The last presentation at FFSC was done by Todd Doehring of Centrec and myself on the proposed guidelines for hedge accounting.
For tax purposes, a valid hedge is usually accounted for on a strictly realized basis, i.e., the futures or options on futures is not recognized in income until the hedge is closed out. For example, if a corn farmer shorts March 2014 corn on December 1, 2013 at $6 and the price closes at $6.50 on December 31, 2013, the farmer has an unrealized loss of 50 cents which is not recognzied for tax purposes. If the farmer closes the short on February 15 at $5.50, this 50 cent gain is recognized on that date.
For accounting purposes, there are two types of hedges:
- Fair Value Hedge - This is a hedge of inventory owned by the farmer. For a corn and bean farmer, any crop that has been harvested and placed into storage would qualify for a fair value hedge.
- Cash Flow Hedge - For farmers, this is a hedge of growing crops or raised livestock. It would also cover feed to be purchased to be fed to livestock.
The accounting treatment for each of these hedges are basically the same. On a daily basis (or whenever the farmer issues a financial statement), the hedge is marked-to-market and any resulting gain or loss is recognized. The difference is where it is placed on the income statement.
For all fair value hedges, the gain or loss flows directly into the income statement. For cash flow hedges, these gains or losses are reported as part of "other comprehensive income". This statement primarily reflects changes in valuation equity.
However, the Council has also proposed an alternative method which allows all hedges to simply run through the income statement.
The key difference between Tax and GAAP is that GAAP requires a mark-to-market valuation on all hedges while the tax laws allow you to wait until you close out the transaction to report the gain or loss.
The Council has spent many years on getting these guidelines finalized and the hedge accounting guidelines should be issued in 2014.