The Financial Accounting Standards Board (FASB) is expected to propose changes that would address some of the differences between companies’ risk management strategies and the hedge accounting model.

According to PwC, closer alignment of the hedge accounting model to companies’ derivative risk management activities “would result in financial statements that better reflect the economics of these activities”. In a recent report titled Hedge accounting: The case for change, the accounting firm adds: “In addition, enhancements to existing rules regarding presentation could provide better transparency and more decision-useful information to stakeholders.”

The report explains that some of the shortcomings of the current system include:

• hedge accounting for just a component of an overall risk is permitted only in certain circumstances. This means that “The inability to hedge components more broadly may drive differences between how companies manage risk internally and how the current accounting model allows them to report it in the financial statements.”
• some economic hedging relationships that do not qualify for hedge accounting at all, or qualify with some ineffectiveness recognized in earnings.
• from a financial reporting perspective, ineffective portions of the derivative may be recognized in different periods than those impacted by the hedged risk.
• companies are not required to present the derivative and the hedged item in the same income statement line item, which may limit transparency for financial statement users.
• some companies choose not to apply hedge accounting because of the administrative burden.

The report sets out the possible future state of hedge accounting, which, according to the FASB's proposal, should “better align the recognition and presentation of hedge accounting with a company’s risk management objectives”.

This would improve the transparency of hedging in the following two ways:

• recognizing the full change in fair value of the hedging derivative when the hedged item impacts earnings (there would be no periodic ineffectiveness separately recorded in different periods); and
• presenting the hedged item and hedging instrument in the same income statement line item.

The FASB's proposal, which would apply to hedge accounting guidance for financial and non-financial assets and liabilities, allowing more derivative hedging relationships to qualify for hedge accounting, is due in the second quarter of 2016.