Three Questions in Accounting - Article Example

Running Head: THREE QUESTIONS IN ACCOUNTING Name: Institution: Date: Three Questions in Accounting Introduction The latest financial crisis has led to a forceful discussion in accounting circles about the advantages and disadvantages of the fair-value accounting (FVA). The discussion has stood in the way of the future of FVA as well as in the way of the plans of the parties responsible for setting accounting standards to push FVA to other correlated quarters. Four main concerns have predominantly been brought forth in an effort to formulate good judgment when it comes to FVA namely; what is novel and what is special regarding FVA as compared to other accounting standards, as much as the concerns brought forth in the discussions might hold some water when it comes to adopting pure FVA during financial crisis first’, secondly, there is no clarity concerning the extent to which the financial crisis is applicable to FVA as predetermined by the accounting standards, thirdly, Historical Cost Accounting (HCA) cannot be the remedy considering that it also has problems of its own which in this case might be bigger than those associated with FVA and fourthly, FVA has its own problems and specifically when it comes to legal action in its implementation. This paper will look at various issues that have been associated with FVA, its role if any in the recent financial crisis and how the International Accounting Standards Board (IASB) has responded to the whole issues and the effects this is likely to have on the global financial stability in Part A of the paper. Part B will specifically look at the IAS39 standard which is one of the standards by IASB due to the attention that this particular standard has attracted in the backdrop of the recent financial crisis, its problems and the efforts that IASB has made to improve the standard. Part C will seek to establish the processes and the reasons behind the Australian Accounting Standards Board’s (AASB) response to the recent financial crisis as well as the influence that IASB has on AASB when it comes to the pursuance of a worldwide union of Australian accounting standards. Part A The role of FVA in the recent financial crisis has led to a serious discussion regarding policies among bodies such as the US Congress, the banking sector, the accounting regulatory and the EU among others. Opponents of FVA are of the opinion that FVA has had a major role in the recent financial crisis and that it worsened an already bad situation for institutions across the world. Proponents of FVA are however of the opinion that FVA had nothing to do with the recent financial crisis and that as Veron among other writers have put it, “FVA merely played the role of the proverbial messenger that is now being shot” (Veron, 2008 ; Turner, 2008). Others such as Laux and Leuz are of the opinion that FVA is not liable for the recent financial crisis and also that it is not a mere structure of quantification that simply gives account of asset values with no economic effects on its own (Laux & Leuz, 2009). One of the major concerns in the application of FVA in business phases is that FVA is “procyclical” i.e, FVA aggravates imbalances in the financial system and may also lead to a downhill escalation of financial marketplaces. There are two arguments that have been put forth by researchers to explain why “Procyclicality” may result from FVA. The first argument is that FVA and asset write-ups permit banks to increase their control in times of financial boom which in effect leads to a more vulnerable financial system leading to severe financial crisis’ (Plantin et al, 2008). The second argument is that FVA is capable of inflaming infection in financial markets in the sense that if banks are forced to sell assests for prices that fall below the basic cost, then this is likely to filter to other institutions that are required by the jurisdictions of FVA to “mark their assets to market” (Plantin, Haresh, & Hyun, 2008). However, According to (Laux & Leuz, 2009), the first argument leaves out the fact that FVA supplies the financial systems with timely signals as regards a looming financial crisis that may well act as early warning signs for banks to take precautionary measures. The second argument is true and requires that there exists express or circumlocutory ties to the accounting system that would lead to the sale of assets. (Allen & Carletti, 2008) have expressed that dogmatic investment prerequisites imposed on banks through accounting-based regulations are actually capable of being transmittable. Agreements related to Bonds which are also based on accounts are also capable of causing ties related contracts. (Plantin et al, 2008) have demonstrated that organization that is directed at “short-term” accounting incomes can also cause comparable outcomes fundamentally because they concern existing market prices which often lead to circumlocutory bindings. Agencies have also been shown to create circumlocutory bindings through the utilization of accounting information and issuance of ratings that relate to debt contracts or assets prerequisites. (Allen & Carletti, 2008) as well as (Plantin et al, 2008) have through the use of specific models demonstrated that FVA in its wholesome structure namely “marking-to-market prices” can actually lead to infection regardless of the situation. Additionally, during the 2008 hearing on Capitol Hill regarding the recent global Financial Crisis, it was argued by both senators and congressmen that FVA has led to the unfair punishing of companies with many executives in the area of finance calling for the modification and improvement of certainparts FVA or even their complete suspension (Pannese & Delfavero, 2010). IASB has been very surppotive of the use of FVA in fiscal reporting since the early 2000s through a number of accounts related regulations. Presently IASB regulations that apply to FVA include; “Financial Instruments: Recognition and Measurement, IAS 32 – Financial Instruments: Disclosure and Presentation, IAS 36 – Impairment of Assets, IAS 16 – Property, Plant and Equipment, IAS 37 – Provisions, Contingent Liabilities and Contingent Assets, IAS 40 – Investments Properties, IAS 41 – Agriculture, IFRS 2 – Share-based Payment, IFRS 3 – Business, Combinations, IFRS 7 – Financial Instruments: Disclosures, and IFRS 9 – Financial Instruments.” (Lefebvre et al, 2009). Regarding the role that FVA played in exercerbating the recent global financial crisis (GFC), IASB together with other parties has moved to update FVA. In a seminar held in november 2008, which was led by IASB, SEC and FASB among other stakeholders, there was an argument that adjustments and or revisions must be made on FVA in order to safeguard the intergrity of accounting as well as that of the entire financial system. According to Johnson, one suggestion that came from this discussion was that FVA should be made capable of being invalidated (Johnson, 2008). Part B When the IASB was given a chance to deal with the Global Financial crisis regarding the new advances in the market, it acknowledged the necessity to organize IAS as well as the IFRSs for the sake of responding to the global financial credit crisis (Guo & Matovu, 2009). This was meant to ensure that financial establishments in Europe were not denied the chance to contend amongst their counterparts as well as competitors when it comes to the utilization of the rules of accounting as well as their suppositions. In order to do this and to create a “level playing field” with the GAAP of the EU, with respect to the possibilities of categorization of financial assets, IASB began to monitor the developments within the US accounting standardization procedures to bring about cohesion between both standards (Deloitte Touche Tohmatsu, 2010). The changes made to IAS39 “Financial Instruments: Recognition and Measurement” as well as IFRS 7 “Financial Instruments : Disclosures”, and officially endorsed by the European Union on the 15th of October 2008 allowed for the reorganization of specific financial mechanisms under “held for trading” to either “”held to maturity”, “loans and receivables” or “available for sale” (Guo & Matovu, 2009). It also allows for the conveyance of specific monetary assets from the grouping of “available for sale” to “loans and receivables”. These amendments were done to allow banks to document instruments that are not viable for trading in the modern dynamic marketplace at pay back price as a substitute to mark-to-market values (FVA) (Ernst &Young, 2009). The IAS 39 amendment took effect on the 1st of July 2008 with high expectations that there would be reduced unpredictability and budding problems with all assets being calculated on the basis of their own specific “fair value” from the date of their reclassification (Guo & Matovu, 2009). “Derivative and non-derivative financial assets” The amendment to IAS 39 and the changes to regulations have nothing to do with categorization and dimension of derivatives according to Guo & Matovu (2009). Derivatives are still subject to the preceding rules of IAS 39 which necessitate that they are to be quantified at “fair value through profit and loss”. The single exemption to this rule is when they are used in “cash flow hedge accounting” in which case fair value amendments are acknowledged in evenhandedness. Nonetheless, considering the existence of mechanism which bear the mark of embedded derivatives, the preliminary amendment became vague as regards the reorganization of this type of mechanism (Guo & Matovu, 2009). With regard to the latest proposal published by IASB, all entrenched derivatives must be evaluated and if duty calls for it, they should also be treated as separate accounting entities in statements of finance. However, there is a need for a closely bound monitoring system for auxiliary assortment of processes. As pertains non-derivative finacial assets, association can only take place if there is a set of reorganization rules. The previous IAS 39 stipulated that non-derivatives are categorized only under one of the following groupings; "fair value through profit and loss”, “loans and receivables”, “available-for-sale” or “held-to-maturity”. Under the group of “fair value through profit and loss”, non-derivatives are further re-grouped into “held for trading” or “fair value through profit and loss”. The latter re-grouping emanates from description by unit. Ensuing Categorizations Under this amendment, Non-derivative financial assets that fall under “held for trading” can additionally be re-grouped into “available for sale” or “held for maturity” in the case of exceptional conditions and into “loans and receivables” if they qualify to be labeled as such. More distinctively, any “trading debt securities” that don’t fit into the category of “loans and receivables” can further be re-grouped into “held-to -maturity” (meaning that they are calculated at pay back price). But this can only be done if the body in question has the objective and capability to clasp them pending their maturity. On the other hand, if the body decides to sell the securities, for instance as it happens in the case of revolutions in market settings that could contaminate the whole group of “held-to-maturity” which would then require that it be “fair valued” by means of justice for a period of not less than two years of financial reporting (KPMG, 2008; Lopes et al, 2008). The circumstances under which financial assets can be shifted from “available for sale” or “held for trading” to “loans and receivables” ” (meaning that they are calculated at pay back price) comprise: the description of “loans and receivables” during the preliminary identification being convened at the position of appropriate financial assets and also in a case where the bodies involved in the conversion have the objectives and the abilities to keep the assets until such a time when they mature. Prior to or after the reorganization, financial assets cannot be regrouped into “”fair value through profit or loss” after the preliminary identification. The financial assets shall therefore stay as they are and no amendment can change this necessity. Figure 1: Reorganization to Available-for-Sale” or “Held-to-Maturity” Russell Bedford Hong Kong (2008) Figure 2: Reorganization to “Loans and Receivables” Russell Bedford Hong Kong (2008) Part B: Conclusion After reorganization, the consequential outcome is acknowledged as a modification to the effectual interest rate from the date when the change is made in approximates as opposed to being a modification to the carrying amount of the asset. The parties involved therefore gain in terms of freedom to increase their approximations on future cash flows in anticipation for increased recuperations and thereafter this change in expectations is accredited in “profit or loss” grouping for the outstanding period of time as a component of interest revenue rather than being immediately recognized as profit or loss (KPMG, 2008)The amendment of IAS 39 by IASB can therefore be viewed as an effort to avoid abrupt changes in profits and avoid misunderstanding of the reorganization. IASB recognizes “rare circumstances” which is the occurrence of any event that is bizarre but IASB does not give any specific instance of such an occurrence. The recent global financial crisis has however been cited by the press release of October 13 2008 as one such occurrence as mentioned in IFRS amendments. IASB however believes that if assets are reorganized following an occurrence of a “rare circumstance” then they need to be reorganized as per the date of the occurrence of such an event. And there has only been one such “rare” occurrence with regard to IAS 39 amendments. IASB has continued to work on a complete overhaul and replacement of the IAS 39 (Lefebvre at al, 2009). Part C The paradigm shift that has been taking place in the global financial system often motivated by the borderless e-commerce, innovations in financial management and extended terms of changing consumer needs has led to many regulators in the world resorting to making critical choices regarding the use of international accounting systems for listing their stock. Australia has not been left behind and considering the small size of the financial market in Australia, the regulators there have been forced to start reorganizing their regulations to be at par with those of other global financial partners. This is because after the paradigm shift, it has not been business as usual and because the changes will also make it possible for companies in Australia to access capital and benefit from the current international competition and financial innovations (Wise & Spear, 2000). Australia has therefore realized that harmonization of its accounting regulation systems with those of the global market are of benefit to its market (Nguyen & Faff, 2006). Some of the changes that Australia is making include the “International Harmonization Program (IHP) by the Australian Accounting Standards board (AASB) and the Public sector Accounting Standards (PSASB)” Both programs are aimed at harmonizing the Accounting system of Australia with the International Accounting Standards (IAS) as per the requirements of the International Accounting Standards Committee (IASC). Therefore, the regulations set by the IASC have been very fundamental in the regulatory change that Australia has been undertaking particularly with regard to the changes that IASB has been making in the IAS 39 standard. This has compelled Australia to think of an ideal Australian Accounting reporting unit that complies with both AASB standards and IAS standards because compliance with IAS standards alone cannot guarantee an automatic compliance with AASB standards. According to Louis (2003), this move has been one of particular importance considering the “poor drafting” in the international standards which forced regulatory bodies in Australia to vitally assess its efforts towards harmonization following the pronouncement by IAS. According to Wise & Spear (2000), the harmonization that Australia has been pursuing should consider two factors of great importance namely: to change both the AASB and AAS series’ of Australian standards and to sway the improvement and modify of the IASC standards. The future of Australian Accounts regulations therefore lies in having a single accounting standard due to the changing tide in the global financial markets Conclusion The recent global financial crisis has confronted all market regulators with choices of whether they should allow foreign based accounting systems to govern their financial markets or not. These confrontations have been occurring amidst the erosion in the quality of reporting and a dash to meet market needs which have also been a major cause of alarm for top regulators of financial securities. Harmonization is not an end by itself but rather it is a means to an end with a greater need for global regulators to work in partnership with IASC and G4 members. The domineering role of the United States in the harmonization process has resulted in a big dilemma which in the wake of the recent global crisis left many regulators in a midpoint. It is now a matter of seeing if the global regulatory bodies will be able to cope and whether they will comply with the IASC standards to the letter. List of References Allen, F., & Carletti, E. (2008). Mark-to-Market Accounting and Liquidity Pricing. Journal of Accounting and Economics Vol. 45 (2-3) , 358-378. Deloitte Touche Tohmatsu. (2010). Technical Brief for Investment Companies: Accounting , Financial reporting and Regulatory. Cayman Islands: Deloitte Touche Tohmatsu. Ernst &Young. (2009). Embedded Derivatives: Amendments to IFRIC 9 and IAS 39-Supplement to IFRS Outlook. London: Ernst &Young. Guo, Q., & Matovu, M. (2009). Impacts brought by reclassification of financial assets: A study on the application of new amendments to IAS 39 & IFRS 7 in different bank entities. 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