Arlette C. Wilson

Using and accounting for derivatives: An international concern

Abstract Global markets have changed dramatically with increases in importing, exporting, and foreign investment activity. Use of derivatives has also increased in order to help firms hedge the foreign currency exposure risk associated with this increase in international activity. The growing use of derivatives has resulted in concerns from the international community over the current accounting practices for these instruments. The Financial Accounting Standards Board (FASB), with input from the International Accounting Standards Committee (IASC) and accounting standards-setting bodies from various countries, has recently issued a proposed approach to account for all derivative financial instruments. This method is relatively simple while still accommodating many of managements hedging strategies. This proposed method increases visibility, comparability, and understandability of the risks associated with derivatives by requiring that all derivatives be measured at fair value and reported as assets or liabilities on the balance sheet. It reduces the inconsistency, incompleteness, and complexity of current accounting practices by providing comprehensive guidance for all derivatives. This paper defines the basic derivatives and how management may use them in their overall risk management. The proposed method of recognition and measurement of derivatives on the financial statements is then illustrated followed by a discussion of how this approach addresses the concerns of current accounting.

Enron’s hedging scheme: what went wrong?

The authors look at the way in which Enron used hedging techniques before the corporate collapse of the organization triggered a crisis of confidence in US business practices and standards. They provide an analysis of how the system was structured and show how the transactions worked before analysing the roots of the company’s downfall.

Regression as an Analytical Procedure: Are Adjustments for Autocorrelation Really Necessary?

Auditors who use regression analysis when performing analytical procedures may be exposed to the problem of autocorrelation, especially if small-interval time-series data are used. The existence of autocorrelation may bias the standard error of the estimate, which is used in calculating the upper precision limit. This limit determines the acceptance or rejection of an account balance as not materially misstated. Using real-world data and the STAR decision rule, the results of this study suggest that transforming autocorrelated models increases effectiveness (capability of detecting material errors) only slightly, if at all. The results, however, did indicate that efficiency may increase significantly (reduced Type I errors), and that the more severe the autocorrelation, the more likely that efficiency will increase. Therefore, auditors have the most to gain in terms of audit-time savings when models are more severely affected by autocorrelation since fewer incorrect rejections requiring unnecessary additional audit attention would occur with successful transformation.

Accounting for hedges: foreign currency exposures

Accounting for foreign currency hedges has become a fiercely complicated procedure. At a time when financial institutions are having to alter disclosure methods, the authors provide a practical guide to dealing with each type of hedging procedure.

Use of Regression Models as Analytical Procedures: An Empirical Investigation of Effect of Data Dispersion on Auditor Decisions

The newly issued Statement on Auditing Standards No. 56—Analytical Procedures [AICPA 1988] has placed greater emphasis on analytical procedures by requiring their use in the audit of financial statements. Regression analysis may be used as an analytical procedure and has been shown through research to be an effective audit tool. The purpose of this paper is to empirically investigate whether different levels of dispersion of the data around the regression line affects auditor decisions when using regression models as analytical procedures. Monthly data from 15 companies in various industries used in analytical reviews by a CPA firm were used to determine the effect of data base dispersion on auditors decisions. The decision model used in this study is the statistical technique for analytical review (STAR) approach used in the audit practice of Deloitte, Haskin, & Sells. This study reveals data bases with larger dispersions are more likely to have incorrect rejections than those data bases with smaller dispersions (an incorrect rejection is the signaling of a month for investigation when no error exists in that month). This study also develops a rule of thumb model for the auditor as follows: then dispersion may be too large, and results should be carefully interpreted. Regression analysis has proven to be a useful technique for auditors in the analytical review phase of the audit; however, care should be exercised to identify individual data sets which may not be suitable for application of this type of model.

DOES ALLOWING ALTERNATIVE HEDGE DESIGNATIONS AFFECT FINANCIAL STATEMENT COMPARABILITY

The comparability of hedge accounting disclosures between companies increases the informational value of financial statements. In order to eliminate inconsistency in the reporting of hedging activities, the FASB issued SFAS No. 133, which was intended to provide comprehensive guidance for all derivatives reporting and disclosure. The fact that SFAS No. 133 allows some hedging transactions to be designated as either a fair value hedge or a cash flow hedge might suggest a lack of comparability for similar transactions. This paper identified several of these transactions and provides the comparative accounting. Even though fair value and cash flow hedges are accounted for differently, there was little difference in their net effect on reported earnings while other comprehensive income did fluctuate somewhat for cash flow hedges.

New accounting guidance for variable interest entities: will the new rules reduce the risk?

Special purpose entities, generally known as SPEs, have been the bane of everyone in the risk management and the asset management business. But they can also be extremely useful. Now, post‐Enron, further rules have been put into place to ensure that SPEs are clearly identifiable and their purpose can be transparent. The author examines how these new rules will work and assesses the likelihood of success.