FASB Eyes Hedge Accounting; Disclosing Tax Returns?

The Financial Accounting Standards Board has decided to tackle four separate hedge accounting issues, including proper use of “the shortcut method,” to provide new guidance targeted at helping companies comply with complex derivatives rules. The Board stopped short, however, of agreeing to amend hedge accounting rules to allow a risk-based approach to fair value and cash flow hedges of nonfinancial assets and liabilities.

Hedge accounting is governed primarily by Financial Accounting Statement No. 133 Accounting for Derivative Instruments and Hedging Activities, which in 1999 generally established that companies must report derivative instruments as assets or liabilities at fair value. It has been cited, however, as the cause of accounting problems in dozens of restatements in 2005 alone. Accounting experts agree it is among the most complex aspects of U.S. Generally Accepted Accounting Principles.

Derivatives are securities or contracts based on underlying assets, like stocks, bonds, commodities, currencies, interest rates and others. The value of the derivative is set to fluctuate in correlation with the underlying asset, to offset the risk of adverse changes in value. The goal is to minimize swings in asset values that create volatility in the balance sheet.

Under circumstances precisely outlined in Statement No. 133, companies can use a “shortcut” to assure a hedge qualifies for lower-maintenance hedge accounting treatment, but its improper use has tripped up numerous companies and led to restatements.

In addition to clarifications on the proper use of the shortcut method, FASB also plans to issue guidance on convertible debt with elements of foreign exchange risk, proceeds from a forecasted issuance of debt denominated in a foreign currency, and interest cash flows on variable-rate assets or liabilities.

“These are issues that have come to our attention as a result of technical inquiries and, in the case of the shortcut method, some restatements,” FASB project manager Mark Belcher says. The staff decided to put together a variety of hedge accounting issues and present them to the board as a package to avoid “piecemeal” guidance, he explains.

Belcher says the staff is still researching the issues to determine what it will recommend to the Board. The guidance likely will be issued as a series of staff positions, he says, although guidance regarding the shortcut method may be issued in a different form depending on what the staff recommends and the board decides.

The staff is targeting the second quarter to present definitive ideas to FASB. Says Belcher: “Our goal is that these will not be long, drawn-out projects.”

IRS Commissioner: Publish Parts Of Corporate Tax Returns

Mark Everson, commissioner of the Internal Revenue Service, recently urged policy-makers to consider making at least some portions of corporate tax returns public in the interest of improved compliance.

Everson

While there are valid reasons for keeping corporate tax returns private, “I believe this idea merits debate,” Everson said during an address last week to the National Press Club in Washington, D.C. As long as financial accounting standards differ from the tax rules, he said, “there will be a continuing tension between increasing book earnings in order to drive up share value, and lowering taxable earnings to minimize tax payments and maximize cash flow. If we are not willing to operate the two systems by the same set of rules, it makes sense to discuss whether corporate tax returns should be public.”

Everson also suggested that tax compliance, as well as with corporate and shareholder interests, might best be served if regulators set “generous but fixed compensation for specified contract periods” for certain officers in the executive suite, such as CFOs, general counsels and non-executive board chairs. “The potential incentives now associated with stock appreciation are staggering compared with traditional executive compensation,” he said. If boards were to move to the compensation model he suggests, “it would reinforce sound, conservative, fiduciary stewardship.”

Tax arbitrage, or the structuring of transactions to take advantage of incongruous national tax systems, is growing, Everson said, prompting the IRS to work more closely with its counterparts in other countries. “Tax administrations worldwide are increasingly challenged to keep up with the consortia of stateless accounting firms, law firms, investment and commercial banks, and other financial players who structure arrangements not just to park income in low tax jurisdictions but to avoid tax altogether,” he said. “All too often tax administrations don’t know what is on the other side of the transactions they are looking at.”