Measurement in Accounting Is a Complex Area - Essay Example

Institution : xxxxxxxxxxx Course : xxxxxxxxxxx Title : Measurement in Accounting Tutor : xxxxxxxx @2010 Introduction The latest financial crisis had grave impacts on world economy. The crisis brought about intense debates concerning the cons and pros of the concept of Fair value accounting. There have been legitimate concerns about how FVA as one of the issues in measurement standards, has contributed to the global financial crisis. The following presentation attempts to analyze how the existing debate is actually factual. The fair value accounting (FVA) or also referred to as (MTM) Mark-to- Market accounting is defined as the rate at which an asset can be exchanged or liabilities be settled between parties that are willing and Knowledgeable. According to the regulations of IFRS, prices quoted within an active market must be utilized as a fair value if available. In addition FVA are most frequently used for financial liabilities and assets (Wyatt 1991). A fair value accounting (FVA) and its application has alarmed so many debates for example Banque de France of 2008. Its major objective was to make FVA procyclical, i.e. it intensified swings in the financial approach. In addition it was stated as being the cause of downward effects on the financial market. There are basically two reports made on reasons that contribute to procyclicality; which are booms and bursts. The first report establishes that an increase in FVA and assets increases banks leverage in booms which subjects the financial approach more susceptible and financial effects more severe as well. Contrary, the HCA which prohibits the idea of asset writing –up the assets, instead it formulates a hidden reserve which can be accessed during the financial crisis. However, HCA tends to ignore the fact that FVA acts as a measure in detecting coming effects for an imminent crisis to the banks thus allow most of them to put up a policy that would ensure the crisis does not affect the continuity of business transactions (Ramanna & Watt 2007). The second argument stipulates that FVA can easily inflame contagion in the financial market, the banks may decide to dispose assets at a lower price than the original market price. This argument states that there is a clear connection between the FVA and the accounting system which distorts the sale of assets (Shleifer 2000). FVA has contagion effects of on the market price. Banks stand on the Fair value accounting (FVA) during and before the effects in the subsequent half 2008. Most banks if not all raised an important issue about the FVA any but mostly focused on the liquid assets. They pointed out that FVA was intensified with a downward spiral that failed to observe the effects of market price on the assets. Many banks in United States of America and Europe requested for more time in order to switch to models which will help them determine the fair value or unforeseen prospect cash flow (Ramanna & Watt 2007). Some of the banks shifted these problems to the generally accepted accounting standard. By doing so, it has proven that banks are more concerned with FVA, especially on matters that dealt with related financial instruments of both assets and liabilities. Assets may be defined as a company’s possession whereas, a liability may refer to what an organization owes to someone or an institution. Very Many effects have been suggested, with different opinion made by the experts. Especially on the market -economy and regulatory key solution for the global economy. These economic constraints are sometimes referred to as an economic depression. Fair value is linked to an association which guides very many business transactions prices. Such business transactions are relied upon where the business market economy is liquidated. But the requirement of fair value, as differentiated from market value, takes place in a condition where a major transaction in the business is liquidated. Most business have to define what price they have to use before starting any business operation. The collapse in the housing sector has led to most of the price to plummet thus affecting the financial organization globally. Banks that were concerned with giving credits to its customers were adversely affected and thus distorted most of the investors’ confidence. Economies around the world declined with a decrease in both the international trade and the credit tightness. Surveyors argued that credit ranking agencies together with the investors failed in their ability to rate accurately the effects involved with the mortgage financial products. Fair value largely contributed to the relapse in the operations of the housing sector due to the implications of FVA on banks who are the main lenders of the housing sector (Benston 2008). Fair value has mostly been used by managers in different organisation to make vital decisions in terms of cost fluctuations, so as provide a report that can be relied on by the users of the information. This was mainly carried out to facilitate better accounting information needed to improve the market economy. However, this information cannot disregard the fair value price of financial assets, the effects on the price and of course the fair cost at specific moment can easily to boost the market ups and downs. More so, the fair value measurements of the assets must be adjusted according to the market on a daily basis, the financial effects has led to a decrease in the market price of business assets, reduction in financial terms and conditions, financial assets, lose of investor’s confidence in most business operations and decline in credit rating which reduces the customers ability to borrow money from the financial institution such as the world bank.   Fair value in accounting captured many prominent headlines of the financial statement. Its major effects on the financial institution and capital market have been the main subject of the considerable controversy. For instance, Grant Thornton of United States of America gave his verdict on the financial position of the fair value. Most managers believe that there is a clear connection between the present regulatory frameworks that affects the generally accepted accounting principle (GAAP) on operations, this was a major opportunity of attracting more investors to most business in the world, provides framework of business stability, predict on the financial position of the company or institutions and regulates major stakeholders values (Benston 2008). The effects of fair value measurements mostly reflect on the present global conditions, whereas, financial statements reveal the impact of global economy on financial instrument. Failure of price requires calls for fair value. Fair value is not used at all time in a day to day business activities but when the assets of the company are damaged. The need to record all losses incurred should be based on fair value that corresponds to the present market prices during the financial reporting (Ramanna & Watt 2007). There are however several problems that hinders most organisations in dealing with fair value accounting standard. Given the proceeding section of the discussion, it is not true that all blame is caused by the accounting standard. Most business organisation have deviated their market price, even if the price are below the contagion effects, by permitting variation from market price in some situations. With restricted approach, their standards are easily gamed. There are evidence which strictly proclaims that managers at times may be reluctant in providing there financial statements regarding the company’s assets and liabilities. This is so, in order to misguide the prevailing competitors dealing with the same aspect. They may not publish their account regarding the impairments of assets and liabilities. In addition, problems may come as result of litigation risk and substantial legal matters, which includes legal restrictions such as prison terms. In this scenario both the managers, auditors and the directors are likely to establish the effects that is associated with the deviations from the market price. For instance, it is most likely to occur that managers may refuse to use a proper approach that if fair other than a high observable price as of very illiquid price, mostly when the substantial down side for the firm or the organisation is classically on the financial crises( Benston 2008). Finally it is vital to realize that accounting changes and rules are not only linked to FVA, at times these particular changes are shaped by the existing political process, just like any other stipulated regulation. The function of political forces additionally makes the situation complex. For example there is a possibility that the changing rules in accounting in a particular crisis may be as a consequence of political pressure which results to outcomes that are worse. In reference to the aspects of intense lobbying and interference by the political system through the process of setting standards, the intensity of the financial crisis may actually be more profound. In total the debate concerning the aspect of fair value accounting requires in-depth analysis in order to come up a comprehensive of conclusion to the contributions of FVA to the financial crisis (Allen & Carletti 2008). Conclusion Determining an appropriate time for the deviations in a global market is very important, especially on litigations and where the enforcement is considered strong. Therefore, very essential for both the managers and the directors to evaluate the risks involved in the financial market and the possible mechanism that may be installed to curb these effects. Bibliography Allen, F & Carletti, E, 2008, Mark-to-market accounting and liquidity Pricing, Journal of Accounting and Economics, 45, 358–378. Benston, G. J, 2008, The shortcomings of fair-value accounting described in SFAS 157, Journal of Accounting and Public Policy, 27, 101–114. Gjesdal, F,1981, Accounting for stewardship. Journal of Accounting Research, 19, 208–231. IASB Advisory Panel, 2008, Measuring and disclosing the fair value of Financial instruments in markets that are no longer active. Ramanna, K & Watts, R., 2007, Evidence on the effects of unverifiable Fair-value accounting. Harvard Business School working paper no. 08- 014. Shleifer, A, 2000, Inefficient markets: An introduction to behavioral finance, Oxford University Press. Wyatt, A, 1991, The SEC says: Mark to market! Accounting Horizons, 5, 80–84. Read More