union, however, has yet to endorse any aspect of IFRS 9 (Financial Instruments) of which its new hedge accounting standard is a component. This means that EU entities are not yet able to adopt it. Sandra Thompson, an expert in financial instruments and Partner at PwC said that “the new IFRS standard will enable companies to better reflect economically valid hedging strategies in their financial statements. A number of entities outside of the EU are already considering early adoption with EU entities likely to follow as soon as the standard is endorsed”.