A hedging instrument is a designated financial instrument whose fair value or related cash flows should offset changes in the fair value or cash flows of a designated hedged item (IAS 39). A derivative could be designated as a hedging instrument if it meets the conditions of IAS 39. An entity can by using hedging instruments to reduce risk in investments.
All gains or losses originated by the hedging instruments (both derivative and non-derivative hedging instruments) at fair value should be recognized in profits or loss. For example, some companies may make future contract with banks in order to avoid the risk of currency exchange rate fluctuation.
The cash flow hedges are required to (1) be attributable to a certain risk related with a recognized asset or liability and (2) be able to influence profit or loss under paragraph 88 (IASC, 2009). For example, some companies make future interest payments with variable rate. The effective portion of gain or loss on hedging instrument should be considered as other comprehensive income, and the ineffective portion is recognized in profit or loss.
Similar with cash flow hedges, the effective portion of this hedge’s gain or loss is recognized in other comprehensive income, and the ineffective portion is belongs to profits or loss. For example, a company sold its overseas net investment with a fixed exchange rate in a 6 month future contract.
According to the Agency theory, the owners delegate management to achieve the firm’s objective which is maximizing shareholders’ wealth. The separation of ownership and control allows the shareholders do not bear the full costs of their decisions, consequently resulting better risk diversification possibilities for investors (Maher & Anderson, 1999). By this way, the shareholders avoid full costs while still enjoying the benefits.
However, this separation gradually displays importantly negative influences on firm performances. Not only the objectives of managers and shareholders are diverged, but also the incentives of both sides in principal-agent model are also particularly weak. Actually, shareholders are inclined to be free-riders because the benefits from monitoring are shared while the full cost of monitoring is paid by the monitor. Consequently, the end result is that both management and corporation are not willing to consider all costs, especially the cost to the society, such as the firm’s unpaid credits or environmental pollution (Hooper et al, 2008). In some public corporations which control important amounts of resources, the ownership is just nominal and the owners actually control the corporation. This may eventually result in highlighting self-benefits and ignoring the costs to society.
It is the accountants’ responsibility to pursue the notion of full disclosure in corporate financial reports, which means accounting has a role to play in realizing full costs. Accountant is also considered as a stakeholder of a corporate. Moreover, accountants need to disclosure all important information when necessary in order to pursue corporate transparency and social responsibility.
It is generally recognized that conventions reflection the power distribution among diverse stakeholders (Schaltegger & Burritt, 2000). Along with the constant changes within the modern society, power relations between stakeholders have been keeping changing, so that various stakeholders put forward their differentiated preference of information. In particular, the introduction of ‘sustainability’ emphasizes the vulnerability of environment and the importance of long-term development of the whole ecological system. Therefore, the environmental twist in the conventional accounting demonstrates the new aspect of stakeholder concern and involvement, and the consideration of justice and equity, which are compatible with that of sustainability (Maunders & Burritt, 1991). Furthermore, along with the improvement of pro-environment awareness, customers would require producers and sellers to take certain actions. For example, if some brand is reported to have adverse environmental impacts due to particular materials used in production, although such environmental costs would not be reflected in the corporate accounts, consumers would refuse to buy its products as punishment and certain non-governmental organization would sue the company as well.
As such, in order to suit the conventional accounting for the environmental and social issues, multiple sources of information should be captured, not just mirroring what business leaders temporally consider to be important from their perspectives. Then, since the government has enforced some environment-related tax policies and social regulations, conventional accounting should internalize the externalized costs and revenues, reflecting economic consequences of environmental costs and opportunities (Sharma & Starik, 2002; Schaltegger & Burritt, 2000).
IASC. (2009). IAS 39 Financial Instruments: Recognition and measurement. Available at: http://www.iasb.org/NR/rdonlyres/BCE30C2D-F85E-42B7-ADB6-E91B50F13B39/0/IAS39.pdf. Accessed on: 2011/12/17.
Maher, M. & Anderson, T. (1999). Corporate governance: effects on firm performance and economic growth. Available at: http://www.oecd.org/dataoecd/10/34/2090569.pdf Accessed on: 2011/12/17.
Hooper, K. & Davey, H. & Liyanarachchi, G. & Prescott, J. (2008). Conceptual Issues in Accounting: A New Zealand Perspective. Cengage Learning: Melbourne.
Schaltegger, S. & Burritt,R. (2000). Contemporary Environmental Accounting: Issues, Concepts and Practice. Sheffield: Greenleaf Publishing Limited.
Maunders, K. T. and Burritt, R. L. 1991. Accounting and Ecological Crisis. Accounting, Auditing & Accountability Journal 4(3): 9-26.
Sharma, S. & Starik, M. (2002). Research in Corporate Sustainability: the evolving theory and practice of organizations in the natural environment. Cornwall: MPG Books Ltd.