Accounting Observer > Public Blog - Is It That Time Of Year Again?

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Is It That Time Of Year Again?

Location: Blogs AAO Weblog (Public)
Posted by: Jack Ciesielski	11/21/2005 9:19 AM
No, not the holidays... It was just about this time last year that the "Great Lease Restatement" was kindled, instead of the fireplace. A year ago this Wednesday, CKE Restaurants filed its 8-K indicating there were problems with its lease accounting, the first one of any note. Gradually, more and more firms started restating; mostly KPMG clients like CKE Restaurants, then other firms. (Note: KPMG is a subscriber to The Analyst's Accounting Observer.) Eventually, the letter that launched a hundred restatements was issued by the chief accountant of the SEC. Back to the question: is it that time of year again? Maybe; in the last month, there's been a brace of restatements having to do with failed hedge accounting using derivatives. Last Thursday, Pride International filed a non-reliance 8-K indicating that had incorrectly accounted for swaps and caps as an integral part of certain loans rather than as discrete derivatives. Proper accounting would have marked the instruments to market, with changes in fair value going through other income. (Their auditor was PricewaterhouseCoopers.) In late October, Kilroy Realty also indicated that their hedge accounting needed to be revised: their documentation of hedge accounting was insufficient to allow hedge accounting treatment, but the 8-K offered few details on what was lacking. Their auditor was Deloitte & Touche. Also in the last couple weeks, three regional financial institutions reported on non-reliance 8-K filings that their use of the "short-cut method" of testing hedge effectiveness was incorrect. The institutions: Pulaski Financial, Provident Bankshares, and Taylor Capital Corporation. Going back into late October, South Financial Group filed a non-reliance 8-K for the same reasons. All four of these institutions share KPMG as their auditor. Time out for a very quick background on the accounting issue here. When firms use derivatives to hedge a risk - say, the fair value of a brokered CD or an interest rate swap - they have to designate (by documentation) that such a hedge has been created and they must continually monitor the effectiveness of the hedge. "Effectiveness" means that the relationship that was set up between the hedged item and the hedging derivative instrument is still working at later reporting periods. If the effectiveness no longer exists, the hedge accounting is discontinued and any gains or losses on the hedge accounting are reported in period's earnings where the hedge accounting failed. This is a lot of follow-up and documentation that firms would prefer not to do; for obvious reasons, such testing of the relationship is called "long-haul" testing. There is an alternative built into Statement 133 called a short-cut test for effectiveness. At its core, it assumes that a cash flow hedge or fair value hedge is effective if it meets the (many) criteria listed in paragraph 68 of the standard. Meet those criteria, and no long-haul effectiveness testing needs to be done. Effectiveness is presumed. This is where the four institutions had their problems: their didn't actually qualify for the shortcut treatments. They'll all go back and restate earnings with the changes in fair value of the derivatives flowing through earnings. Two of the firms - Provident and South Financial -said that going forward, they'll re-designate the derivatives as hedges and use "long-haul" testing to monitor effectiveness and regain hedge accounting treatment. There's certainly a sense of deja vu here, what with the time of year and the KPMG presence. It's way, way too early to expect a restatement trend for termination of "short-cut" derivatives accounting. For now, consider it a coincidence.

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