Top Ten Reasons To Hate Derivatives Accounting

1) They impose stringent new investments in staff and systems and a significantly large extra work burden

2) They can cause artificial income statement volatility

3) They can cause artificial balance sheet (equity) volatility

4) They can lead to the dismissal of high-quality, value-adding employees

5) They can entrap companies into simple, potentially economically inferior, plain-vanilla hedges

6) They can discourage companies from entering into sophisticated, potentially economically superior, exotic hedges

7) They can annihilate hedges that had been delivering sensational economic results

8) They can lead to destabilizing earnings restatements

9) They expose companies to new truly ridiculous risks that did not exist before and that have nothing to do with how the entity makes a living

10) No one seems to know how they really work

This list clearly conveys a central message concerning derivatives accounting standards: they are an entirely counterproductive exercise because they do not necessarily do any good while creating lots of trouble. It is doubtful at best that FAS133-IAS39 enhance corporate risk management practices and disclosure and transparency are certainly not enhanced at all. The many negative consequences of the standards definitely outweigh any possible positive.

Should companies stop using derivatives in light of such hostile accounting? Not really. Corporates must forget about accounting effects and focus on economic effects. FAS133-IAS39 offer bad news all around and there really is no scaping some type of malaise so you might as well hedge in the best economically possible way, take the earnings volatility, and clearly explain to outside parties the artificial character of any derivatives-induced suprises. Treasurers and CFOs should choose to be free to enter into hedges that make the most economic sense and have the bravery to face any accounting nastiness with their boots on.

ptriana@profesor.ie.edu