Standards Responsible For Global Financial Crisis And Responses Of International Accounting Standards

Effects of Global Financial Crisis

Question:

Discuss About The Standards Responsible For Global Financial?

The global financial crisis has hit the economy of the world quite badly. The effects and after effects of the global financial crisis was devastating. Global financial crisis started to show its effects in the middle of the year 2007-2008 (Castleden, 2009). Various incidents such as failure of stock markets around the globe, collapse of large financial institutions had made it evident for common people that in later times the situation will worsen. The wealthiest nations also saw its effects as the government started to roll out rescue packages.

In the increasingly inter connected world, the effects of global financial crisis was much as estimated by the economists around the globe. It has affected every single person on the earth in one or many ways. Various reasons were concluded by the people behind the happening of such devastating event.  The global financial crisis has raised questions related to fair value accounting (Pozen, 2009). The essay portrays various aspects of global financial crisis and the responses and actions taken by the international accounting standards. In addition to this the essay also covers the aspects which deal with financial instruments and the response of Australian Accounting Standards Board (AASB) over global financial crisis.

The global financial crisis started to emerge during the late 2007, the business organizations around the world started to incur huge losses in their earnings. The accountants and directors of business firms started to ask for reasons behind their deteriorating income.  The re-measurement of fair value of derivative instruments which are engaged in special purpose vehicles was the one aspect that was understood by the board of the organization.  Earlier an increase in the fair value has also led to an increment in the profits of the business organization which has considerably increased their performance ad market stability (Pozen, 2009).

Due to declining prices of houses, the sector of home loans started to make losses. Many financial institutions around the world which were dealing with home loans started generating losses because the product of home loans was being kept in special purpose vehicles. Prior to this, the product of home loan was the one which was majorly in demand by the public because of high interest nominal returns (Ciro, 2013).  This resulted in creating fair value adjustments which later recognized as profit and losses by the business organizations. Soon the decline in housing process geared up and the demand for low quality home loan paper disappear which certainly led to the rapid decrease in the fair value of the product. European financial institutions have also purchased the low quality home loan paper so to participate in the demanding market but as soon as the need for this paper declined, the business organizations working in Europe also felt the distress in their economy. In the wake to remain safe and profitable various companies securitized their mortgages as well but that also couldn’t save them from incurring losses (Sun, Stewart and Pollard, 2011).

Reasons for Global Financial Crisis

The results of global financial crisis forced IASB (International Accounting Standards Board) to formulate strategies that can be followed by all the firms that are operating business in the world. The extensive pressure from the government and business communities around the world forced IASB to regulate a strict timetable for the provisions of financial instruments.  Due to this pressure, IASB planned to carry out reclassification of financial instruments (Oldani, Kirton and Savona, 2013). This was the first time when IASB formulated strategies that should be followed within the business houses in maintaining their accounts. IASB released an amendment to the already existing standards in 2008 of October, in which the reclassification of financial assets were carried on fair value is required to be carried on amortized cost. This allowed the business organization to reverse their losses on fair value. IASB also made amendments in IFRS7, it involves the categorization of fair value measurement of all the financial instruments into three levels, and it also stated that any change or non enforcement of any level will be followed by the proper reason for the same (Castleden, 2009).  The actions taken by IASB has proved certainly beneficial as companies have moved from making higher profits to working fairly in order to remain competitive and effective in the competitive market.

The global financial crisis has led to huge disparities and creation of cash crunch in the market.  Business houses and political parties were started blaming the accounting practices being followed by the companies and specially the fair value measurement (Grant and Wilson, 2012). In such an environment of upraised criticism, IASB formed FCAG. The group was made in order to gain information about the potential causes that can lead to financial crisis. The group also looks into the proper implementation of the accounting standards mandate recommended by the IASB and also it undertakes potential improvements in the accounting standards that are followed by the business organization (Castleden, 2009).  FACG also looks into the matter that accounting standard that were followed during the global financial crisis and also fair value measurement of financial instruments.

In addition to this, IASB also amended various standards that were followed by organizations around the world. IASB made amendments in the IAS 39 because due to its stringent requirements for hedging of financial instruments many business houses were unable to do the same. Due to this reason many business organizations applied for fair value measurement to fixed rate.

Responses and Actions of International Accounting Standards

The old accounting standard related to the fair value accounting has some issues prior to global financial crises basically in valuing the financial instruments. Global financial crisis is due to one basic reason that can be failure of banks. The problems were mainly linked with the financial instruments disclosures at fair market value and its classification. These were the two main reasons that have been contributing more to the occurrence of the global financial crises. In order to solve this problem following the three levels of fair value measurement hierarchies have been introduced. “Level 1: fair value directly obtained from market prices; Level 2: fair value principally derived from market prices, but with minimal unobservable market inputs; and Level 3: fair value principally derived from unobservable market inputs (i.e. fair value of instruments valued off models)” (GAA Accounting. 2009). Classification of financial instruments was changed in amendment to the accounting standard of IAS 39. Prior to change the classification the management classifies the financial instruments in one of the four ways now management can classify in one of two ways. “These are ‘Financial instruments at Fair Value’, ‘Loans and receivables’ and ‘Available for sale’ under certain conditions” (ACCA, 2011).

IASB also made amendment in the IFRS 13 fair value measurement because it requires disclosures about the fair value measurement. The notion was based on exit price concept which results in a market based measurement rather than organization based measurement. IFRS applies to financial period beginning on or after 1^st January (IFRS 13 — Fair Value Measurement, 2017). In addition to this IASB also issued IFRS 9 on the place of IAS 39, this standard is used for recognition impairment and de-recognition and general hedge accounts (IFRS 9 — Financial Instruments, 2017).  The standard has been removed owing to its complications in every stage.

 As various methods has been introduced by IASB to improve accounting standards but due to one or the other issues, IASB made amendments in the same. Owing to the criticism for not launching a standard that is easy to use and apply, IASB again moved to fair value measurement. IASB released an amendment to the existing IFRS 7, financial instrument disclosures; this standard was effective for the organizations that follow the period of after 1^st January 2009 (Castleden, 2009).  This method was based on the US GAAP standards FAS 157, fair value measurement. IFRS 7 categorized fair value measurement in there levels of measurement hierarchies, these three levels indicates the following:

Fair Value Accounting

1^st level: fair value should be acquired from the market prices

2^nd level: it should involve very less unobservable market inputs

3^rd level:  fair value derived from major unobservable market

The business organizations are required to follow fair value measurement according to the standards prescribed by the IASB. It also involves disclosures of sensitivities in fair value measurement of financial instruments. This method is quite sensitive and is also effective because it requires disclosures of financial instruments and their classification as well (Financial Reporting & Accounting Standards, 2017). This method has certainly made the accounting procedures of the business organizations more effective than before.  

The global financial crisis started to affect Australia in the year 2008, as the first clear sign was the drop of the stock exchange. In between February and April, the impact of global financial crisis raised and it was quite clear from the performance of the large business organizations, small money lenders etc. every aspect of the economy started to get effected by the same (Parker, 2009). The issue of credit in the market got increased and the difficulties in the availability of funds were clearly evident. In Australia, the stock market crashed very badly which also resulted in the downfall of the Australian currency.

 The government started to deliver simulation packages, apart from this the government also started to provide bank deposits, two substantial interest rate cuts all these events impacted the trust and confidence of the people who were dealing directly and indirectly in the market. The decisions made by IASB also influenced the AASB (Australian Accounting Standards Board); the Australian constituents became the beneficiaries by the decisions made by IASB (Financial Reporting & Accounting Standards, 2017). Various standards made by IASB have proved quite helpful in reconstructing the Australian market. AASB also applied certain standards in their accounting practices such as AASB 132, AASB 139 and AASB 7; all these standards were made in order to clarify the fair value measurements (Parker, 2009).

Conclusion

Global financial crisis has affected every sector and segment of the economy quite badly. Due to the devastating effects, several questions were raised regarding the fair value measurement and the accounting standards being followed in the business organizations. In such a situation IASB introduced various standards to cope with the situation. In addition to this, the standards were also helpful in avoiding the situation of financial crisis ever in future. No country remained unaffected with the effects of global financial crisis; Australia was also one of them. In the year 2008, the effect of global financial crisis could be felt in the market. The standards suggested by IASB were quite effective in the Australian marketing and it also helped in bringing back the economy to normal phase.

References

ACCA. 2011. The future of financial reporting 2011: Global crisis and accounting at a crossroads. [Online] Available at:  https://www.accaglobal.com/content/dam/acca/global/PDF-technical/financial-reporting/tech-tp-farsig11.pdf [Accessed on: 16 September, 2017].

Castleden, D. 2009. Are accounting standards responsible for the global financial crisis? [Online] Available at: https://www.gaaaccounting.com/are-accounting-standards-responsible-for-the-global-financial-crisis/ [Accessed on: 16 September, 2017].

Ciro, T. 2013. The Global Financial Crisis: Triggers, Responses and Aftermath. Ashgate Publishing, Ltd.

Financial Reporting & Accounting Standards. 2017. [Online] Available at: https://home.kpmg.com/au/en/home/services/audit/financial-statement-audit/financial-reporting-accounting-standards.html [Accessed on: 16 September, 2017].

GAA Accounting. 2009. Are accounting standards responsible for the global financial crisis? [Online] Available at:  https://www.gaaaccounting.com/are-accounting-standards-responsible-for-the-global-financial-crisis/ [Accessed on: 16 September, 2017].

Grant, W. and Wilson, G.K. 2012. The Consequences of the Global Financial Crisis: The Rhetoric of Reform and Regulation. OUP Oxford.     

IFRS 13 — Fair Value Measurement. 2017. [Online] Available at: https://www.iasplus.com/en/standards/ifrs/ifrs13 [Accessed on: 16 September, 2017].

IFRS 9 — Financial Instruments. 2017. [Online] Available at: https://www.iasplus.com/en-us/standards/international/ifrs-en-us/ifrs9 [Accessed on: 16 September, 2017].

Oldani, C., Kirton, J.J  and  Savona, P. 2013. Global Financial Crisis: Global Impact and Solutions. Ashgate Publishing, Ltd.

Parker, C. 2009. [Online] Available at: https://www.tved.net.au/index.cfm?SimpleDisplay=PaperDisplay.cfm&PaperDisplay=https://www.tved.net.au/PublicPapers/April_2009,_Accountants_Education_Channel,_Lessons_from_the_Global_Financial_Crisis.html [Accessed on: 16 September, 2017].

Pozen, R.C. 2009. [Online] Available at: https://hbr.org/2009/11/is-it-fair-to-blame-fair-value-accounting-for-the-financial-crisis [Accessed on: 16 September, 2017].

Sun, W., Stewart, J. and Pollard, D. 2011. Corporate Governance and the Global Financial Crisis: International Perspectives. Cambridge University Press.