Volatility in income is an anathema
for most US MNCs. Analysts hate it. Investors dread it.
CEOs/CFOs want to avoid it. It is the potential for
income-statement volatility brought on by FAS 133’s
basic requirement that all derivatives be carried at
fair value on the balance sheet, which created much of
the outcry about the standard.
This volatility potential emanates
from a basic timing mismatch in the recognition of
gains/losses of derivatives and the items that they
hedge. Some derivatives hedge exposures that may not
occur from an accounting perspective for some time. So
while the derivative gains or losses flow through the
P/(L), the underlying is nowhere to be seen.
FAS 133 offers companies two
approaches: (1) they can mark to market their entire
book of derivatives in income; or (2) in some
special situations, they can link some of those
derivatives in “hedge relationships” with their hedged
items, thus smoothing out the timing differences and
reducing income volatility.
