Journal of Applied Research in Accounting and Finance

Vol 3 (2) December 2008


The Non-Designation of Derivatives as Hedges for Accounting Purposes by Eugene E. Comiskey and Charles W. Mulford

The FASB recently issued Proposed Statement of Financial Accounting Standards, Accounting for Hedging Activities: An Amendment of FASB Statement No. 133. The proposed standard simplifies the accounting for hedging activities and generally increases the appeal of hedge accounting. In this report we survey firms' reporting practices and examine hedges and hedge accounting generally and seek to determine why firms may decide not to designate derivatives as hedges for accounting purposes. In reviewing the reports of a large sample of firms, we find the following four explicit reasons why companies may decide not to designate derivatives as accounting hedges: (1) the substantial cost of documentation and ongoing monitoring of designated hedges; (2) the availability of natural hedges that can be highly effective; (3) a new accounting standard that broadens the applicability of natural or economic hedges; and (4) qualifying hedges are not available or are too costly or documentation is untimely, inadequate, or unavailable. In addition, a fifth reason, not offered as such by the surveyed firms, is the increased risk of restatement that accompanies hedge accounting. The proposed standard combined with the recently-released SFAS 159, The Fair Value Option for Financial Assets and Liabilities, offer companies a welcome relief to the onerous accounting and reporting requirements of SFAS 133.

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The Impact of Mandatory Conversion to IFRS on the Net Income of FTSEurofirst 80 Firms by Vincent O'Connell and Katie Sullivan

Since the start of 2005 all European Union (EU) firms trading in a regulated market are required to adopt International Financial Reporting Standards (IFRS) for their consolidated financial accounts. Many more countries will - soon or later - follow suit and adopt IFRS for all listed firms. Nonetheless, the process of conversion from domestic standards to IFRS can often cause confusion for both preparers and user groups. This study investigates the impact of the mandatory conversion to IFRS on the Net Income of some of the largest firms in the EU - specifically, the constituents of the FTSEurofirst 80 index. The sample for the present work comprises those 37 constituents of the FTSEurofirst 80 index which: (i) are first time adopters of IFRS and (ii) had, at the sample selection date, voluntarily revealed their 2004 annual Net Income figures under both national standards and IFRS. Our results show that the conversion to IFRS leads to a statistically significant increase in 2004 Net Income and for nearly 75% of sample firms we find that the increase is material at the 5% level. Additional analysis reveals that IFRS 3 (Business Combinations) dwarfs all other international standards in terms of driving the observed differences between reported Net Income under domestic GAAP and IFRS for our sample firms.

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Compensation Structure and Portfolio Selection in a Banking Firm by Guy Ford

This paper examines how the structural form of a bank's compensation payment function may impact on incentive-compatibility conditions between the centre of the bank (principal) and managers in the bank (agents). If this payment function is asymmetrical, with bonuses paid only upon the realisation of gains, then the ranking of prospective investment portfolios by managers will be influenced by both the distribution of gains in the numerator and the distribution of losses in the denominator of the risk-adjusted performance measure (RAMP). If the distribution of gains is uneven, then it may not be possible to determine which portfolios managers will select without specific knowledge of their utility functions. If the centre is charged with managing both risk and return, as opposed to only managing downside risk, then the RAMP upon which managers are renumerated should incorporate the preferences of the centre with respect to right tail of the distribution of returns in the investment portfolios available to the bank. A reward to risk ratio, where the numenator measures upper partial moments in the distribution of returns, allows portfolios to be ranked in accordance with the attitude of the centre towards variability in upside returns.

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