By: Joe Di Rollo, CEO and Founder, ALMIS International
Interest rate swaps and other derivatives can no longer be treated as off-balance sheet, and now appear on financial statements at their fair value. This value can change quite dramatically, even in relation to relatively small changes in interest rates thus creating significant profit and loss volatility that would be difficult to explain. Hedge accounting is designed to demonstrate in accounting terms that as the derivative is a hedge, this volatility should be offset in fair value terms by equal and opposite movements to the underlying hedged asset (for example, a fixed rate loan).
The accounting standard setters first only allowed a micro approach, where the effectiveness of each hedge had to be tested and accounted for individually. Since this was an administrative headache for firms who take out many derivatives to hedge a portfolio of loans, the standard setters were persuaded at the last minute to publish an amendment which allows a portfolio approach to hedge accounting. The standard (IAS 39) covering portfolio hedge accounting has not been changed since it was first published in 2004.
ALMIS International specialises in hedge accounting for building societies. This article highlights the challenges faced by firms in practice and the accountancy profession as a whole.
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