FAS 133: What Is Accounting Truth?

FAS 133, the rule that governs accounting for derivatives, has been controversial since its inception. Besides being expensive to implement and maintain, the rules often cause accounting treatment to diverge markedly from economic reality, making financial statements less transparent and less useful. For example, by marking to market only one side of what are in fact two‐sided (hedged) positions, FAS 133 often introduces artificial volatility into earnings and, in so doing, discourages companies from hedging. How should companies tackle financial disclosure and balance the economic and accounting effects of hedging? This article recommends that companies make economically sensible hedging decisions and then present two sets of earnings numbers to the investment community: (1) the first prepared and audited in strict accordance with GAAP; and (2) a supplemental calculation showing what earnings would have been had the firm qualified for hedge accounting treatment. This kind of supplemental disclosure should be viewed by companies as an opportunity to explain to their investors, creditors, and counterparties how they conceptualize, measure, and manage risk.