The Socio-Economic Context of Financial Accounting - Example

Abstract The paper which evaluates the role and importance of fair value accounting from the socio-economic perspective shows the manner in which financial reporting has changed. It is seen that business give importance to fair value reporting so that the society at large is provided with better information. This would have been beneficial even during the global financial crisis and would have helped to reduce the degree of risk to a large extent. In addition to it the manner in which different European economies work in close relation with one another the role of fair value accounting becomes important as it will help to provide correct and timely information through which better corporate governance will be achieved. This is tune with IFRS will help to ensure that the different needs of the society is better preserved and protected thereby helping to create a conducive environment for working. Introduction Financial accounting and reporting holds an important place in the society as it shapes the socio-economic environment. Financial reporting not only holds an important aspect for firms, investors, bankers and others associated with the industry but also impacts the society on a large. This thereby makes it imperative that the accounting standards are considered in tune with socio-economic context so that the larger interest of the society can be protected. This paper thereby looks to evaluate the manner in which the principle of fair value accounting will help to serve the purpose of socio-economic needs and the role it has in IFRS. This is also looked from the manner in which global financial crisis could have been of lesser magnitude and could have impacted the economies if fair value principles were used. The paper then looks at the same from the European context and presents different principles and mechanism for different groups and constituencies so that the impact can be better understood. This will help to ensure that economies will be able to look at the socio-economic context and the manner in which better opportunities for the society could be garnered in the future. Fair Value Accounting Organizations today give more impetus and importance to International Financial Reporting Standard (IFRS) as better standards have been developed and used so that recognition of assets and liabilities becomes better. The approach looks to work on the principle of recognizing assets and liabilities at a value which is fair. The value which is identified might be either more or less than the market value. The value which is identified should be actually a fair value and should be consistent (Adams, Coutts and Harte, 2005). This helps to ensure that assets and liabilities are presented in correct value which will thereby ensure that the interest of the stakeholders is protected. The traditional accounting practices focused towards the concept of historical cost i.e. identifying the assets or liabilities at the purchase price; the realizing concept which doesn’t recognize profits until they are actually realized; matching principle which looks at matching cost with revenues and having a principle of conservatism. The inadequacy to identify the different assets and liabilities has led towards the concept of fair value measurement which ensures that all assets and liabilities are identified at fair value (Blokdijk and Drieenhuizen, 2012). Even the global financial crisis brought forward the fact that if organizations had used the fair value measurement the impact on different economies would have been much less and would have ensured that economies don’t engulf into a financial contagion. The basic purpose of fair value measurement is to estimate in the best possible manner the prices at which the assets and liabilities would change hand based on the present condition and information. This thereby requires that firms incorporate all information pertaining to future cash flow and current risk-adjusted discount rates while identifying the correct value of assets and liabilities. Using the same principle during the global financial crisis would have helped economies to provide the society, lenders, bankers, financial institutions and other stakeholders with better information. This would have acted as a guide through which the valuation of assets and liabilities would have been fairer and would have helped to ensure that society doesn’t lose. On the whole the concept of fair value measurement would have helped to reduce the impact of global financial crisis and would have acted as a check point through which better liquidity would have prevailed. IFRS advocates the principle of fair value measurement on the ground of relevance as they consider fair value to be the most relevant measure for identifying the correct value of assets and liabilities. This becomes possible if the value of assets and liabilities is identified clearly and unambiguously and can be measured reliably. Further, fair value estimation should be based on important determinants like understand ability, relevance, reliability and comparability. This would have helped investors and the society on a large to understand the actual ground reality during the global financial crisis and would have helped to ensure better liquidity and deal with the financial crisis in a better way. Fair Value Measurement & Global Financial Crisis The concept of fair value measurement and reporting would have helped during the global financial crisis as it would have helped the society to use the different information in a better way. Even during the bubble price period, fair value principles would have ensured more accurate, timely and accurate information which could have been easily compared thereby providing alternative measurement attributes. This would have guided the society by providing timely and accurate information through which better decisions would have been taken. This would have at least provided the time and opportunity where the society would have looked to identify new and better ways to reduce illiquidity and deal with crisis in a better way. The global financial crisis resulted in large write downs in the value of assets and increase in the value of liabilities as organizations didn’t look to reflect the true value of the assets and liabilities. The usage of fair value measurement would have resulted in large write down before the crisis and would have averted the risk. It would have made investors more and more pronounced as they would have had the information which they could have used to take important financial decisions. The usage of fair value measurement after the financial crisis has been mostly witnessed within the banking and broker-dealer industries. Organizations which tend to provide credit protection to people through the process of credit defaults swaps for the underlying assets as compared to insurance contracts have been impacted drastically by fair value measurement (Crowther, 2000). This is because the process of fair value measurement results in bringing forward the actual value of assets and liabilities which gave importance to insurance contracts and moved away from credit default swaps. This is on the backdrop that the defaults which would have triggered protection might not have occurred but organizations under the fair value measurement have to recognize the unrealized losses which resulted in the value of the underlying assets to decrease significantly. This was not clearly highlighted before the global financial crisis and when the same was brought forward it resulted in reducing the value of the underlying assets which created a financial illiquidity and thereby resulted in impacting all economies which includes European economies as well. Fair Value & European Context The application of fair value measurement has its applicability in the European context as well. Since, all countries are interrelated to one another and they carry out transactions so fair value estimation would have helped economies to ensure that all assets and liabilities are recognized at correct value. This would have reduced the contagion impact between economies as it would provide the required platform through which informed and better decisions can be taken. This will help the stakeholders to be able to garner better and accurate information based on which financial decisions can be taken (Birkin, Edwards and Woodward, 2011). This will help the stakeholders to be better placed as having the correct financial picture will reduce the risk and provide an opportunity to take decision through which their financial risk will be reduced. The concept of fair value measurement has also been criticized by different proponents on the grounds that it produces inaccurate results in unusual market conditions which was experienced during the global financial crisis. This has an impact on the long run performance of organizations. Recording losses in such an unusual circumstances leads towards decrease in the value of assets which is misleading as over a long period of time it is bound to change. This thereby requires that only realized gains and losses are recorded and others should not be recorded (Bondy, Matten and Moon, 2014). This again goes again the principles of fair value measurement which looks to provide accurate information to the investors so that their interest can be protected over a longer period of time. This thereby helps to ensure that the long run which is not certain is preserved by having policies which looks to protect them in the short run and fair value measurement serves as an important dimension in ensuring that the requirements are better met. In addition to it the impact fair value measurement has on the long term is unknown. The accuracy with which the fair value measurement helps to reflect the long term can only be seen over a longer period of time. Since, the process looks towards having a mechanism where the current market conditions are incorporated; it thereby helps to increase the degree of transparency and provides stakeholders with better picture of the performance (Blokdijk and Drieenhuizen, 2012). This could have been helpful during the financial crisis as it would have changed the manner in which different business decisions were taken and would have protected the stakeholders from losing money in the market. The concerns which have been developed due to the present market illiquid conditions raises doubts about the applicability of the fair value measurement due to illiquidity and volatility in the market. But, since fair value measurement helps to bring forward the actual realities to the investors it ensures transparency and protects the stakeholders (Bebbington and Thomson, 2011). It serves the socio-economic need of financial accounting to ensure that the interest of the stakeholders are protected and fair value measurement acts as a guide and important determinant which helps to achieve the same. Fair Value in Developed Economies It is also seen that developed economies like UK have stressed the need and importance of using fair value measurement under the IFRS. It is on the backdrop that fair value measurement is one of the most effective and reliable method which provides actual reality about the market conditions. This helps to ensure that the stakeholders are better placed and can use the information to take different decisions which they think applicable. UK has ensured that all financial information are made under the principle of fair value measurement to ensure that the actual market conditions are incorporated in the planning process (Adams, Hill and Roberts, 2008). This will help them to reduce the chances of another financial crisis and will help to protect the interest of the stakeholders. The process will also ensure that UK is able to carry out the socio-economic needs of the society and the financial accounting is developed in such a manner that it helps to serve the interest of most people. UK on the same direction has been more attentive as the different methods which have to be used for ascertaining the correct value has to be selected correctly. It has been estimated that fair value measurement should be applicable to the market irrespective of the erratic market conditions and similar securities should be used as a point to match the same. This will serve as a point of comparing and based on it the market information is looked at so that correct value of the assets and liabilities can be ascertained. Conclusion The usage of fair value measurement thereby helps to serve as a framework through which better information is being provided to the stakeholders. This helps to serve as a guidelines through which correct information is being supplied and acts as a point of protecting their interest. This serves in the socio-economic interest of the society as all people who are directly or indirectly associated with the organization is protected. Since, fair value measurement helps to provide correct it thereby will provide an avenue through which people will be protected and better information will be supplied to the society. On the whole the concept of fair value measurement would have helped to reduce the impact of global financial crisis and would have acted as a check point through which better liquidity would have prevailed. It serves the socio-economic need of financial accounting to ensure that the interest of the stakeholders are protected and fair value measurement acts as a guide and important determinant which helps to achieve the same. This will thereby ensure that all people are better off and will be able to determine the path through which the overall mechanism of market will improve and will help the investors over a longer period of time. References Adams, D., Hill, W. and Roberts, C. 2008. Corporate social reporting practices in Western Europe: legitimating corporate behaviour?’, British Accounting Review, 30 (1), 1–22. Adams, C., Coutts, A. and Harte, G. 2005. Corporate equal opportunities (non-) disclosure. British Accounting Review, 27 (2), 87–108. Bebbington, J. and Thomson, I. 2011. Commentary on: Some thoughts on social and environmental accounting education’, Accounting Education: An international journal, 10, (4), 353-355. Birkin, F., Edwards, P. and Woodward, D. 2011. Some Evidence on Executives’ Views of Corporate Social Responsibility’, British Accounting Review, 33, 357–397. Blokdijk, J. and Drieenhuizen, F. 2012. ‘The environment and the audit profession – a Dutch research study’, The European Accounting Review, 437– 443 Bondy, K., Matten, D. and Moon, J. 2014. ‘The adoption of voluntary codes of conduct in MNCs – a three countries comparative study’, Business and Society Review, 109 (4), 449 – 478 Blokdijk, J. and Drieenhuizen, F. 2012. ‘The environment and the audit profession – a Dutch research study’, The European Accounting Review, pp. 437– 443. Crowther, D. 2000. Social and Environmental Accounting, Harlow: Financial Times Prentice Hall, p. 109 (Financial Times Executive Briefings), ISBN: 0273650920. Read More