How Accounting Can Help Businesses to Overcome Recessions - Research Paper Example

 IFRS The purpose of this report is to consider and discuss the works that are related to the Global Financial Crisis and the International Financial Reporting Standards. Hence the main purpose of this article is to conduct the literature review for a specific dissertation. The importance of accounting In the past many authors have written about the profession accounting. Various books about different aspects of accounting have been published. These aspects vary from the role of accounting in the world today, the use of accounting in management and decision making and so on. While some books like the one written by Mclaney and Atrill (2010) concentrate on a certain aspect or certain benefit of the profession of accounting, for example the use of accounting in better decision making, others concentrate on the importance of the basics and the foundational concepts of accounting. By and by accounting is considered a very important profession. The importance of the profession of accounting is also stressed in many journals and articles. The major significance for this is that according to Warren et al (2004), accounting indeed is very important for the businesses that operate in today’s world. This is because accountants can help the businesses through many recessions. The procedure of data keeping is also particular important for the businesses because it helps them to have data of their businesses that can be used for various purposes. For instance, as Orne (1998) and Boyd (1998) relate, it is easier for them to analyse the costs and the benefits of certain transactions, compare the costs associated and the revenues earned and so on. Accounting is also likely to help certain businesses through recessions as Boyd (1998) discusses. Need for a uniform method Because the profession of accounting is so important for the businesses today particularly because of the advancements in technology in the last two decades there has been a lot of research conducted on the methods employed by different businesses while recording data. Since the businesses throughout the world are not the same and vary from region to region, product to product etc, the general methods that were adopted in the book keeping process were different in the past. A lot of writers have worked on the impacts of differences in the accounts reporting methods. For some people, like Sawani (2008), the differences in the reporting styles have advantages. Analysts argue that all the companies are not alike. They come in different sizes and specialize in different products. The markets that the companies and businesses operate in may also be different in many regards. While some small companies might operate locally, there are companies that specialize in world markets and are active exporters. (Must Accounting Rules be Global?) Because of the differences between the companies, analysts often approve of different accounting standards for businesses throughout the world. However the disadvantages of having different systems outweigh the advantages. Over the past few decades, there has mainly been a focus on the establishment of one reporting standard for the companies of the world. The disadvantages of using different reporting methods and the advantages of having a standard system of reporting are critical determinants of this fact. According to a FASB report (1991), accounting standards are necessary because they assure that the financial information pertaining to the businesses is presented in such a manner that it becomes easier for the investors to invest appropriately. It is also usually argued in the favour of accounting standards that the presence of the differences in the accounting methods results in the companies manipulating the financial information of the companies. This way the business executives, as Orne (1998) explains, paint a rosy picture of their businesses in order to attract the investors. The investors who are not aware of the real situation might be exploited this way. A report by FASB (1991) suggests that an accounting standard could lead to more credible and useful information. This is because one accounting method ensures that it would be more complete in order to be applicable to all the companies throughout the world. As a result of the completion and usefulness, as Orne (1998) analyses, one accounting standard could make certain that the companies and businesses throughout the world, irrespective of the size, are comparable. The importance and usefulness of an accounting standard was one reason why in 1973 the International Accounting Standards Committee (IASC) was formed in England according to Camfferman and Zeff (2007). The purpose of the IASC was to design accounting standards that could be applicable to all kinds of businesses. As a result, various standards were introduced from IAS1 to IAS41 in the twenty seven years the committee existed. In 2000 IASC was replaced by International Accounting Standards Board (IASB). Since the replacement the IASB has worked a lot to remove the differences between the two accounting methods that are followed commonly the USGAAP and the IFRS. The objective of the IASB here was to concentrate on the convergence of the USGAAP and the IFRS. It was supported in its objective by the FASB in 2002. Attempts were made to converge the differences between the two accounting systems. The FASB in collaboration with the IASB announce joint projects like the short-term convergence project according to a report of the FASB (2002). These attempts were made because the IFRS was affecting the US and the non-US companies around the world. The convergence project could not eliminate the differences between the two accounting standards however it aimed at the reduction of these in certain areas. However IASB and the FASB could not be very successful in their motives. The reason for the failure of the convergence was the fact that the basics of the two accounting systems were different as Nobes (2004) relates. When the basic foundations of the systems differed, it was difficult to remove the differences. It is interesting to note that the differences in certain areas, where the convergence projects have been completely fully, are still evident. (US GAAP vs IFRS, 2009) Although in 2009, according to Hallstorm (2004), the FASB and the IASB updated their agreement on the project of convergence it is highly unlikely that the process will yield any fruitful results. The basic differences between the systems include discrepancies in the financial periods required, layout of the balance sheets, income statement classification of expenses, changes in equity and so on. Since these are the basic foundations of the systems it is very hard to change them. The convergence agenda of the IASB and the FASB, according to Hallstorm (2004), have not had any productive results so far but it would be wrong to say that the convergence procedure did not affect the accounting systems. In fact much of the IFRS that is followed today is a bi-product of the convergence agenda. The convergence programme has affected the IFRS in many ways. Defining Fair Value Marketing The main difference of the new and the old IFRS is the notion of the Fair value marketing. The new IFRS defines the concept of the fair value accounting stating that it includes the recording of the accounts at a time when the two parties that are carrying out the transaction are knowledgeable and willing as Barrett (1972) discusses. The fair value of the asset and the liability under the fair value accounting is defined to be the amount of money that is spent with regard to the market prices of the assets and the liabilities. This approach is different from the old one because, as Plantin et al. (2004) relates, the old system of IFRS mainly concentrated on the historical costs of the assets and the liabilities. The historical records were used previously for the determination of the prices of the assets and the liabilities as Barrett (1972) relates. Now, in contrast, the market values of the assets and the liabilities are considered. Since the introduction of the fair value accounting, there has been a debate over whether it should be followed or not. The way it is defined is the reason why there has been controversy over the following of the procedure. The definition of free value marketing that was issued by the IASB in May 2009 was that the fair value was defined to be the price paid for an asset or a liability in an orderly transaction between market participants at the measurement date. (IASB, 2009) The definition that is followed presently however is different because it defines the fair value as the ‘amount for which an asset could be exchanged, a liability settled, or an equity instrument granted could be exchanged, between knowledgeable, willing parties in an arm's length transaction’ The definitions might seem similar but the differences in these definitions are responsible for the affects on the businesses and the companies that have adopted the IFRS. The definition that is followed presently according to Halligan (2009) is inappropriate. This is because it focuses on the ‘transferring’ of liabilities. Liabilities are not something that can be transferred. Usually the markets for the liabilities are not very active and it creates confusion when the definition comes to determining the price of a liability. The current price notions for the assets and the liabilities are also not mentioned very properly and thus when it comes to determining the value of the assets and the liabilities, there is perplexity. The differences in the definitions can be discussed in a lot of detail however it is important now to move onto the reasons why the fair value accounting is preferred and yet not favoured by the companies throughout the world. Advantages and Disadvantages of Fair Value Marketing and the effects on the IFRS following companies The advocates of fair value accounting usually argue that the entire process can lead the companies into having better ideas about the current financial situations of their businesses. This fact is reiterated by Plantin et al. (2004) when he states that the concept of fair value ensures that the current market prices are taken into account and thus the current situation is what the companies can be more aware of. The previous method was focused on the use of the historical costs of the assets and the liabilities. Plantin (2004) argues that this did not prove to be very fruitful because there was a chance of the balance sheet reporting wrong data. The use of the historical costs meant that the costs like depreciation and amortization were not taken into account. With such costs missing the true picture of the company’s current financial situation could not be observed. This was the reason that led to the investors making decisions that were not appropriate, as Plantin et al. (2004) discusses. Advocates also argue that the historical collection of data about the accounts meant that two or more companies could not be compared. Plantin (2004) argues that it was likely that the costs and the revenues of two companies were same in the current period were same, but because of the differences in the initial prices of the assets and the liabilities, the income and financial statements were different. To avoid the problems mentioned above the IFRS was modified by the introduction of the Fair value marketing. With an intention to converge the differences between the IFRS and the US GAAP the system of fair value marketing was introduced. Initially it was expected to be welcomed because it seemed easy to follow (considering the current prices); however this was not the case. Under the fair value accounting of the IFRS, mostly companies try it hard to find the market values of the assets and the liabilities. This is what is argued by many critics like Pita (2006). According to Pita (2006), the markets for the products keep changing consistently. Since the markets are fluctuating constantly, there is no proper means to establish the ‘current’ prices of the assets and the liabilities. Also since there are no active markets for the liabilities, it is usually very hard to determine the price associated with the liability. The companies that use the fair value accounting methods may actually be forced to price the assets and the liability at any expected value. Previously it was easier to determine the prices of the assets and the liabilities because of the historical data present. Now however, the new IFRS may actually force the companies to report the costs and the revenues earned at ‘expected’ amounts of money according to Zack (2009). While some companies might not genuinely be able to determine the prices of the assets and the liabilities, some working under the new IFRS can deliberately manipulate the data of the accounts in order to attract investors. In fact, for some analysts, the fair value accounting is the reason of the global recession that is prevalent. The relation of Fair Value Accounting and the economic crisis As mentioned earlier, the fair value accounting has usually been associated with the economic crisis that the world is going through. According to Bostat and Horobin (2010) fair value accounting should only be practised if it applies to the business model of the company. For certain companies and businesses it is easier to follow the fair value accounting because of the nature of the business; though this is not valid for all circumstances. Certain companies that cannot determine the exact current prices use other means that can be manipulative. Fair Value Accounting according to Pita et al. (2006) is a procedure that invites economic crisis itself. The rosy picture of the financial statements that is portrayed through the ‘expected’ prices of the assets and the liabilities is misleading for the investors. The investors invest thinking that they would gain from investing where in reality they actually lose. One reason of the existing economic crisis is bad investment decisions and choices on the part of the investors according to Bostat and Horobin (2010). Although other factors may also lead to the wrong investment choices, analysts argue that the concept of fair value is one of the basic reasons of the wrong decision making. Hence the IFRS accounting standard because of its fair value accounting is often held responsible by the analysts and accountants for the global economic crisis. While some analysts argue that the fair value accounting leads to economic crises, others concentrate on the implications of the global crisis on the methods adopted by the accounting standards. Global Crisis in relation to IFRS Global recessions affect many different businesses and companies. Since the companies are affected, the costs and the revenues associated with the transactions are also affected. As a result, the accounting profession is also influenced. The influence on the accounting profession means that the accounting procedures would also be changed. Recently this is what has been observed. Analysts like Ryan (2009) argue that the global recession is responsible for the increased adoption of the IFRS. Although concepts such as the fair value accounting are generally not favoured because of the economic crisis that it may cause, yet it has been observed that 50% of the companies that had IFRS were more successful through the global recession as compared to the companies that followed US GAAP. This trend was observed among different businesses in different parts of the world. The companies that were following had better business results. However this fact does not prove that the IFRS is the best reporting method. Many firms that adopted the IFRS also suffered because of the global recession. According to Bostat and Horobin (2010), the global recession made it hard for the companies to concentrate on the accounting methods. The fair value accounting particularly proved to be a problem. .This is because the global recession meant that the markets were not stable. Unstable and volatile markets further meant that the market prices for the assets and the liabilities were indeterminable. Hence the reporting methods did not prove to be useful or complete. Firstly, it was difficult to comprehend the changes in the prices of certain products. Secondly it was difficult to maintain the same set of prices as Mangion (2009) discusses. The third implication according to analysts was that the investors were not very keen to invest in the companies because they were aware of the market situation and the consequent accounting methods. Investors no longer had confidence in the IFRS. The IFRS according to Bostat and Horobin (2010) was also insufficient and incapable of reporting the market values of the assets and the liabilities. Mangion (2009) argues in this regard stating that the system was insufficient because it did state the prices at which to record the prices. Yet it failed to mention how to determine the prices. Although there has been mention of an ‘orderly’ transaction with a certain measurement date mentioned in the definition by IASB (2009) yet it does not classify the particular transactions according to Halligan (2009). Overall, the result of the global recession on IFRS was that a need was felt for more appropriate measures regarding the reporting because of the deficiencies of the IFRS. Mangion (2009) argues that some action was also taken by the IASB. For example there have been certain reforms under IAS39 whereby the companies are now able to reclassify the securities out of the trade in certain circumstances. This reform is particularly important because of the reduction in the bank assets of the companies that were heavily indebted due to the global recession. Proposed Changes Because of the inefficiency of the IFRS that was observed through the global recession many analysts have argued the fact that something must be done about the reporting procedures. Some analysts like Bostat and Horobin (2010) argue that the principle of the fair value accounting should be applicable only to the companies that have particular business models. This is because the notion of changing market values does not apply to all businesses. Also people like Ryan (2009) argue that there is a need for the IFRS to discuss in detail the determination of the market prices so that companies do not have to suffer a lot in the process of determination of the market prices in ‘rare circumstances’. Other propositions include work on the convergence of US GAAP and the IFRS. Many analysts like Mangion (2009) argue that efforts should be made to eliminate the differences between the two. This would ensure that the reporting methods followed throughout the world would be universal. These proposed changes are likely to affect the businesses in a better way. Since the accounting methods would be sufficient and useful, there would be a lesser chance of manipulations on the part of the companies. The changes are likely to affect the companies in Saudi Arabia too. Since there is no specific literature that discusses the implications of the IFRS on companies in Saudi Arabia, the paper would discuss the implications in more detail. References Barrett, M. (1972). Fair Value Accounting. UK. Financial Executives Institute. Bostat, N and Horobin, W. (2010). ECB Tumpel-Gugerell:Fair-Value Use Should Depend On Business Model [Internet] Available from < http://www.gfmag.com/latestnews/latest-news.html?newsid=3833116.0> [Accessed 3 May 2010] Boyd, J. (1998). The Benefits of Improved Environmental Accounting : An Economic Framework to Identify Priorities. USA. Resources for the Future. Camfferman, K and Zeff, S. (2007). Financial Reporting and Global Capital Markets: A History of the International Accounting Standards Committee, 1973-2000. USA. 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