The Role of International Accounting Standards in the Global Financial Crisis - Essay Example

The Role of International Accounting Standards in the Global Financial Crisis Student’s Name Affiliate Institution GLOBAL FINANCIAL CRICIS AND INTERNATIONAL ACCOUNTING The global financial crisis that peaked in 2008 has many lessons that have been learned by governments, financial institutions, regulatory and monitoring bodies, multinational corporations, companies as well as individuals. Conversely, many debates have and are going on concerning the main what causes of the crisis. The inconsistencies and disparities in the accounting standards and their enforcements were contributing factors. Perhaps the crisis could be curbed through a better and unified/ standardized accounting system that considers compliance strictly. This paper will look at the global financial crisis, its causation, accounting connection, best practice and conclusion on the best direction of accounting practice. PART A The Global Financial Crisis (GFC) has led to a major debate about fair-value accounting. Many critics argued that fair-value accounting is a root cause of the GFC. However, in trying to identify what might have triggered the GFC; one will always land on the US housing market particularly the difficulty with sub-prime mortgages (Davies, and Whittred, 1980). The initial event was when the news came about owners of homes defaulting on their starting home payments at the start of spring in 2007, which had not occurred before. Most of the literature that had been written about the real estate sector since 2000 through 2005 in the U.S. there was all indications that something was actually wrong. In particular the connection between the ownership society promoted by president Bush and the housing bubble, where it was argued that it would result into a huge transfer of wealth to the rich when the bubble eventually bursts (Wray 2005). However, this might not be the true picture of what caused the GFC. Anything could have triggered the same since in any economy various aspects interact to cause a problem even if one factor may seem very pronounced (Scott, 2011). This means that the GFC as pointed out with more analytic writers it was as a result of several aspects including, debt, and deindustrialization, unfunded liabilities, unemployment, crash of the stock market, inflation as well as Federal Reserve System. Actually anyone who was keen and had knowledge about the operation of the economy especially on accountability and reporting will note that GFC got most of the people off-guard including the policy makers. Some of the economist could predict and sense on what could result out of the events that were occurring in the economy (Leuz, and Schrand, 2009: Diamond, Douglas, and Robert Verrecchia, 1991). A portion of the analysts points an accusing finger on the Fed because it kept the interest rats too low resulting into speculation. This is also not very true because the fed moved to increase the interest rates in 2004 and most of the occurrence was after 2004. Before 2004 the rates had been extremely low but most of the intrigues in the housing market occurred before then. Some other people view GFC to as a result of the stagnant actual wages of the U.S as well as augmenting inequality. Actually this also has got a big part to play because it describes the reason behind the American households going beyond debt trying to keep the living standards. There had not been increase of wages from the start of 1970’s, thus households were going for loans to purchase cars, college and even pay bills (Stocken, 2000). For sometime, raising workers per family assisted to support consumption, however as lending standards went normal and as prices went high, consumption was raised by home equity loans. Really about fifty percent of sub-prime as well as Alt-A lending were second mortgages or homes cash-out refinances (Scott, 2011). Eventually financialisation that refers to the growing role of finance in the economy, augmenting leverage, rising debt layering on top of debt and most of the GDP share that is going into the financial system, looking for interest greater than profit and many others (Harvey, 1999). For instance, the total debt of the U.S went up close to five times the GDP that is compared to the prior peak in 1929 where it was three times as much as the then GDP (Forstater, Mathew, 1999). Actually the debt ration was on the increase since 1960’s however, there was a kink in the two decades that have passed. Financialisation is measured as the ratio to GDP of financial institutions liabilities that shows a new aspect had operated within the latest years. It can be looked at as financial layering: where financial institutions access credit from each other to lend. As a result complex linkages like that failure of one financial institution would lead to the collapse of all others that had its liabilities. This just but a close highlight of financial fragility and thus the GFC was one of the storm acid tests to accounting practices. Accounting information is always for two purposes in a market based economy (Beyer et al., 2010). Firstly, valuation purposes-capital providers like shareholders and creditors use the information to evaluate the probable return of opportunities. Secondly, stewardship purpose-they use the accounting information to monitor the use of the capital once invested/committed (Gassen, 2008). The two roles target to reduce the information asymmetry that characteristically exists between a firm’s insiders and outsiders (verrrecchia, 1990). When there is high information asymmetry, investors are worse placed to make informed judgments which in turn results in sub-optimal investment decisions (Healy and Palepu, 2001; Scott, 2011). The worse decisions as well as moral hazard difficulties resulting from information asymmetry decrease the effectiveness of capital markets like the liquidity, capital cost as well as operating effectiveness of both economy and firms are affected (Galbraith, 1961: Verrecchia and Leuz, 2000). The major mitigation measure to reduce the asymmetry information extent in the capital markets is thus wanted, and this is the disclosure principles. Disclosure has to be complete and timely (Papadimitriou, Dimitri and Wray. 1998). 1. Consolidation as well as enhanced accounting off balance sheet. This involved IASB publishing proposal to strengthen as well as improve the needs for knowing which entities are controlled by a company. These proposals formed a portion of a comprehensive review by IASB of off balance actions and points on a part cited by G20 leaders during their meeting. The response also seeks to give answers to the report that was published during 2008 by the financial stability forum. To both FSF and the G20 a matter of concern was to use of special structures by entities of reporting, especially banks, for managing securitization as well as other extra complex financial arrangements. Part of the commentators have asked if the present needs have led in entire assets controlled by an entity and entire liabilities being reported on the balance sheet. Like concerns are that financial institutions do not communicate the extent to which entities of reporting are exposed to perils from those sorts of structures (Kothari, Wysocki and Susan Shu, 2009: Kasznik and Baruch 1995). 2. Derecognition On derecognition, more proposals on off balance sheet objects, covering the derecognition of both the financial assets as well as liabilities were published to ensure compliance with the best practice in the field. PART B some particular IASB standards have received much attention during the GFC, for example IAS39 financial instruments. As part of IASB’s responses to the GFC, the IASB amended IAS39 during the crisis to allow for reclassification of financial instruments. 3. Financial Instruments There are different financial instruments that are characteristic to the circulation of money in an economy. Some of them are discussed here as follows: (i) Short term Via October 2008 an Amendment to financial assets reclassification by IAS 39 Due to the crisis as well as amidst complaints emanating from the EC that those entities utilizing IFRS were at a demerit as compared to their counterparts in the US , the board did issue an amendment to ISA 39 that allow reclassification of particular financial assets in specific situations. Whereas bringing US GAAP (generally accepted accounting principles) and IFRSs (International Financial Reporting Standards) more in order, dissimilar scope, and vary and destruction requirements meant that variations in treatment would still be there. The incident exposed sharply the difficulties for investors if two dissimilar sets of accounting rules for the same situations are present. A draft of exposure-Improving Disclosures concerning Financial Instruments – October 2008 The draft of exposure put forward amendments to requirements of disclosure that are based on a three level fair value hierarchy (the same to that utilized in Statement of Financial Accounting Standards of No. 157 Fair Value measurements that were issued from the Financial Accounting Standards of the US). The amendments proposed would need disclosure concerning the fair value hierarchy level into which fair value measurements are classified in their totality, the fair value measurement resulting from the utilization of important unobservable inputs to assessment techniques as well as the movements amid dissimilar levels of their fair value hierarchy. The draft of exposure also proposes those amendments that would elucidate the meaning of liquidity risk, enhance the quantitative disclosure concerning liquidity risk as well as strengthen the relationship amid qualitative and quantitative disclosures concerning liquidity risk. Educational leadership on the appliance of financial instruments’ Fair Value Measurement when markets turn out to be inactive This guidance occurred in the form of a summary document that was prepared by IASB staff as well as the ultimate report of the expert advisory panel that was set up to look into the matter. The summary document underlined the context of the expert advisory panel and outlines issues associated with measuring financial instruments’ fair value when markets turn out to be inactive. It took into account as well as it is consistent with documents that were issued by FASB based in the US on October as well as by the accounting office of the SEC (securities exchange commission of US) as well as FASB workforce. The report by the expert advisory panel sums up seven meetings of experts that happen to users, preparers as well as auditors of financial statements and regulators as well as others. Within the report, the panel recognizes practices that experts utilize for measuring financial instruments’ fair value when markets turn out to be inactive as well as helpful practices for fair value disclosures like situations. The report offers helpful information as well as educational guidance concerning the processes utilized and judgments made during measuring as well as disclosing fair value. IASB further utilized the panel’s work that address the matters of disclosure, a field recognized by the (FSF) Financial Stability Forum together with fair value measurement as well as accounting off balance sheet. The results of the panel were integrated in the preparation of the exposure draft suggesting enhancement to IFRS seven financial instruments: the published disclosures that are utilized in the development of the standard on fair value measurement (Gallery, Cooper and Sweeting, 2008). Some of the new developments by the boards include: (a) Impairment This is a new requirement of disclosure linked to impairment. Following the latest convened round tables of FASB-IASB, the FASB as well as the IASB are both proposing identical new requirements of disclosure connecting to impairments. The proposals do require corporations to disclose the profit or loss which would have been recorded if entire financial assets (besides those that are classified at fair value via profit or loss) were measured utilizing amortized cost (that is utilizing an incurred model of cost) or entire had been measured utilizing fair value. Both boards published their drafts of exposure in late December 2008. They are seeking comments to better their work with time as soon as they purpose. (b) Guaranteeing reliable treatment of accounting for specific credit-linked Investments amid US GAAP as well as IFRSs A number of stakeholders have pointed out the need to elucidate any likely dissimilarity in the accounting treatment amid US GAAP as well as IFRSs. The FASB is process of planning to issue obligatory guidance of implementation, and would undertake the guidance draft in a short while. The guidance would make sure consistence amid US GAAP and IFRS- an aim backed by the entire G20 leaders. (ii) Medium term The round tables participants saw an urgent requirement for a wider examination by the FASB and the IAB of the position held by fair value measurement for financial instruments, comprising of the issues of enhancing the impairment needs, classification issues, the fair value alternative, and the transfers amid the categories (Chan, Faff, Ho and Ramsay, 2007). The two boards have concurred concerning fast trucking of this urgent project that could involve important alterations to IAS 39 as well as the relevant standards of the US. Given the urgency of the issue by the two boards’ aim is to work to complete this project in a period of few months as opposed to many years. The two boards have considered the FASB/IASB recommendations of financial crisis advisory group that was chaired by Goldschmidt Harvey, a former commissioner of the SEC of US as well as that of Hoogervorst Hans, the chairman to the Netherlands Authority for the Financial markets which will be together taken into account via the two boards as they debate main changes to the current financial instruments standard (Greenhouse, Steven. 2011). Among the many issues that the FCAG undertook to discuss include the following: Those areas that financial reporting was useful in identifying issues of concern throughout the credit crisis; those where financial reporting standards was in a position to offer more transparency to assist either expect the crisis or react to the crisis more rapidly (Towle, Ray and Ross, 2007). Other areas included whether to reconsider priorities for the FASB and the IASB in credit crisis light; probable areas that need future attention of the FASB and IASB so as to avoid future disruption of the market; the credit crisis implications for the interaction amid overall purpose financial reporting needs for capital markets as well as the regulatory reporting, especially for financial institutions; the association amid off balance sheet and fair value accounting and the present crisis, both throughout and resulting into the crisis; the outcomes and relevance of conclusions of different studies underway, comprising of the US SEC’s study under the 2008 of Emergency Economic Stabilization Act; the necessity for due process of accounting standard-setters as well as its implications on resolving emergency matters on a timely as well as inclusive process, and eventually the independence of accounting standard-setters as well as governmental steps to the international financial crisis (Laux andLeuz. 2010). PART C At the same time the two boards moved to enhance accounting practice the Australian, accounting standards board also teamed up with the IASB to come up with its standards that would meet the international level. AASB in Australia makes accounting standards that should be applied by corporations lodging their financial statements as par part 2m. 3 of the company’s Act 2001 as well as are further responsible for developing a conceptual framework within the context that the standards are made. The AASB was concerned with the financial reporting part during the GFC (Corporations Act, 2011). We should first note that Australia was not highly hit by GFC since it was able to take a proactive or rather reactive measure to combat the impact. Concentrating on the disclosure aspect of information it was able to map its way out. The AASB did note that the proposed simplified needs in relation to offers for investors of institutions’ investors rely to a higher level on the market being offered with pertinent information via annual reports and comprise proposals which issuers have particular continuing information in their yearly reports (Tinaikar, 2008)information is suggested, for instance, in connection to relief since the on-sale necessities for the on-sale of underlying quoted securities issued on the convertible notes . This comprises the number notes which can still undergo conversion, the number of fundamental securities they will have to be converted into, how much will be paid on converting as well as the situations under which conversion might take place. Like information might already be seen in financial statements through virtue of requirements of disclosure within AASB 7 financial instruments: Disclosures. Nevertheless, the requirements of AASB 7 are widely expressed as well as might not capture the particular information that ASIC regards significant in the context of the suggested relief. Accordingly, given this particular information does not detract from, or disagreement with, the information needed by AASB 7, the AASB is not concerned with ASIC looking for that particular information comprised in annual reports (Vyas, 2011). Yearly reports as an effective source of data for investors according to this importance, AASB notes that entire projects that are undertaken by the AASB as well as IASB –whose standards have, are integrated by the AASB- targets enhancing the helpfulness of the financial statements to users, comprising of investors (Corporations Act, 2011). The important test to find out if a need must be comprised in an accounting standard is whether the profits to users are considered to be beyond the costs of preparing and communicating that information. This examination is integrated in conceptual framework for the preparing as well as presenting the financial statements of the board. In this line AASB and the IASB are carrying out a number of projects that are of specific relevance o taking into account the requirements of users of financial statements (Whittred, Greg and Zimmer 1984)he IASB is presently revising its conceptual framework which comprises of the following stages: objectives as well as qualitative characteristics; measurement; definitions of elements, derecognizing as well as recognition; reporting entity concept; purpose as well as status of the framework; boundaries of disclosure, presentation and financial reporting and application of the framework to non profit making organizations. CONCLUSION To sum up, the global financial crisis has many lessons learnt by regulators and standard setters. 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