The rule provided a way to avoid that, called hedge accounting.

If these criteria are not met, hedge accounting cannot be applied.

That rule makes it possible for companies to smooth their results by using what is called hedge accounting.

Hedge accounting requires that a company be able to show that its transactions actually will take place.

The non-applicability of hedge accounting can lead to significant volatility in corporate earnings.

Hedge accounting allows for limited aggregation of mutually offsetting risks.

It used less onerous hedge accounting, shifting losses to a line on its balance sheet known as "other comprehensive income."

Hedge accounting is an accountancy practice.

The aim of hedge accounting is to provide an offset to the mark-to-market movement of the derivative in the profit and loss account.

It said that the rule, even with the changes, was "a significant step forward" because no current European accounting rule "contains any hedge accounting provisions" at all.

An entity can mitigate the profit and loss effect arising from derivatives used for hedging, through an optional part of IAS39 relating to hedge accounting.

The IASB is working with the EU to find an acceptable way to remove a remaining anomaly in respect of hedge accounting.

In announcing the decision, the commission rejected what it said were criticisms "that the relaxation of the hedge accounting provisions make the standard 'seriously deficient' and 'not credible."'

"It is safe to say that on the margin there are companies that are recognizing economic risk but do not hedge because they can not get hedge accounting," he said.

To achieve hedge accounting requires a large amount of compliance work involving documenting the hedge relationship and both prospectively and retrospectively proving that the hedge relationship is effective.

Note that hedging-related transactions will attract their own accounting treatment: see Hedge accounting, Mark-to-market accounting, FASB 133, IAS 39.

- The IAS 39 Hedge Accounting plug-in allows users to generate IAS 39 accounting reports for derivatives [3].

Hedge accounting may be applied if there is hedge documentation and gains and losses in the value of the derivative with gains and losses in the value of the underlying transaction.

Hedge accounting rules tend to limit hedges over longer periods of time and hedges that would be made against anticipated income from the development of new products, as compared with expected sales from existing merchandise in the future.

Regulators involved in the investigation were surprised by A.I.G.'s conclusion that a reinterpretation of rules for hedge accounting would result in a $2.4 billion increase in the company's net worth - almost offsetting the $2.7 billion decrease in net worth.

One person briefed on A.I.G.'s hedge accounting said the company was able to arrive at a conclusion so quickly because its auditors at PricewaterhouseCoopers chose a method that did not require as much time as A.I.G. originally had thought.

Dr. Li has held this position since 2000 and his research interests include IPO Valuation, Accounting Information and Financial Markets, Environmental Accounting, Hedge Accounting, and Game Theory in Accounting Research.

To be designated and qualify for FAS 133 hedge accounting, a commodity (hedged item) and its hedging instrument must have a correlation ratio between 80% and 125%, and the reporting enterprise must have hedge documentation in place at the inception of the hedge.

Representatives from the Securities and Exchange Commission, the New York attorney general's office and the New York State Insurance Department were first briefed last week on the hedge accounting issue and were told that it was a large and complex problem that would require significant time to understand.