Matthew Daniel of ABN AMRO offers some hints to organisations implementing the International Accounting Standard 39.
For many companies making the transition to International Accounting Standard (IAS) 39, Financial Instruments: Recognition and Measurement, the deadline of January 1, 2005 is coming all too quickly. There is much to be done: risk management systems to be changed, new procedures to be developed, risk management strategies to be evaluated, documentation to be completed, and methodologies for assessing and measuring hedge effectiveness to be designed.
It took many US companies more than a year to implement the US equivalent, Federal Accounting Standard (FAS) 133. If the experience of US corporations is representative, then many European companies are behind schedule with their implementations and will have a lot of catching up to do during the next seven months. If you are a corporate treasurer, chief financial officer or controller facing these challenges, here are some key recommendations to help your IAS 39 implementation run more smoothly.
Reality check
First, if you are still in denial or cannot believe that IAS 39 will happen, get real. This new accounting framework is going ahead and there will not be a last minute reprieve from the courts or regulatory agencies to block it. You will have a better chance of success if you embrace IAS 39 as your new friend. Get familiar with it, understand it, tell your friends about it, read about it on the train.
Comparisons with US
Get friendly with FAS 133, too. The new international accounting standards were designed to be convergent with US Generally Accepted Accounting Principles and auditors will be looking at guidance on issues from FAS 133 in interpreting how to apply IAS 39. So, if you do not know what the Derivatives Implementation Group is, you have some work to do: it was the task force set up to assist the FAS Board in providing guidance for companies. Also watch out for differences between IAS 39 and FAS 133 that will have a significant impact on how each standard is applied, and could be important in the design of hedging activities under IAS 39.
Documentation
Do not skimp on documentation. We recommend that you write a “long form” document that provides a background section on your exposures and how you hedge them. List what exposures are being hedged and the types of hedges used for each one. This should produce a list of hedging relationships that you can code by whatever means you choose.
For each hedging relationship describe the hedge objective, the methodology for assessing and measuring effectiveness, the risk being hedged and how the hedge will be specifically designated against an underlying exposure. Every time you make a trade, you can list the appropriate code on the ticket or in your risk management system, effectively tying the transaction to your accounting documentation. Write this document in simple language, avoid acronyms and assume the reader knows nothing about your company, hedging and derivatives, or about IAS 39. This will save many hours of aggravation later.
Seek guidance
Hire a consultant, talk to experts and go to seminars. If you have been to two IAS 39 seminars, go to a third. You can always learn something new or gain a new perspective. If you are going to hire a consultant, make sure you get someone with considerable experience of helping US companies with their FAS 133 implementations. If you are looking to your auditors for resources, check out their qualifications carefully and make sure you are getting their best team.
Accounting requirements
Meeting the requirements of IAS 39 means total involvement from many different areas of the organisation that may not be accustomed to dealing with accounting issues. Linking derivative transactions to specific transactions, tracking exposures ongoing, assessing hedge effectiveness and documenting that forecasted transactions are highly probable means that business managers will be more involved in the accounting process than ever before.
A major obstacle that US corporations faced when implementing FAS 133 was that they did not have the information they needed to support the accounting requirements. If this sounds like your company, addressing this problem should be a high priority.
Be wary of labels
Beware of any product, system or derivative that comes with the label “IAS 39 compliant”. Meeting the requirements of IAS 39 has nothing to do with buying a particular system or entering into a certain type of transaction. A system that has great functionality can be a big help but it will not make a risk management programme compliant.
A dose of scepticism
The most important recommendation is to view almost everything your auditor tells you with scepticism. While we would agree that your auditors are supposed to be the experts, remember that a typical auditor probably knows little about interest rate swaps or how your euro put-spread works.
Even when the local audit team reaches out to their team of IAS 39 experts for guidance, you can not always be assured that they will fully understand your issue and have the relevant experience to give you a good answer. And remember, the audit firms’ resources are going to be seriously stretched over the next year.
Get smart
Get smart and get educated. Become familiar with the basic principles of the accounting, read and understand the guidance provided. Understand the FAS 133 guidance and become acquainted with accepted practices of companies with similar issues and what the other audit firms are saying about a problem. Give your auditors your proposed accounting methodology that is well-researched, based firmly on the relevant guidance and consistent with the underlying accounting principles. This is a much better approach than asking your audit team: “How do we account for this?”
If your auditor tells you something that you think is silly, find out where that guidance came from – the local audit team, a local office expert, an on-call group, a national office partner? Was this a new issue that had to be addressed or have they seen this many times before?
If you think the situation warrants it, then push back. Your auditor should be glad to provide you with the relevant guidance that was the basis of their decision. If you are aware of differing practices between audit firms, they should find this interesting too and research it further.
Remember: this is hard and it is going to take time for everyone to get smart, including your auditor.
Matthew Daniel is director, FX analytics and risk advisory, Financial Markets Advisory, at ABN AMRO
Helpful hints checklist
1. Get real: IAS 39 is going ahead from January 1, 2005.
2. Familiarise yourself with the US equivalent, FAS 133, because auditors will be looking at guidance on issues from FAS 133 in interpreting how to apply IAS 39.
3. Do not skimp on documentation of your exposures and how you hedge them.
4. Hire a consultant, talk to experts and go to seminars – get as much help as you can.
5. Make sure you can access all the information needed to support the accounting requirements, no matter which part of the organisation holds it.
6. Be wary of products, systems or derivatives that come with the label “IAS 39 compliant”.
7. Check almost everything your auditor tells you. You can not always be sure they will fully understand your issue.
