Using and accounting for derivatives: An international concern

Abstract

Global markets have changed dramatically with increases in importing, exporting, and foreign investment activity. Use of derivatives has also increased in order to help firms hedge the foreign currency exposure risk associated with this increase in international activity. The growing use of derivatives has resulted in concerns from the international community over the current accounting practices for these instruments. The Financial Accounting Standards Board (FASB), with input from the International Accounting Standards Committee (IASC) and accounting standards-setting bodies from various countries, has recently issued a proposed approach to account for all derivative financial instruments. This method is relatively simple while still accommodating many of management's hedging strategies. This proposed method increases visibility, comparability, and understandability of the risks associated with derivatives by requiring that all derivatives be measured at fair value and reported as assets or liabilities on the balance sheet. It reduces the inconsistency, incompleteness, and complexity of current accounting practices by providing comprehensive guidance for all derivatives. This paper defines the basic derivatives and how management may use them in their overall risk management. The proposed method of recognition and measurement of derivatives on the financial statements is then illustrated followed by a discussion of how this approach addresses the concerns of current accounting.