The Impact of Global Financial Crisis on the International Accounting Standards - Essay Example

Running Head: THE IMPACT OF GLOBAL FINANCIAL CRISIS (GFC) ON THE INTERNATIONAL ACCOUNTING STANDARDS THE IMPACT OF GLOBAL FINANCIAL CRISIS ON THE INTERNATIONAL ACCOUNTING STANDARDS (Your Name) (Your School) Abstract When accounting standards are created, adopted and implemented the world over, it is done in the aim of improving accountability and efficiency in financial institutions and more importantly in the hope that such practices can act as a cushion for absorbing any ‘shock’ that may hit the institutions in an unprecedented manner and period. In the event that such institutions experience a financial shock, despite the existence of such standards, there arises a question of effectiveness. Are the standards able to predict and cushion the financial institutions against massive changes? In this analysis, an attempt has been made to show that the current International Accounting Standards are actually below standards and were not effective in shielding financial institutions especially in the US against a backdrop of massive borrowing and credit. In the face of a financial crisis, the biggest in history, there is call to address the existing standards with an aim of reviewing them to make them more effective. Several theories have been advanced to explain the cause of the financial crisis. There is a possibility that the factors involved are multiple and therefore requires an in-depth scrutiny before any major policy shift is adopted. There is also evidence that despite the global impact of the financial meltdown, there are countries which seemed largely unaffected. Examples include Australia and Canada. This brings a different orientation in the theories with the suggestion that part of the then meltdown was contributed by poor individual country’s fiscal policies and the prudence of individual financial institutions management. The Global Financial Crisis (GFC) Impact on the Use and Implementation of International Accounting Standards (IAS) Introduction-meaning International standards of accounting refers to the set of procedural framework set for use in preparing, analyzing and presenting financial events and transactions in a globally consistent and agreed method. The framework however does not limit use of corporate internal standards which may be adopted by institutions as far as they are seen to be in agreement with the IAS. This paper is an attempt to evaluate the IAS in face of a global economic crisis. Since accounting standards in a great way are concerned with financial institutions and the processes within such institutions, there is a need to make an assessment of whether an upheaval in the financial institution processes reflects the prudence and effectiveness of standards in use. The Global Financial Crisis-Tracing it’s Genesis The new millennium has seen massive changes in different commercial frontiers all around the world. 1The result of this has been enormous expansion of commercial ventures all around the world with particular phenomenal growth observed in china. Heavy investments in the US especially by Asian investors boosted the government and financial institutions reserve kitty which led the government to utilize the opportunity to lower rates on lending to help boost development (Ben & David, 2008). 2The major beneficiary of the low lending rates was the housing sector which greatly increased through provision of favourable mortgages (Bogle, 2005). The credit sector also grew rapidly due to provision of favourable credit terms and the use of credit cards. The phenomenal lending experienced early this millennium plus other associated financial factors led to a huge expansion of the financial system and this made the system highly fragile due to lack of accompanying creation of sufficient financial framework that would cope with an expansion of such a magnitude. The incentives given earlier had encouraged investors to engage in difficult borrowing-borrowing too much. Most of the borrowers soon found they were unable to honour their repayments and this led to a massive increase in defaulters who found themselves unable to repay their loans. 3Due to lack of a sufficient framework to guard them, financial institutions found themselves unable to cope with heavy losses incurred due to loan defaults and this affected their ability to sustain their activities and consequently slowed down economic activity(Ben & David, 2008). The affected institutions, which rely on heavy borrowing from the banks could no longer access loans easily leading to massive slow down in businesses, job cuts and investor apathy especially to the capital markets, where most of the affected financial institutions were trading.4 The capital markets are crucial to business operations and loss of confidence in it meant a big blow to financial operations (Lahart, 2007). Factors attributed to the crisis includes the easy lending conditions encouraged by the government and free market competition as well as ill purpose lending adopted by unregulated sectors with an aim to cash in on the housing boom. The financial shake up of the size experienced recently implies that the standards adopted by financial institutions are not sufficient to cover the financial industry. The argument here is that, there would have been no economic crisis if the current standards used by financial services providers were prudent enough. Formal financial providers apply international standards in the hope that such standards are properly constituted to direct financial activity and absorb shock in cases where the activities do not bear the desired results. The implication of this is that the current accounting standards are not sufficient and there need to be more comprehensive standards which will address risks incorporating global concepts such as fast paced technological advancement, unprecedented population changes and the varying global climatic changes which affect key economic activities and the human resources responsible for production. Need for Change in Standards The economic upheaval experienced implies severely that the international standards used in tracing financial services are actually below expected standards. This argument is validated by virtue of the international accounting standards failure to achieve their objective of protecting the financial sector from risks associated with rapid expansion like the one experienced in the housing and lending sector of the US in the period 2004-2007. 5There is therefore need to critically analyze the standards used today, with a view to assess their weaknesses and shortcomings(James & Roberta,1997) 6There is also need to initiate and draft possible new regulations which would incorporate global factors that are associated with huge economic changes(Ben & David, 2008).. It is worth noting that the economic failure cannot be blamed entirely on use of international accounting standards. 7There are other factors which may not be addressed simply by change of policy. For there to be change, underlying causes of the failure of the financial systems needs top be laid bare so that policies regarding each failure may be constituted (Krugman, 2009). This therefore calls for an in depth analysis of cause and conscious efforts needs to be adopted if a similar meltdown is to be avoided in the future. What Needs To Change In the face of a meltdown similar to the one experienced by major countries who are front runners in shaping the economic shape of the world, there is clear need for change in framework governing financial practice. However, it should be noted that financial activities and the resulting consequences are greatly interconnected and therefore, it will not be sufficient to change only the policy and assume that everything else will fall in line. 8There will be need to address the rigor with which adopted financial framework is followed with in different countries (Ben & David, 2008). This is because the implementation of standards will have a direct bearing on the observable result. Poor policy implementation may taint the strength of a prudent policy and vice versa. There is also need to assess the underlying myriad of political soundness of different regimes which seem to have a bearing on the outcome of policy implementation. 9Worth to note here is the fact that several countries which have relatively huge economies appeared to go through the financial crisis without apparent effect (Krugman, 2009). A case in analysis is Australia which apparently was largely unaffected by the economic crisis. There is therefore need to acknowledge that despite the failure of accounting standards to protect institutions in some countries, the same standards appears to have worked well in some countries. 10The changes needed therefore have to adopt a running theory that the current system is not entirely faulty (Goodman, 2008). That it will be illogical to propose a complete turn around to the current practices. There is need to change the rigor with which supervision of accounting policies is done. 11There is also need to assess the prudence with which major financial institutions are run because this seems to have a direct bearing on economic stability (Goodman, 2008). There is also need to scrutinize the fiscal policies adopted by institutions which apply their own built mechanisms of directing financial activities. A look at Australia during the economic down turn portrays an image of soundness among major players in financial services. Their financial institutions are large and adopt a conservative approach which reduces vulnerability to risk. Also, the past plays a role, where government practices adopted in the past gave a lot of stability to the reserve bank therefore providing a cushion for financial institutions in case of an unprecedented occurrence. Relevance of the Positive Accounting Theory In Face Of the Crisis Accounting procedures and practises the world over needs to take in necessary adjustment to be able to remain consistent with rising cases of global events that alter to a large extent the shape of financial activities among major players. 12The positive accounting theory however does not lose its supremacy in determining direction of accounting standards and regulations (Krugman, 2009). For accounting standards to match international standards, all the complex processes that affect financial situations ought to be analyzed. This is because policies themselves are not enough to ensure efficiency if the implementation strength of policies lacks in strength. Any shift in policy formulation can only be built upon the already existing practise if the financial sector is to remain stable. As argued in this analysis, what is needed is not a complete u-turn in the standards but a deep analysis on the weaknesses of the already existing practise. This can be achieved through consultations among major players. There have been significant efforts so far by the developed nations to enact legislations aimed at addressing the loopholes in the accounting standards. 13According to Krugman (2009) there remains a big room upon which random changes that affects financial service providers can be factored in improving and making necessary changes that would make the international accounting standards more responsive to global changes. Conclusion The current financial meltdown is an illustration of a failure by the standards used to provide a cushion for financial service providers during times of massive changes which have a direct bearing on the economy. This implies that there is need for conscious efforts to be put in place to upgrade or review the current international accounting standards so that they can address such challenges. It is however important to point out that a u-turn in policy framework is not necessarily needed but an assessment into the effectiveness of the existing traditional tools to predict and cushion major financial players in the face of massive changes in the financial sectors. The case of Australia points out that healthy policies adopted over a lengthy period of time can act as a shock absorber when eventualities occur. The steps so far adopted by the developed countries, G20 in reviewing accounting standards and adopting new legislative pieces aimed at bringing accounting standards to a new phase are important and they need to be constantly scrutinized and supported by even more prudent measures. Reference Ben S. & David B. (2008) The Financial Crisis blame Game. Retrieved on 12th Oct.2009 from www.Businessweek.com Bogle, J. (2005) The Battle for the Soul of Capitalism. Yale: Yale University Press. Goodman, P. (2008). Credit enters a lockdown. Retrieved on 12th Oct from http://www.nytimes.com/2008 Krugman, P. (2009). The Return of Depression Economics; the Crisis of 2008. W.W. Norton Company Limited Lahart, J. (2007).Egg Cracks Differ In Housing, Finance Shells. Retrieved on 12th Oct from wsj.com Read More