The Impact of Fair-Value Accounting on the Global Financial Crisis

Discuss about the Various Tenets Of The Accounting.

The present study focuses on the various tenets of the accounting standards, which are published by the International Accounting Standards Board (IASB). For instance, it is determined that in what manner the use of fair-value of accounting had led to the issue of global financial crisis (GFC) and the manner in which the intervention of the IASB can resolve the issue. It has been discussed in the study various ways through which the accounting standards of the IASB had to be modified due to the GFC. It is also determined that in what ways AASB can use the IASB standards.

Accounting standards are depicted to have an impact on the global financial crisis that occurred during the year 2008. More precisely, it can be stated that the crisis mostly happened due to the use of fair-value accounting. Fair value accounting refers to the approach that involves timely revaluation of the values pertaining to assets and liabilities. It enables to explore the actual value of the assets and liabilities at the market price. For this reason, the method is also termed as market-to-market accounting. The supporters of fair value accounting thus argued, that the method enables to get insights regarding the present situation that prevails in the market (Financial Times, n.d.; Tab?r? & Rusu, 2011).

 On the contrary, the opponents of the theory clearly explain that fair value accounting made the investors to consider inappropriate market value of the securities. This created economic turbulences such as bankruptcy that raised the issue of for the banking sector. This is due to the fact that various types of securities were present in the market were valued at an inappropriate manner due to which the investor was unable to get proper return on their investments. Low return reduced the ability of the investors to repay back their debts, as they had low income. Such instances raised the amount of bad debts of the banks (Small, 2012).

The problem with fair value accounting is that during economic upswings, the tendency of the firms to adopt debt was considered as a major form of financing. Such situations can lead to losses, when the economy is in boom situations. Prices of financial assets during the crisis were mostly done with the help of fair-value accounting, as depicted from the excessive reliance on market values (Laux & Leuz, 2010). Banks at the time of financial crisis had to write the value of assets at a lower price due to the prevailing situations. For mitigating away the losses, the banks had to sell their assets at low prices for surviving the issue of financial crisis. Such sale of financial assets at a significant low price is termed as ‘asset fire’. Furthermore, it was observed that the sale of assets became a source of earning revenue for the banks. It means that asset fire sale became a common phenomenon in the banking sector that further triggered the issue of economic crisis. Collapse of the Lehman Brothers can be regarded as a standing, which was mostly due to the limitations of fair value accounting (The Economist Newspaper Limited, 2017).

The Role of IASB Intervention in Resolving the Flaws of IAS 39

The IASB has played a crucial role during the event of economic crisis. It is however noted, that the board made it necessary to mark up the financial assets at the prevailing market price, which prevailed at that time (The Economist Newspaper Limited, 2017). Pertaining to cope up with the situation, the IASB issued a new standard known as International Financial Reporting Standards (IFRS) 9. This is supposed to resolve the issues that were prevalent during the economic crisis. As per IFRS, it was necessary for the business houses to record the financial losses on a timely basis, which is often observed s in case of credit. The absence of such timely recording of financial assets is responsible for triggering the financial crisis of 2008. IFRS 9 makes it necessary for the organizations to estimate all the credit losses that can arise at the time, when financial instruments such as stocks or bonds are purchased. The standard also makes it essential for the organizations to disclose the initiatives taken for mitigating away the risks. This is especially important for the investors (PwC, 2017; Deloitte Global Services Limited, 2017).

The standard is depicted to reduce the chances of financial crisis that prevailed in 2008. This is due to the fact that it is mentioned that the fair value of assets needs to be calculated using the profits and losses that occur at a particular period. Additionally, making estimation of the losses at a predefined manner is also supposed to reduce the chances of suffering from inappropriate income pertaining to credit risks. Thus, it can be stated that the business environment of Australia is supposed to get rid economic issues after such action of the IASB to the accounting standards (European Systematic Risk Board, 2017; Deloitte Global Services Limited, 2017). However, it requires proper monitoring by the regulatory bodies, so that IFRS 9 is properly followed in the Australian context.

As an amendment to IAS 39, the IASB passed another accounting standard known as IFRS 13. It infact mentions about a more precise and modern way of assessing fair value. As per IAS 39, the value of asset is determined by the existing market forces that operate at a particular time. In the same manner, IFRS 13 also mentions the need for determining the market value of an asset based on the price agreed between the parties involved in transaction. Additionally, IFRS 13 makes it mandatory to consider the credit risks, which is involved while calculating the value of the assets. It enlarges the chances of exploring the actual value of the assets after calculating the bad debts, which can arise when a party is involved in entering into the business transactions. Thus, it is important for the seller or a buyer to consider his/her credit risk during the assessment of valuing the assets (Deloitte Touche, 2013).

The Implementation of IFRS 9 and IFRS 13

The global financial crisis is mostly depicted to be caused due to the flaws that were present in IAS 39 standard. It was not needed by the financial entities to recognize the value of assets and liabilities as per the income statements. Thus, it is depicted that IAS 39 made it necessary to calculate fair value based on the situation. Low estimation of the assets based on market situation is observed to enhance the issue of solvency. As an amendment to this, IFRS 9 makes it important to consider the value of assets based on profit and loss statement. This is supposed to reduce the chances of losses that are caused due to inappropriate calculation of the asset values. As per the standard, it was not necessary for the business entities to disclose the initiatives taken to mitigate away the risks pertaining to credit. Thus, it made the investors unaware of the risks that were associated with investing in the securities of a particular entity. Therefore, it is necessary to mention about investment strategy of the business entities in the financial accounts. The replacement of IAS 39 by IFRS 9 is supposed to take place on first of January, 2018 (European Systematic Risk Board, 2017; Deloitte Global Services Limited, 2018).

The Australian Accounting Standards Board (AASB) is observed to be cautious about the global financial crisis that took place in the year 2008. It resorted to revise the proposals of accounting standards that were previously maintained by the board. AASB made changes on the reporting of leasing, revenue recognition and insurance that were used by the business entities. It is also observed AASB has followed a proper mechanism to adhere to the standards mentioned by IFRS. It has tracked the amendments made by the IFRS on the aspects of leasing (Australian Accounting Standards Board, 2010). The IFRS 13 standards, which have been adopted by IASB, are applicable to Australia. AASB mentions about the fact that aligning with IFRS 13, it is important to take into account the costs of freight while calculating the value of an asset. Thus, adoption of IFRS 13 can be regarded as an initiative to bring convergence between IASB and AASB (EY, 2012). AASB has also proposed usage of the IFRS 9 pertaining to determination of fair values during the preparation of financial statements. The adoptions of standards, which are prescribed by IFRS, are useful for the analysts and researchers. This is because relevant information gets disclosed in the financial statements (Deloitte Global Services Limited, 2017a; Deloitte Global Services Limited, 2017).

Conclusion

The above discussion clearly reveals that the global financial crisis, which occurred in the recent year of 2008, was primarily due to the prevalence of fair accounting theory. It reflects the need of considering the value of an asset or liability at the prevailing market price. Thus, problem is that at certain times, the value can be inappropriate due to use of fair value accounting. It is observed that during the global financial crisis, the banks had to face the issue off solvency as assets were valued at low rate by means of fair value theory. The standards IFRS 13 and IFRS 9 provide solution to the issue of financial crisis.

References

Australian Accounting Standards Board. (2010). Australian accounting standards board, 2010. File, 1-134.

Deloitte Global Services Limited. (2017). IFRS 9 — financial instruments. Retrieved September 29, 2017, from https://www.iasplus.com/en-us/standards/international/ifrs-en-us/ifrs9

Deloitte Global Services Limited. (2017 a). Research into the impact of IFRS adoption in Australia. Retrieved September 29, 2017, from https://www.iasplus.com/en/news/2016/03/aasb

Deloitte Global Services Limited. (2018). IFRS 9 — financial instruments. Retrieved September 29, 2017, from https://www.iasplus.com/en-us/standards/international/ifrs-en-us/ifrs9

Deloitte Touche. (2013). Fair value measurement of financial instruments under IFRS 13. IASB, 1-8.

European Systematic Risk Board. (2017). Financial stability implications of IFRS 9. Pub, 1-83.(2012). Fair value measurement. Publications, 1-197.

Financial Times. (n.d.). Definition of fair value accounting. Retrieved September 29, 2017, from https://lexicon.ft.com/Term?term=fair-value-accounting

Laux, C. & Leuz, C. (2010). Did fair-value accounting contribute to the financial crisis? The Journal of Economic Perspectives, 24(1), 93-118.

PwC. (2017). Practical guide general hedge accounting. Practical Guide, 1-28.

Small, C. (2012). The role of accounting in the financial crisis. Retrieved September 29, 2017, from https://corpgov.law.harvard.edu/2012/03/02/the-role-of-accounting-in-the-financial-crisis/

Tabara, N. & Rusu, A. (2011). The role of accounting in the global financial crisis. Assumptions and realities. EuroEconomica, 30(3), 1-7.

The Economist Newspaper Limited 2017, All’s fair. Retrieved September 29, 2017, from https://www.economist.com/node/12274096