Risk Management

Hedge Accounting Snags Teekay

The shipping company will restate after some derivatives fail the "hedge" test.
Stephen TaubAugust 7, 2008

Teekay Corp. said it plans to restate its financial results going back to 2003 to adjust its accounting treatment for derivative transactions under a complex hedge accounting rule. The oilfield services company said the restatements will have no impact on cash flows, liquidity, or shareholders’ equity as of June 30. However, the adjustments will result in greater fluctuations in reported net income for the restated periods.

Teekay plans to restate financial results from 2003 through the end of the second quarter of 2008, including preliminary and previously announced results included in this earnings release. In a regulatory filing the company explained that the restatements will correct its accounting for some interest rate swaps, foreign exchange forward contracts, and freight forward agreements used in its hedging strategies to fix otherwise variable interest costs.

Over the past few years, FAS 133, Accounting for Derivative Instruments and Hedging Activities, has tripped up a number of large companies, including General Electric, Ford Motor, and Bank of America, which have been forced to revise earlier financial statements. At issue is whether the companies are permitted, under FAS 133, to apply the more favorable hedge accounting to their transactions.

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Currently, to qualify for hedge accounting — in which gains and losses on derivatives can be deferred until they mature — a company must prove that the derivatives are being used to manage risk, rather than just for market speculation. To prove that the hedge is a risk management tool, companies are required to show evidence that the derivative amount and timing match the attributes of the commodity being hedged.

This proof via pairing means managers have to thoroughly document each hedge from the outset and explain why the company is undertaking the transaction. They must mark their derivatives to market every quarter, then prove that the company is effectively hedging the underlying exposure.

To date, Teekay said it has accounted for the applicable derivatives as hedging instruments in accordance with SFAS 133. The fair values of these derivatives were recorded as derivative assets and liabilities on the company’s consolidated balance sheet, with the fair value changes each quarter recorded in accumulated other comprehensive income as a loss.

The company further explained that it recently discovered that since 2003, some of its derivatives did not qualify for hedge accounting treatment under SFAS 133 because aspects of its hedge documentation did not meet the strict technical requirements of the standard. As a result, Teekay will not be able to defer recognizing the changes in the fair value of the derivatives, and instead must run the loss through the income statement as a loss, rather than as a component of accumulated other comprehensive income on the balance sheet and in stockholders’ equity.

“The company believes that the applicable derivative transactions were consistent with its risk management policies and that its overall hedging strategy continues to be sound,” it said in a press release. According to its filing, Teekay will finalize restatement amounts as soon as it is practical and will release the revised results and file amendments to its previous filings as required.

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