Can FASB Fix Complex Commodities Accounting Rules? Not Without IFRS, CPA Group Says

Accountants who believe that the FASB may end up aligning U.S. GAAP with international financial reporting standards on commodities, recently said that such a move would make the sense.

Today’s rules are overly complex, unmanageable, expensive to implement and do not align with how businesses manage risk, Allison Henry, VP of Professional and Technical standards at the Pennsylvania Institute of Certified Professional Accountants (PICPA), said. “The international standards are more aligned and have a clear objective of alignment with a company’s risk management activities and I do think they align more closely and I do think that convergence with IFRS makes sense,” she said on July 19, 2023, on behalf of the group.

Hedge accounting under IFRS 9, Financial Instruments is broad with a clear objective for tackling commodities, Henry said. “They’re saying that the objective of hedge accounting is to represent in the financial statements, the effect of the entity’s risk management activities,” she said. On the contrary, U.S. GAAP does not allow the same flexibility which, for example, Southwest Airlines Co.’s recent 10-K signals.

“If you look in their financial derivative instrument footnote, you can see what they’re saying; what they do is they cannot find jet fuel contracts, derivative contracts to perfectly align with the jet fuel that they’re trying to manage,” said Henry. “And so what they do is they hedge using a variety of different derivatives, using things like West Texas intermediate crude oil, Brent crude oil, heating oil, unleaded gas, and so they’re using a potpourri of different derivatives contracts to manage the risk of the jet fuel,” she said. “And in many cases they can’t qualify for the hedge accounting treatment, because it’s not perfectly aligned with jet fuel derivatives, there’s just not a market there and so they have what they’re referring to in that footnote as an economic hedge, meaning their business risk is being managed, but they’re not qualified for the accounting standards and so they end up with volatility in their financial statement because they don’t meet the hedge accounting requirements and that is technical the request the FASB got to address.”

Board Has a Research Project on Accounting for Commodities

The FASB has a project on accounting for commodities on its research agenda, but has not yet voted on whether or not the topic meets the cut for its technical agenda where rules are set.

The issue came to the board from the International Swaps and Derivatives Association’s (ISDA) Accounting Committee, which two years ago asked that the scope of Topic 825, Financial Instruments be expanded to include physical commodity inventories and executory contracts for physical commodities such as storage, transportation, non-derivative purchase or sale contracts.

The ISDA in a letter stressed that current accounting rules for measuring physical commodity inventories and related executory contracts cause companies’ earnings to appear volatile and at variance with their economic position. (See Accounting Rules for Physical Commodities Causing Earnings Volatility, Industry Group Says in the June 16, 2021, edition of Accounting & Compliance Alert.)

A Colossal Challenge

The topic is complex and has been so for years – stemming from FASB Statement (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, which was issued in 1998 using a rules-based approach.

Companies that had to implement the standard found it nightmarish and costly, some holding two-day and three-day programs to train staff just to get an understanding of the standard. Ultimately, the FASB received so many questions that the board issued derivatives implementation guidance – affectionately called “the dig” by accountants who felt that the board kept digging itself deeper into a rules-based approach with hundreds of pages of nuance upon nuance around various facts and circumstances.

“It was a colossal challenge,” Henry explained. “The hedge accounting requirements are so rigorous, not only do you have to meet certain requirements but the specific documentation requirements are extensive, and when they originally pushed it out they had to defer it for a year because there were so many questions,” she said. “Then we had this huge rash of restatements and you think you have the best and brightest from all these international firms working on these companies and then there were all these massive restatements, you just have to step back and say ‘something’s not right.’”

Compounding the issue was the SEC’s decision that companies were not meeting the hedge documentation requirements, were not eligible for hedge accounting, and therefore had to restate their financial reports. Subsequently, the FASB kept making changes to the guidance – in 2017 and then in 2020 to fix the questions resulting from the 2017 changes.

“Now you see it’s coming back again,” Henry observed. “On the other side of the pond you have IFRS and it’s really interesting that they have such a different perspective on their standards.”