Irish Author George Moore is quoted as saying, "Everybody sets out to do something, and everybody does something, but no one does what he sets out to do." This quote speaks to the conflicting messages being delivered by the FASB with the recent release of the exposure draft Proposed Accounting Standards Update Issued: May 26, 2010 File Reference No. 1810-100. Specifically, I am referring to the simultaneous elimination of the qualitative (shortcut/Critical Terms Match) assessment methods along with the quantitative assessment requirement under long-haul hedge accounting.
With the first change, the FASB is asserting that an entity can no longer qualitatively assume that a hedge is perfectively effective based on the terms of the trade and exposure. With the second, the opposite point is made, and the FASB states that a qualitative assessment of the terms of the trade is enough to assert that the relationship will be an effective hedge. Sounds a lot like assessment under shortcut right? After all, what can better pass a qualitative assessment than a perfectly matched derivative that would have previously qualified for shortcut?
While many will commend the FASB for mandating measurement in all circumstances, it seems odd to go the other direction by eliminating the highly effective criteria under the current quantitative assessment requirement. The FASB states that "eliminating the shortcut method and the critical terms match method would result in a more consistent model for assessing hedge effectiveness." While that may be true, the new “consistent model” is one in which an entity can determine, with a wide degree of freedom, what can and cannot qualify for hedge accounting. This is essentially like removing the speed limit on the highway, mandating governors in vehicles, but allowing them to be set between 20 and 200 miles per hour.
What is the alternative?
My view is that keeping the current quantitative assessment criteria, along with the removal of the shortcut and critical terms match methods (which are qualitative) would impose a standard under which all entities are assessing and measuring with a statistical test and adhering to the same set of acceptance criteria.
It seems that the reason for the relaxation is as follows: "The Board believes that the costs of compliance would be reduced because an entity would not have to develop sophisticated quantitative statistical models to prove a hedging relationship is effective in situations in which it is obvious that a hedging relationship is effective." What about in situations where it is not obvious? Who determines what makes an obviously good hedge? While I don't expect those questions to be answered, it seems we are back to the original quote:
"Everybody sets out to do something" - The Board set out to clarify hedge accounting in order to make application more consistent across entities and lead to more comparable financial statements.
"and everybody does something" - The Board removed shortcut, Critical Terms Match and basically removed the quantitative assessment requirements.
"but no one does what he sets out to do" - It seems that a similar, but more cautious effect would have been accomplished by simply requiring measurement on shortcut and Critical Terms Match while allowing a qualitative assessment on perfectly/critically matched hedges and keeping status quo in hedge relationships where a perfect qualitative relationship cannot be established.
I think we will start to see a great deal of confusion and, ultimately, divergence in reasonably effective classification, and this will certainly not lead to more consistent application of ASC-815 (FAS 133).