Sandra Koch
In today’s changing global economy, corporate interest in hedging commodity price risk is escalating as commodity price volatility soars. However, the economic decision to hedge commodities and lock in or insure against unpalatable losses is frequently thwarted by the ability to qualify for special hedge accounting treatment under ASC815. Special hedge accounting aligns the timing of the derivative gain or loss with the recording of the hedged item in income. Without that timing benefit, economically effective hedge programs introduce and exacerbate the very earnings volatility that the derivative is executed to protect against. The difficulty for commodity hedgers is the requirement that the derivative provide offset for ALL of the commodity price changes. And the accounting world does not take the term “all” lightly. Frequently it takes significant effort for the corporate client to capture “all” the historical purchases/sales components reflecting the location, grade and other characteristics of the commodity. The company must access this historical data in order to establish the effectiveness of the hedging relationship. Research on the purchasing side generally starts in procurement, understanding how many locations the company receives goods, then how many suppliers are used and how the prices aredetermined under each supplier agreement.
The next hurdle is finding the derivative instrument that will best match the exposure you need to hedge. Is price based on spot, current-month-average or prior-month-average index pricing? You may need to consider a combination of derivatives to get the best price match as well (for instance, an indexed future contract with a location basis swap—if one is even available). While these hurdles are not insignificant, there are opportunities to qualify for hedge accounting when hedging commodity price is economically the right thing to do. The IASB has proposed absolute simplification of commodity hedging: we are crossing our fingers.
