Industry Insights

Commodity Price Volatility, Consumer Taste Changes & Cash Flow Hedging

July 2017
Author:  Eric Mies

Eric Mies

Director

Audit

Manufacturing & Distribution

910 E. St. Louis Street, Suite 400
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Business leaders within the farm-to-fork value chain haven’t been strangers to uncertainties related to domestic trade and fiscal policies. However, the uncertainty level has never been higher with these issues top of mind:

  • Changing attitudes about trade and upcoming talks to renegotiate the North American Free Trade Agreement
  • Looming decisions about the next farm bill
  • Immigration reform

The pace of change for the end consumer is quicker than ever as tastes evolve and diverge. Ingredient quality—natural, local or from otherwise known sources—is more important to a growing subset of consumers willing to pay more for quality. On the flip side, there’s continued growth in store-branded products at lower prices. How people buy also is changing and will continue to do so if the deal announced in June for Amazon to buy Whole Foods is any indication.

In this dynamic landscape—without even mentioning the effects of oil prices or weather—risk management is critical for processors, manufacturers and distributors in food and agribusiness. Uncertain economic policies affect commodity prices and can lead to significant volatility. In addition, evolving end-user markets complicate the predictability of cash flow.

Many companies hedge some of these risks from an economic standpoint by using exchange-traded products, e.g., futures and swaps, forward contracts or insurance.

Hedge Accounting

Accounting for hedging transactions is a highly technical endeavor that has put off many middle-market companies due to costs (personnel time and money) that outweigh the benefits (reduced earnings volatility in the financial statement) consistent with a company’s economic risk management process.

The scales might be tipping for many middle-market companies as the Financial Accounting Standards Board is expected to release a final Accounting Standards Update (ASU) in August 2017 that simplifies and improves hedge accounting. BKD previously commented on the exposure draft in September 2016 and December 2016.

Certain key improvements—especially those related to “cash flow” hedges that are most relevant for the food and agribusiness space—include:

  • Expanding the use of component hedging for nonfinancial and financial risks
    • How are your current sales and purchase contracts, i.e., invoices, purchase orders, written? This will help determine whether the “critical terms match method” can be used.
  • Eliminating the separate measurement and reporting of hedge ineffectiveness
  • Providing more flexibility in timing of certain documentation and qualitative effectiveness assessments rather than quantitative assessments given certain fact patterns

While the ASU will be effective for private companies for fiscal years beginning after December 15, 2019, early adoption will be permitted and presents an opportunity for many companies. Consider whether these changes make hedge accounting worth exploring for your business.

BKD will publish detailed articles about the new standard once the final ASU is released. For more information, contact your BKD advisor.

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