Proposed Accounting for Derivatives: Does it Address the Concerns of Current Accounting?

Abstract Changes in global financial markets and related financial innovations have led to the development and use of new derivative financial instruments to manage or hedge risk exposure. Many believe that accounting standards have not kept pace with those changes. At the urging of the Securities and Exchange Commission, among others, to improve financial information about derivatives and related activities, the Financial Accounting Standards Board has issued an exposure draft proposing the accounting and reporting standards for derivative financial instruments and for hedging activities. The exposure draft attempts to address several of the problems with current accounting by standardizing the accounting for derivatives and similar financial instruments. This paper illustrates the proposed accounting and evaluates the extent to which this new approach successfully addresses existing problems of accounting for derivatives. The proposed method would increase visibility, comparability and understandability of the risks associated with derivatives by requiring all of them to be measured at fair values and reported as assets and liabilities. The proposed comprehensive guidance for all derivatives and hedging activities would reduce the inconsistency, incompleteness and complexity of current guidance. Although improving financial information about derivatives, the proposed accounting is not without limitations and does create new concerns.