Hedge Accounting in accordance with IAS 39:

Driving force or impediment to economically meaningful risk management?

Results of a PricewaterhouseCoopers study in collaboration with the Justus-Liebig-University at Giessen

The regulations governing the accounting of economic securing measures – so-called hedge accounting – are some of the most contested provisions of the International Financial Reporting Standards (IFRS). Practice-relevant literature repeatedly brands them as lacking practical relevance and as being overrated. It is feared that the securing strategies used by companies, cannot be illustrated by the provisions of IAS 39. However, in the absence of hedge accounting, the securing of financial risks with the aid of derivative finance instruments normally leads to high volatility of the accounting results.

This conflict is the starting point of the PwC study “Hedging of Financial Risks and Hedge Accounting in accordance with IAS 39,” which investigates the securing strategy of companies, particularly against the background of accounting disclosure. The object of the investigation consists of the replies of 117 stock exchange listed industrial and trading companies in Germany and Switzerland which were interviewed regarding their hedging activities.

Priority given to the Currency Risk

Of the three financial risks examined - currency, interest and commodity price risks - the currency risk assumes on average the greatest importance for the interviewed companies. 62% of companies attribute to this risk considerable or extreme importance. Interest risks are considered on average to be the second most important financial risks to which companies are exposed and commodity price fluctuation is considered the risk of least importance, but the assessment also showed that these results are dependent on the type of companies’ activities.

The majority of interviewed companies (91.5%) use derivative finance instruments in order to control risk. In currency and interest management particularly, the use of derivatives is wide-spread. The primary objects aimed at by hedging are the reduction of the volatility of accounting results and cash volatility respectively. In the majority of companies, the financial risk management discloses a high degree of centralisation, i.e. decision making, as well as subsequent hedging frequently taking place by involving the Group Head-Office. The majority of companies make use of table calculation programmes for this purpose, and only about every third company uses fully integrated systems with automated interfaces to the accounts.

Hedge Accounting is frequently too expensive

Barely two thirds of all interviewed companies apply hedge accounting in accordance with IAS 39 to disclose their financial-economic hedging activities. However, clear differences can be observed in relation to company size. Whilst almost all large corporations (94.7%) apply hedge accounting to some of their securing activities, this proportion is reduced to just over one third (34.2%) in the case of smaller companies. The most important influencing factors for the decision, concerning the use of hedge accounting, are the expected effectiveness of the securing methods, as well as the volatility of results which would be anticipated without the use of hedge accounting.

A critical point, in addition to the lack of practicability, which was frequently mentioned, was the administrative expenditure incurred by application of IAS 39, which is considered excessive particularly by non-users in relation to the benefit derived from it. In addition, most companies are of the opinion that the present regulations governing hedge accounting do not adequately illustrate their securing effect. Furthermore, more than half the interviewed companies state that the accounting of securing measures partly exerts influence on their hedging conduct. This view is particularly wide-spread among smaller companies.

In conclusion, and overall it seems that the present regulations of hedge accounting are felt in actual practice to be an impediment rather than a driving force of an economically meaningful financial risk management. However, there are noticeable differences - dependent on company size – as regards the practical implementation of hedge accounting and the effect of the regulations on the economic securing conduct.