Question:
Discuss about the Resolution Regimes for Financial Institution.
There are several controversies surrounding the roles played by the Fair value Measurement in the Global Financial Crisis (GFC). There those who think that Fair Value has been used as a scapegoat to avoid the real cause of GFC while others strongly believe that fair value played a major role in the crisis. This evaluates the application of fair value in accounting and financial reporting by both the international and Australian accounting agencies (Benston, 2008). The paper is divided into three parts. The first part discusses my view on the role of accounting standards (fair value) on GFC and the remedies taken by International Accounting Standards Board (IASB). The second part address the problems related to the prior accounting standards and why the IASB’s took actions to improve fair value accounting. Last, part three discusses the influence of IASB on the Australian Accounting Standards.
In the first part, the essay critically addresses the role of accounting standards on GFC. Just like other accounting analysts, I believe that fair value accounting has been used as a scapegoat. There are several factors that contributed to the financial crisis. At the top of the list are regulatory and political factors which are beyond the fair value accounting. Fair value accounting is just like a messenger who cannot be castigated based on the message content. Financial illiteracy was at the heart of GFC (Arya & Reinstein, 2010).
Lack of knowledge on the application of the accounting standard played a major role in an economic downturn. It is the auditors, analysts and statement preparers who contributed to the financial crisis and not the fair value accounting standards. The fair value accounting was introduced in 2006, and only a handful financial analysts and accountants were fair with the standards prior to the 2008/9 financial crisis. Most of the personnel were familiar with the traditional accounting model while they were required to apply fair value accounting. If this personnel were familiar with the standards, the impact of the GFC would have been minimized (Sherry, 2009).
Fair value accounting method is more relevant and transparent than the traditional accounting methods. Therefore, the problem should be blamed on lack of understanding and knowledge by the accountants, analysts, auditors, and management. They did not understand the effect recognition of unrealized gains and losses on the entity (Pozen, 2009). Likewise, the users could not properly evaluate the timing, amount and the uncertainties surrounding financial statements prepared using fair value accounting model.
In response to the claims, the IASB took several initiatives. The board now work closes with accounting standards from different nations to set standards that are accepted globally. For example, the body has pushed for the global adoption of the IFRS and a method to promote global financial stability (Ratcliffe, 2007). For example, IASB has adopted standardized Liquidity Coverage Ratio (LCR), securitization model, and aligning the IFRS with the U.S Generally Accepted Accounting Principles (GAAP). Likewise, the accounting board has harmonized the treatment of consolidated data on credit risks and bilateral counterparty in the banking and financial sectors (Arya & Reinstein, 2010).
The second part is to address the problems related to the prior accounting standards and why the IASB’s took actions to improve fair value accounting. The Accounting Standard IAS 39 addresses the recognition and measurement of financial instruments. However, following the GFC, there was a debate on how best to measure the fair value. The crisis led to the decrease of fair value of different financial instruments resulting from forced liquidation, distress sales and inactive markets (King, 2009). To resolve the problem, The IASB clarified on the implementation of the accounting standards with respect to the fair value accounting. IASB published guidelines on fair value measurement in the illiquid market management. The amendments allowed entities to reclassify given financial items. The reclassification allowed companies to value some items based on the historical cost rather than the fair value (Power, 2010).
In analyzing what led to the amendment of the fair value accounting method, the measurement before GFC should be considered. IASB had IAS 32 and 39 accounting standards to address the treatment of financial instruments. IAS 32 addressed instrument disclosure and presentation while IAS 39 addressed instrument Recognition and Measurement. In 2005, the IASB introduced IFRS 7 stated that financial instruments, either they are measured at fair value or not, should be disclosure (King, 2009). Under the first category, the IAS was amended to grant companies with a choice of using fair value in measuring its financial instruments. Entities were supposed to value their assets and liabilities at the fair value at the issuance or acquisition period. The changes in the value of financial items had to be recognized in the income (FSB [Financial Stability Board], 2011).
Category 2 addressed fair value through profit or loss. The clause stated that financial assets and liabilities held for trading purposes were to be measured at their fair value as well. Category 3 and 5 stated that loans, receivables, and fixed maturity debts had to be recorded using their historical cost after the deduction of subsequent depreciation, impairment, and amortization. Last (Aubin, 2010). Category 4 addressed available for sales. Financial assets and liabilities held for the purposes of sales should be recorded as the fair value and the realized changes to be recognized in the equity. The amended stated that such changes would only affect the income statement after the actual sale of the item (Benston, 2008).
After the GFC, the IASB made three amendments. First, IAS 39 was amended to allow reclassification of certain financial items under given circumstances. Second, the requirements for disclosure of financial instruments was extended. And three, IASB published the guidance on the application of fair value in the illiquid markets. The amendment was meant to offer more transparency on the application of accounting standards in the global market. More specifically, the amendments were meant to reduce the differences between US GAAP and IFRS. Before the amendments, the European companies were disadvantaged when it came to their competitiveness in the global market (Ratcliffe, 2007).
By amending IFRS 7, to include more disclosure of the reclassifications of financial instruments, IASB increased the transparency of financial reporting to the investors. For example, companies are under obligation to disclose a detailed analysis on the impact of the reclassification of items. Clear, the amendments offered mitigation to the problems associated with the fair value measurement prior and during the financial crisis management (Ratcliffe, 2007).
Finally, part three discusses the influence of IASB on the Australian Accounting Standards. Following the Global Financial crisis, the Australian Accounting Standards Board (AASB) welcomed the move to amend its accounting standards in line with the IASB (LANDSMAN, 2007).
According to the Press Release No.67 by Nick Sherry, the then Minister for Superannuation and Corporate Law, we welcome the decision by the AASB to amend the Accounting standards so as to remain consistent with the new accounting guidance by the IASB (Sherry, 2009). The board acknowledged that the GFC had raised concern on the classification particular financial instruments. The amendments were meant to reclassify stressed financial instruments to conform to the IASB and the US GAAP. The objective was to ensure that the AASB produced well-informed and consistent financial reports and statements which offer useful and accurate information to the financial analysts and stakeholders. Likewise, the amendments would enhance transparency, investors’ confidence and promote the entry of the Australian firms in the global markets (Ratcliffe, 2007).
The amendments on the AASB were as a result of adopted changes by the IASB in 2008 which allowed companies to choose between reclarifying some financial instruments using either the fair value measurement or historical cost basis. The adoption of new changes and proposed amendments by the AASB was meant to offer a coordinated accounting approach to the global accounting standard boards with an objective of addressing the existing challenges on financial reporting (Barth & Landsman, 2010). Generally, the amendments were meant to address the economic and financial crisis in the future. IASB had adopted an accounting approach similar to the US GAAP and US Financial Accounting Standard Board (FASB). Therefore, the amendments ensured that the Australian companies could complete in their international counterparts (King, 2009).
The AASB has played a critical role in the creation and global adoption of International Accounting Standards (IAS). With a close partnership with Canada, United Kingdom, United States, and New Zealand, Australia has contributed immensely to the development of the accounting standards. The AASB has its own representatives in the IASB who represents the views of the AASB as well as ensuring that the AASB accounting guidelines are aligned to those of IASB (FSB [Financial Stability Board], 2011).
Clearly, AASB is well represented in the IASB and it has ensured that its accounting rules and principles are in line with those of IASB. Today the Australian companies can compete fairly in the global market thanks to the adoption of IASB (Arya & Reinstein, 2010).
In conclusion, the global financial crisis should not be blamed squarely on fair value measurement. There are several factors that contributed to the GFC. Financial illiteracy on the application of fair value method in one of them. Following the crisis, the IASB proposed new amendments to IAS 39 in an attempt to iron out the previous arising issues. Likewise, the AASB also adopted the IASB guidelines to ensure that the financial reporting by its entities show transparency, integrity and a true and fair value. Lastly, the IASB and the AASB are amended from time to time to be at Par with the accounting trends.
References
Arya, A., & Reinstein, A. (2010). Recent Developments in Fair Value Accounting. The CPA Journal.
Aubin, D. (2010). Mark-to-Market Plan Could be Modified: FASB Member. Reuters.
Barth, M. E., & Landsman, W. R. (2010). How did financial reporting contribute to the financial crisis? European Accounting Review, 19(3), 399-423.
Benston, G. J. (2008). The shortcomings of fair-value accounting described in SFAS157. Journal of Accounting and Public Policy, 27(2), 101-114.
FSB [Financial Stability Board]. (2011). Key Attributes of Effective Resolution Regimes for Financial Institutions. New York: FSB.
King, A. M. (2009). Determining fair value . Strategic Finance , 90 (7): 27-32.
LANDSMAN, W. (2007). Is fair value accounting information relevant and reliable? Evidence from capital market research. Accounting, 19-30.
Power, M. (2010). Fair Value Accounting, Financial Economics, and the Transformation of Reliability. Accounting and Business Research, Vol. 40, No. 3.
Pozen, R. C. (2009). Is It Fair to Blame Fair Value Accounting for the Financial Crisis? New York: Harvard Business Review. Retrieved from https://hbr.org/2009/11/is-it-fair-to-blame-fair-value-accounting-for-the-financial-crisis
Ratcliffe, T. A. (2007). The finer points of fair value. Journal of Accountancy , 204 (6): 58-61.
Sherry, N. (2009, June 8). Australian Accounting Standards Amended in Global Action to Address Impact of Credit Crisis. Retrieved from Australian Government: The Treasury: https://ministers.treasury.gov.au/DisplayDocs.aspx?doc=pressreleases/2008/067.htm&pageID=003&min=njs&Year=&DocType=
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