The Standard Setter - Essay Example

FASB & Fair-Value Accounting Analysis Student’s Name Institution Summaries The Standard Setter: Robert H. Herz, Chairman FASB He acknowledges the fact that the existing reporting model in the United States of America as well fairly integrates both historical costs as well as fair value measurements. He further notes that there have been continued mixed reactions on fair value measurements since its opponents argue that it allows the overstating of level of a firm’s losses, capital erosion and also, as a facet that catapulted the global financial crisis hence calling for its suspensions or intensive modifications (Mark-To-Market Accounting: Practices and Implications, 2009). On the other hand, the proponents argue that it is a fundamental approach that easily exposes the level of problem assets as well as possible weakening conditions of most financial firms hence calling for its continual application. Fair value is defined as being the existing asset worth especially in the course of exchange between informed parties on an arms-length basis as opposed to its potential value at a given future date in regards to distinctive market or even economic situations (Mark-To-Market Accounting: Practices and Implications, 2009). It is noted that the measurement cannot be easily related to the sale of the asset in the event of a distress condition. In essence, the SEC report indicates that the application of fair value measurements varies greatly depending with the entities in place. For instance, it is noted that the application is minimal in such entities as banks in comparison to broker dealers who practice market-to-marker accounting framework (Mark-To-Market Accounting: Practices and Implications, 2009). The mark-to-market accounting occurs in the event that items are carried at their immediate fair value but on a continuous basis. It is especially limited to securities trading portfolios and sometimes accepted in hedges related to derivatives. The Chairman notes that fair value has been existence for a long period as effectively postulated in Standard No. 57 of fair value. This means that the current notion of writing down assets in the course of down markets is not in any way a newer concept hence would be useful and relevant in cases where fair value or other accounting methods are used (Mark-To-Market Accounting: Practices and Implications, 2009). He argues that the slip in the market values of financial assets can be related to complex instruments that have remained to be inactive and illiquid, which calls for immediate data gathering and evaluation processess. These calls have compelled FASB to modify the standard –setting actions in order to resolve possible inconsistencies in regulations related to impairment of securitised assets and, also accounting for financial instruments (Mark-To-Market Accounting: Practices and Implications, 2009).. He continues to note that over the years, FASB has continued to modify standards especially after the crisis period by issuing newer standards as a way of improving transparency related to securitization, financial guarantee insurance as well as credit default swaps. He links the failure of banks and the intensification of the global financial crisis to the role played by financial reporting in relation to economic and regulatory consequences including assumptions made by the immediate application of mark-to-market accounting (Mark-To-Market Accounting: Practices and Implications, 2009).. In fact, he notes that just like the SEC report, fair value measurements did not result to the failure experienced by banks hence discourages against the suspension or even the elimination of the fair value measurements since the role of accounting and reporting standards is to assist the potential investing public positioned within capital markets with logical and unbiased financial information on entities. The Banker: Thomas Bailey, President and CEO; Brentwood Banks The banker argues that the financial reporting regulations intensified the financial crisis as a whole. He notes that the continued application of a mark-to-market accounting model enhanced the freezing of the assets or rather securities markets. Consequently, he asserts that FASB has failed to take any necessary precaution hence prompting the escalation of the global financial crisis as a whole (Mark-To-Market Accounting: Practices and Implications, 2009).. This is despite the fact that FASB claiming to have adopted and employed necessary steps to prevent the weakening of the market. As much as the banking institution finds the support to suspend mark-to-market accounting as a most reliable way, it notes that the action could affect the way the capital markets behave hence; it offers a viable alternative perspective that conforms to the existing accounting rules and regulations (Mark-To-Market Accounting: Practices and Implications, 2009). Mr. Bailey ascertains that both PACB and ICBA encourage the need for transparency of a company’s financial statements. However, he notes that the support cannot be garnered by the current mark-to-market accounting rules and regulations since it fails to promote transparency and thus, misrepresent the true condition of all financial entities that engages in the holding of mortgage-backed securities especially ones related to private label securities as well as other notable financial debt securities (Mark-To-Market Accounting: Practices and Implications, 2009). He continues to argue that adopting fair value measurements in an illiquid market leads to a significantly disproportionate write-downs in regards to the anticipated credit or economic losses. Certainly, he notes that the financial institution is simply concerned with the pro-cyclical nature of a mark-to-market standard within the existing reporting environment. The financial institutions are uncertain about risking the purchase of assets that could lead to possible future material write-downs in the event that a credit loss occurs. Following this line of perspective, the banker notes that the mark-to-market develops a self-fulfilling downward trend especially for prices of MBS as well as other asset-backed and debt securities (Mark-To-Market Accounting: Practices and Implications, 2009). The proposed OTTI rules and regulations are seen to promote level of future possible write-downs that could diminish the capital positions even further and as a result, prompt the hoarding of capital at many of the financial institutions. Mr. Bailey continues to argue that any possible cautious reaction to protect against the future accounting-propelled losses will likely prevent the imminent flow of credit facilities currently in greater demand. In consequence, the OTTI rules have acted to downplay the government efforts to refill capital necessary within the financial industry, which has been seen more of a paper loss since it fails to depict the economic reality(Mark-To-Market Accounting: Practices and Implications, 2009). As a financial institution, the banker notes that the Congress should not be involved in the formulation of accounting standards given that continual application of accounting standard that is focused on valuation emanating from a rather dysfunctional market will only act to increase the existing systematic levels of risk (Mark-To-Market Accounting: Practices and Implications, 2009). Therefore, the institution proposes that the Congress should at all times held FASB and SEC accountable and even ensure that these bodies apply current accounting rules and regulations that relate to application of loans held in portfolio to asset-backed as well as other securities. Consequently, it is further emphasised that the establishment of whether or not OTTI really exists and, also the degree of the loss posted, should be focused on intensive and well-laid credit evaluation that is deemed necessary for the characteristics of the debt security in place. The process is not expected to prevent any form of transparency but rather will improve comparability and consistencies of financial reporting (Mark-To-Market Accounting: Practices and Implications, 2009). The banker notes that the financial institution body is of the similar opinion to the IAS rules that apply both FAS 5and 114 in regards to the recognition of future gains visa-vie posted OTTI losses. The Politician: Paul E. Kanjorski, Congressman The Congressman notes that he had earlier assumed that the entire political system especially the Congress should not interfere with the legislation required in determining and formulating necessary accounting rules and regulations (Mark-To-Market Accounting: Practices and Implications, 2009). He says that the minimal or no interference should because the technical work could be left for other involved stakeholders like regulators, standard setters as well as financial experts. Consequently, the Congress indicates that it has come to realise the existence of pro-cyclical nature of the mark-to-market accounting model, which has resulted to extensive unintended outcomes and, also has played a fundamental role in the recent economic crisis. The Congress ascertains that in the event that the standard setters and regulators fail to provide imminent solutions then the political system will be compelled to act (Mark-To-Market Accounting: Practices and Implications, 2009). The institution does not advocate for a clear suspension of the mark-to-market accounting or even its elimination since it can foster subjectivity of the model. Subsequently, it notes that the standard fails to provide transparency aspect for both existing and potential investors and, also its imminent application within the current environment has distorted as opposed to clarifying the entire picture. The politician further stipulates that the current affected stakeholders should comprehend the fact that fair value accounting does not form a uniformised rule that affects all involved parties in a similar way rather different sectors have witnessed different impacts of mark-to-market rules. In addition to this, it is noted that a given sectors’ challenges in application of the accounting model will always require distinctive treatment or regulatory formulations that will help to resolve the issues related to the industry at hand (Mark-To-Market Accounting: Practices and Implications, 2009). In an effort to effect solution and thus, change, the Congressman has requested the bank-based regulators to consider the process of easing up the current regulatory capital minimum requirements and therefore, allow reasonable formulations that will help curb the economic environment. He argues that the mark-to-market accounting model was not responsible for the economic crisis witnessed just recently hence any effort to alter its functioning and application will not in any way help to curb the economic crisis from ever happening again. But then again, there is still need to improve some of its section in order to conform to efforts meant to tackle global financial distress in future (Mark-To-Market Accounting: Practices and Implications, 2009). Pro-cyclical Nature of Fair Value Accounting &Its Contributions to Global Financial Crisis In my opinion, the existing capital standards, accounting rules and regulations as well as other underlying regulations have contributed to procyclical nature, which has lead financial institutions like banks to ease up credit terms in course of booms and thereafter, tighten up the credit terms in crises (Bout, Hoeven & Langendijk, 2010). The lesser justification of these changes results to uncertain creditworthiness of borrowers hence aggravating procyclical alterations. Most importantly, it is noted that fair value accounting approach always understates the true economic value of all involved financial instruments especially in periods when the securities markets are considered to be depressed facilitating the concerns that relates to the model leading to procyclicality (Barth, Beaver, & Landsman, 2001). There has been significant level of concerns that been put forward to establish the procyclical effect of fair value accounting can have on company’s balance sheets as well as on the overall financial system as a whole. For instance, with the illiquidity of markets in the financial year ending 2007, it was established that only financial instruments that were reported and measured using fair value were considered to have been valued way below their respective fundamental values; that is, their underlying future cash flows or even the amount under which they could have been sold (Ryan, 2008). Due to this phenomenon as well as decreasing securities prices and stringent regulatory capital requirements, compelled many firms to engage in the selling of their financial securities in these illiquid markets (Paolucci & Menicucci, 2014). These unplanned sales might have likely lead to the markets resulting to even more illiquidity and volatility hence leading to a consistent and further decrease in the prices. Likewise, the significant increase in the level of volatility in these markets resulted to increased uncertainties amongst potential and existing investors thereby lowering their confidence within the markets. Moreover, the unrealised losses that resulted from fair value accounting approaches were heavily recognised within the financial statements thereby resulting to a reduced investors’ confidence level facilitating even a further market illiquidity, and also global financial crisis due to instability of the financial instruments prices and company’s immediate value of financial assets (Ryan, 2008). Consequently, it is important to understand the fact that fair value accounting model is deemed to be unreliable especially in the absence of set market prices leading to a possible reduction in comparability and reliability of a firm’s financial statements. In essence, fair value measurements should be able to avail useful and reliable accounting information after incorporating additional disclosures related to level 3 valuations (Véron, 2008). The recent global financial crisis might also have resulted due to the lack of comparability aspect of fair value accounting especially because similar financial assets that are valuated using different purchase prices resulted to identical assets that were apportioned with different fundamental values. Fair value accounting has continued to indicate elements of procyclicality because it increases the level of volatility of reported income, which has a negative effect on financial institutions and the entire financial system as a whole (Wallace, 2008). A recent study conducted in financial institutions indicated that fir value accounting had a direct influence on a bank’s financial statements and, also portrayed that there was a significant increase in the level of volatility in reported revenues and regulatory capital. Some of the recently reported sources of financial statements volatility include; estimation-error volatility, inherent and mixed-measurement forms of volatility. What is more, fair value accounting model promotes a significant inconsistency that occurs whenever measuring assets and liabilities at their immediate present values in case it is expected that a firm will continue operation on an ongoing concept (Ryan, 2008). Most of the financial institutions that sustain their respective business operations model on fair value accounting will likely fail to depict constricted future cash flows of potential investments that are meant to be held till maturity. FASB Modifications on Fair Value Accounting After being pressurised from legislatures and some of the stakeholders within the financial industry, the FASB had no choice but to allow modifications of the fair value accounting measurement so that corporate management could now value assets on their financial statements with less reflection of market prices. The move to bow down to pressure might be a real cause for concern because the adjustments favoured financial institutions over other relevant stakeholders. For instance, the modifications allowed banking institutions to operate under a less risk market environment, which previously had been limited by regulators. However, the modifications could result to potential and existing investors being exploited and deceived on how the banks really are doing. In fact, there is a possibility that the new rules and regulations will now allow banks to eliminate the less risky assets in their financial statements through the Treasury new auction program hence deceiving investors on the true picture of the operations. References Bout B.J., Hoeven, R.L. ter & Langendijk, H. (2010), Fair Value accounting, inactive market en procycliciteit, Maandblad voor Accountancy en Bedrijfseconomie, 84(1/2), 6-25 Barth, M.E., Beaver, W.H. & Landsman, W.R. (2001), The relevance of the value relevance literature for accounting standard setting: another view, Journal of Accounting and Economics, 31, 77-104. Mark-To-Market Accounting: Practices and Implications. (2009). Hearing Before The Subcommittee On Capital Markets, Insurance, And Government Sponsored Enterprises Of The Committee On Financial Services U.S. House Of Representatives One Hundred Eleventh Congress First Session, Serial No. 111–12. Paolucci, G & Menicucci, E. (2014). Critical Insights Back Into the Role of Fair Value Accounting within the Financial Crisis. International Journal of Business and Social Science, 5(8), 80-97 Ryan, S.G, (2008), Accounting in and for the Subprime Crisis, The Accounting Review, 83(6), 1605-1638. Véron, N. (2008). Fair Value Accounting is the Wrong Scapegoat for the Crisis, Accounting in Europe, 5(2), 63-69 Wallace, M. (2008). Is Fair-Value Accounting Responsible for the Financial Crisis? Bank Accounting & Finance, 11(1), 9-18. Read More