The U. Ss Financial Reporting System - Example

Mark-To-Market Accounting: Practices and Implications Name: Institution: Mark-To-Market Accounting: Practices and Implications Statement by John Kroeker The U.S’s financial reporting system is a major asset for its capital markets as it is well thought-out and one of the best in the world. The primary reason for this is that the system is a commitment to furnish investors with relevant financial information. Moreover, the system focuses on investors since they are the main beneficiaries of financial reports. Kroeker (2009) notes that the disturbances in the economic factors should not make the capital markets do away with transparency in its financial system. Due to the market conditions, an independent regulator is the best suit to set financial reporting standards for all the players in the capital markets. The FASB sets these standards in the UK and is independent of any undue influence. After establishing the factors that led to financial crises, many professionals accepted the fact that fair value accounting was the best way to put across investment values. Even though the fair value can be traced back to many generations, it became popular in 1975. The popularity of the fair value can be attributed to the financial crises of the 1970s. After the adoption of fair value accounting, there are several efforts that have been made to improve the concept. Some of the recent recommendations of improving the standards were done in 2008. For instance, the commission believes that financial transparency in the capital markets can only be achieved through the collaboration of all the participants in the markets. Additionally, it is the view of all the players in the capital markets that FASB should continue to address accounting problems that arise out of financial crises. Among the recommendations made that the commission reckons will improve an already world class financial reporting system includes improving FAS 157 rather than suspending it. Just like the FAS 157, the existing fair value as well as mark-to-market requirements should not be suspended. Additionally, more measures should be taken to enhance fair value accounting and the financial asset impairments should be addressed. Besides, accounting standards should be aimed towards meeting the needs of the investors (Kroeker, 2009). Role of FASB The primary role of FASB is to set accounting standards that can be relied upon by all the stakeholders in the financial markets. The process for setting the standards is often public and invites proposals on how to improve the standards. The accounting standards developed must ensure transparency by making certain that the financial reports furnished to the public reflect a true and fair view. Although FASB makes the final decisions on the standards, there is a process that is always followed. The views of all the interested parties in the accounting standards are taken into consideration. These stakeholders include auditors and users of financial information (Herz, 2009). Accounting standard setters play different roles as compared to prudential regulators. While the standard setters focus on coming up with accounting standards, the regulators primary concern is to ensure the safety and soundness and financial stability of the capital markets. The financial reports prepared in accordance with the accounting standards provide investors as well as the capital markets the relevant information required to make investment decisions. Apart from the market regulators, the federal government also plays a significant role in ensuring that the financial markets are stable. Additionally, there is also the GAAP that was enacted in the outcome of the 1980s savings and loan crisis to regulate banks. In general, for accounting standard setters, the question is as to whether the steps taken to address the issue of true and fair value serve to furnish investors with relevant information on the securities markets (Herz, 2009). Background of the GAAP for Financial Instruments The next panelist for the day aimed to shed light on the background of the GAAP for financial instruments that are a mark-to-market. Fair value accounting has been a component of accounting in the United States for a long time. All the financial statements prepared by the firms in the U.S must reflect the true and fair value of the business at the time of preparation o the statements. However, in the U.S, the FASB administers GAAP and determines the extent to which the assets and liabilities represent a true and fair value. In the capital markets, valuation of financial assets is imperative and there are various instruments that are used to value the assets. For example, with the mixed attributes model, specific financial instruments are put under fair value accounting. Furthermore, other financial instruments are measured using the cost-based as well as impairment valuation concepts. At this point, it is of merit to note how periodic changes in fair value and provided for under the income statement. The period-to-period changes in fair value are either recognized through income or as equity in the section of the statement of financial position (Bailey, 2009). A financial asset is considered to be impaired to be impaired if it is not subject to fair value measurement. An example of a financial instrument that is considered to be impaired is the loans. The relationship between fair value accounting and capital requirements is that regulatory capital requirements include any changes in fair value exposures. Just like the preceding panelists, OCC is of the view that fair value measurement provides important information on the value of financial instruments to investors. Additionally, more measures should be taken to improve the purpose of exiting fair value requirements. What is more, when assessing the application of GAAP-based requirements, banks should put into consideration the sensitivity in regulatory capital (Bailey, 2009). Fair Value Accounting: Understanding the Issues Raised by the Credit Crunch Although the next speaker recognizes that the US accounting standard setting structure should be improved, he opposes any efforts by the legislature since it would diminish the independence of the accounting standard setting. It is view of the Council of institutional investors that the U.S should avoid any changes in changes in the accounting standard setting that may only cater for short-term interests. Moreover, the panelist notes that the Council agrees with the recommendations of the first panelist on Mark-to-Market Accounting. Since the Council is independent, it updates its policy from time to time to ensure that it remains independent. At this point, it is important to note the effect of fair value accounting on the economy. Fair value accounting provides investors with accurate information hence improving investment decisions. Moreover, it does not allow firms to manage their income through trading gains. Furthermore, fair value accounting is the unsurpassed platform for mandatory and voluntary disclosure and investors (Mahoney, 2009). The author also outlines reasons that he believes fair value accounting hurts investors during a credit crunch. For example, fair value is a poorly defined notion involving hypothetical transaction prices when markets are illiquid. Moreover, when fair values are provided by sources other than liquid markets, they are unverifiable hence cannot be relied upon by investors. What is more, fair value mixes normal components of income such as interest with unrealized gains or losses. Fair value accounting also increases volatility of firms as it recognizes unrealized gains as well as losses (Mahoney, 2009). The Value of Fair Value The primary role of the audit profession is to promote sound capital markets in the interest of the investing public. The auditors make a significant contribution to financial statements by attesting that the reports are prepared in accordance with GAAP. CAQ recognizes the contributions that fair value accounting in improving the transparency of financial reporting. Nevertheless, CAQ also recognizes that the criticisms against fair value accounting are based on the current issues facing the financial markets but believes that the current fair value requirements should not be changed in the current period. Moreover, it is the view of CAQ that fair value measurements are just as important when markets are illiquid just as in other times. What is more, recent bank failures were caused by the quality of loan portfolios and not fair value accounting. In this view, doing away with fair value and mark-market accounting would affect investor assurance in financial instruments (Fornelli, 2009). Questions on regulatory capital requirements have been raised based on the effect of the financial crisis on financial institutions and specifically on the financial reporting needs of the investors. CIFiR in its 2008 recommended that financial reports be prepared for the sole benefit of the investors. Investors need to be aware of the current value of loans and securities in order to make rational investment decisions. CAQ makes various recommendations that are aimed at enhancing fair value as well as addressing the financial crisis. The first recommendation is that FAS 157 should provide a clear guidance about how to evaluate inputs when valuing financial assets. Furthermore, FAS 157 should come up with a valuation method based on principles and provide more specific examples. What is more additional guidance is required in terms of presenting financial instruments (Fornelli, 2009). Mark-to-Market Accounting: Practices and Implications The current issues before the subcommittee touch the heart of the community bankers and how they will serve their specific marketplace in the future. Given the economic crisis in the country at that time, applying rigid accounting rules would be detrimental to the capital markets. The panelist recognizes that the hearing will bring full public disclosure of the actions of SEC and FASB and all those responsible be held to account. Nevertheless, FASB does not seem to recognize the urgency of the situation a three weeks to the closure of the first quarter, FASB has not taken any action. The panelist aims to offer an alternative that would address only OTTI recognition (Bailey, 2009). The current mark-to-market operations accounting rules hold back the transparency and twist the true picture of financial institutions holding mortgage backed securities. In accordance with GAAP, a company should assess its investment securities portfolio to establish if fair value is lower than book value. Moreover, fair value accounting is difficult to ascertain in an illiquid market. Furthermore, the current accounting rules have various negative impacts on the capital markets. For instance, they hurt the market’s ability to revive and establish market-driven pricing. However, the panelist feels like the solution is for the Congress to hold FASB accountable for letting the situation exist in the first place (Bailey, 2009). The Problem: Market Disruptions and FVA FAS 157 gives three inputs that are used for measuring fair value based on the extent to which the inputs can be observed in the market. Level 1 of the inputs denotes quoted prices in active markets while level 2 is for quoted prices of similar instruments. Level 3 on the other hand is for measurements that integrate unobservable inputs. In theory, the three levels of input seem like they can provide firms with sufficient flexibility to utilize the level that they deem appropriate. It is the view of the panelist that given the current market disruptions, FVA should accord firms the chance to move to level three in the case of securities. This can make the firms integrate internal management assumptions and provide realistic valuations. Nevertheless, this is not currently provided for given the lack of guidance from FASB, SEC along with PCAOB (Cotton, 2009). The panelist provides several solutions that can be used to address the current situation. For example, there is need for additional guidance on the best practices when it comes to fair value accounting. Moreover, there should be guidance from SEC on the clarification that level 3 can be relied upon in the case of disrupted markets. What is more, accounting policy makers should provide reporting entities on where level 3 can be applied. CMSA also believes that there should be a thorough examination of the current accounting models with the aim of gaining a better understanding of their impact in non-functioning markets (Cotton, 2009). Mark-to-Market Accounting: Practices and Implications by SBCC Group The panelist just like the preceding panelist does not support the removal of fair value accounting that applies the mark-to-market accounting. Moreover, the panelist also believes that this would erode investor confidence which is already low. The panelist believes that the Congress Subcommittee should persuade standard setters along with the regulators to provide users with urgent help in gaining an understanding of the difference between going concern and liquidation valuation. What is more, mark-to-market should not be abandoned and that more disclosure should be done when applying different methods (Beder, 2009). In terms of fair value, the panelist is of the view that the subcommittee should adopt a more flexible approach when defining the concept. Current accounting standards do not permit the application of multiple measures. On this matter, the panelist is of the view that the Subcommittee should recommend to the standard setter to give a thought about the benefits of using multiple approaches. Furthermore, the mark-to-market accounting tends to be pro-cyclical as it overstates values during good times and understates them during bad times. The panelist recommends that the Subcommittee should make it its mission to bring down the impact of pro-cyclical valuations (Beder, 2009). Mark-to-Market Accounting: Practices and Implications by NCPA The panelist ascertains that the current wealth destruction is as a result of the unquestioning adherence to the accounting doctrine that in the first place never applied to banks and other regulated financial intermediaries. The author then cites Paul Volcker who had made various recommendations that could help salvage the situation. For example, he notes that fair value accounting should be reevaluated in such a way that it gives realistic guidelines when dealing with fewer liquid instruments in disturbed markets. Moreover, there is a need to resolve the business purpose served by regulated financial institutions and the interests of creditors and investors (McTeer, 2009). Expected Losses vs. Mark to Market Write-downs The author begins his presentation by using an example to show the distortion takes place when applying mark-market accounting. The example shows a bank that required making a maximum expected lifetime losses of $100 but in the end ended up making $913 loss due to MTM. Nevertheless, he disagrees with other panelists by stating that the SFAS 157 should be suspended and that should have been done at least nine months prior to the current events being experienced in the market. The alternatives that the panelist gives include having a system can give to system that reflects market pricing without necessarily eradicating earnings and having a balance sheet that has tables showing the current market value of portfolios. Moreover, the system to be adapted should not value one section of the balance sheet as compared to the other sections (Isaac, 2009). The panelist also recognizes that the current system is unaccountable because while FASB sets the accounting standards, SEC has the power to overrule them in the case of public companies but has never done that. He goes further and opposes SEC quest to let the ISAB set take control because it will be more unaccountable as compared to FASB. Moreover, the panelist also suggests that the Uptick rule should be reinstated by SEC as it provides investors with options during such times of financial crises (Isaac, 2009). Opening Statement of Congressman Paul E. Kanjorski The Chairman starts his presentation by outlining the agenda of the meeting which is to examine the mark-market accounting rules. It is his hope that the meeting will be constructive given the diverse opinions expected to be presented. It is of merit to note that he also restates his position on the issues since he does not see it to be best suit for the Congress to interfere with the process of setting accounting rules. It is his view that the process should be left to standard setters as well as financial experts along with regulators. Nevertheless, he notes that the discussion can no longer be delayed since the mark-to-market accounting has already caused enough unintended consequences. Moreover, MTM has enhanced the current economic crisis. He notes that the Congress had no option but to intervene since the standard setter together with the regulators had failed to act in time to prevent the current events. Additionally, he also notes that although the MTM gives investors transparency, its strict application in the current market conditions is distorting instead of giving a clearer picture (Kanjorski, 2009). The Chairman goes further and gives an example of the Federal Home Bank of Atlanta that had estimated cash flow losses of $44,000 but due to MTM this was not the case hence leading to the intervention be the Congress. He also notes that although many industries have been hard hit by the distortions due to MTM, the financial services sector has been hit the most. Moreover, he reminds the panelists to keep in mind that what may offer solutions for one sector may not offer solutions for the other hence they should aim at providing diverse solutions. He also notes that the meeting is all about progress and solutions to the current crisis and action must be taken sooner. Statement of Representative Ron Klein It is always imperative to furnish investors with unbiased information to enable them make sound investment decisions and fair value accounting serves as a way of increasing transparency. Although they are laudable principles that need to enjoy universal support, however, they have shown notable flaws in practice. Even though, mark-to-market accounting rules could not have necessarily caused the economic downturn, they seem to have accelerated it. The panelist then gives an example of Warren Buffet who has been a strong supporter of MTM but had recently called for the suspension of the rules in the current market conditions (Klein, 2009). Question 2 I partly agree with the view expressed by the participants that even though mark-to-market accounting rules did not cause the economic downturn, it contributed to some extent. For instance, Asian policy-makers took several severe responses to the global financial crisis and the looming economic downturn. Moreover, some countries in Asia emulated the U.S and some European countries and guaranteed repayments of all deposits held by legal institutions. Moreover, other countries considered easing of the mark-market accounting rules to ensure that asset values decline (ASEAN Studies Centre, 2009). This is itself is a clear indication that MTM contributed to some extent the economic downturn to which I agree. Moreover, in another report other than that of the Congress, the financial inquiry team also notes that MTM was partly to blame for the economic downturn. For example, the lack of ability by financial institutions to liquidate their PMBS assets under MTM was an accelerator to the crisis (Financial Crisis Inquiry Commission, 2009). Question 3 It should be a cause of concern that FASB eased the MTM rules just after the hearing. The primary reason for this is that FASB is an independent body and its decisions should not be influenced by any other parties. Moreover, FASB maintains influence as the accounting standard setter for the United States by carefully protecting its prestige and status for setting excellent standards. However, when it is influenced by the Congress to ease some of its rules, then its prestige and independence is called into question. FASB must walk a fine line between constant improvements of accounting standards as well as provide more full and fair information to all stakeholders. Nevertheless, to balance the opposing forces, FASB often seeks consensus by requesting written comments and sponsoring public hearing on all its proposed standards (Albrecht, Stice, Stice & Swain, 2010). This did not happen in this case as FASB was summoned by the Congress for failure to take proactive action to prevent the crisis. Moreover, instead of FASB inviting all stakeholders to share their views on the subject, it was the Congress that did so calling into question the role of FASB in the whole hearing. Nevertheless, the action that FASB took in easing the rules was worth it as it helped in easing the situation. In future, FASB should take action if such events are anticipated. References Albrecht, W., Stice, J., Stice, E., & Swain, M. (2010). Accounting concepts and applications (11th ed.). Mason, Ohio: Thomson/South-Western. ASEAN Studies Centre,. (2009). Global Financial Crisis: Implications for ASEAN.. Singapore: Institute of Southeast Asian Studies. Bailey, K. (2009). Testimony of Kevin J. Bailey Deputy Comptroller Office of the Comptroller Of The Currency Washington: U.S House of Representatives. Retrieved from http://archives.financialservices.house.gov/Hearings/hearingDetails.aspx?NewsID=1290 Bailey, T. (2009). Statement Of Thomas Bailey, Chairman, Pennsylvania Association Of Community Bankers, And President And Chief Executive Officer, Brentwood Bank, On Behalf Of The Independent Community Bankers Of America (1st ed.). Harrisburg P.A: Pennsylvania Association Of Community Bankers. Retrieved from http://archives.financialservices.house.gov/Hearings/hearingDetails.aspx?NewsID=1290 Beder,. (2009). Mark-to-Market Accounting: Practices and Implications New York: SBCC Group Inc. Retrieved from http://archives.financialservices.house.gov/Hearings/hearingDetails.aspx?NewsID=1290 Cotton, L. (2009). Statement Of The Commercial Mortgage Securities Association Before The United States House Of Representatives Committee On Financial Services Subcommittee On Capital Markets, Insurance, And Government Sponsored Enterprises New York: Commercial Mortgage Securities Association. Retrieved from http://archives.financialservices.house.gov/Hearings/hearingDetails.aspx?NewsID=1290 Financial Crisis Inquiry Commission,. (2009). The Financial Crisis Inquiry Report: The Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, Including Dissenting Views. New York: Cosimo, Inc. Financial Crisis Inquiry Commission,. (2009). The Financial Crisis Inquiry Report: The Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, Including Dissenting Views. New York: Cosimo, Inc. Fornelli, C. (2009). Testimony of Cynthia Fornelli Executive Director, Center for Audit Quality Before the United States House of Representatives Committee on Financial Services Washington D.C: Center for Audit Quality. Retrieved from http://archives.financialservices.house.gov/Hearings/hearingDetails.aspx?NewsID=1290 Herz, R. (2009). Financial Accounting Standards Board Washington: U.S. House of Representatives. Retrieved from http://archives.financialservices.house.gov/Hearings/hearingDetails.aspx?NewsID=1290 Isaac, W. (2009). Mark to Market Accounting Expected Losses vs. Mark to Market Write-downs (1st ed.). Emeryville: The Secura Group of LECG. Retrieved from http://archives.financialservices.house.gov/Hearings/hearingDetails.aspx?NewsID=1290 Kanjorski, P. (2009). Opening Statement of Congressman Paul E. Kanjorski Subcommittee On Capital Markets, Insurance, And Government Sponsored Enterprises Washington: U.S House of the Congress. Retrieved from http://archives.financialservices.house.gov/Hearings/hearingDetails.aspx?NewsID=1290 Klein, R. (2009). Statement of Representative Ron Klein Washington, D.C: U.S House of Representatives. Kroeker, J. (2009). Mark-To-Market Accounting: Practices and Implications Washington, D.C: U.S Securities and Exchange Commission. Retrieved from http://archives.financialservices.house.gov/Hearings/hearingDetails.aspx?NewsID=1290 Mahoney, J. (2009). Fair Value Accounting: Understanding the Issues Raised by the Credit Crunch Washington D.C: Council of Institutional Investors. Retrieved from http://archives.financialservices.house.gov/Hearings/hearingDetails.aspx?NewsID=1290 MacTerr R (2009) MARK-TO-MARKET ACCOUNTING: Practices and Implications. Dallas. 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