Accounting rulemakers tighten rules on derivatives

U.S. accounting rulemakers on Wednesday tightened existing rules on derivatives in an effort to help investors clearly identify when companies use them to raise money rather than simply hedge risks.

Typically corporations use derivatives to hedge against fluctuations in currencies and interest rates. Cash usually changes hands between the parties involved over the life of a contract, which could last anywhere from a few months to several years.

But companies can also construct fine-tuned derivatives such that they pocket funding early in the life of the contract and pay back later — essentially making the contracts a disguised method of raising cash.

Under the amended rules issued by the Financial Accounting Standards Board, companies that receive such upfront payments as part of a derivatives contract must now report that as a financing activity in the cash flow statement, a FASB spokeswoman said. In the past, such payments were typically recorded under cash flow from operating activities, she said.

The accounting board had hoped to use the amended rules, known as FAS 149, to harmonize accounting of derivatives and securitized financial instruments, said Rob Royall, a partner at Ernst & Young. Securitized instruments are usually bonds made up of underlying assets like car loans and mortgages and tend to have derivative components.

But analysts said the FASB's proposal for fusing those rules proved too cumbersome. Instead FASB is expected to take up outstanding questions on the accounting of securitized instruments separately in coming months.

Separately, FASB on Tuesday reappointed Gary Schieneman to another term on the accounting board and named Leslie Seidman, an accountant who formed her own firm a few years ago, as a board member. Seidman will complete the term of John Wulff, who recently said he would resign from the board to return to working in private industry.

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