Mark-to-Market Accounting - Article Example

Mark-To-Market Accounting: Practices and Implications Name: Institution: Mark-to-Market Accounting: Practices and Implications Fair value accounting has faced a lot of criticisms especially on of its subsets which happen to be mark-to-market accounting. During the economic crisis of 2008, FVA was blamed to have caused the crisis with some stakeholders in the finance and accounting sectors calling for its suspension. When the crisis got worse, the Congress called for a hearing of the various stakeholders to give their views on the issue. The rationale of this paper is to summarize some of those views based on the presentations that were done in 2009. The article will go further and scrutinize if FVA played any role in the crisis. Moreover, the paper will also analyze the independence of FASB. Summary of Statement by FASB Chairman The chairman of FASB aims to give a brief overview of the roles played by the organization and how it maintains its independence. In his statement, he explains the differing functions of the standard setters and regulators as well as the concept of fair value accounting. Moreover, he provides observations on the calls that have been made for the suspension of fair value accounting. FASB belongs to the private sector and is independent of any interventions. The Chairman notes that the independence of FASB is imperative in achieving its mission. Besides, the standards that are set by FASB are essential for the economy to function to properly. The independence of FASB is guaranteed by the Sarbanes-Oxley Act of 2002. Just like the investors and creditors, Congress along with other stakeholders need and independent FASB for proper guidance on the standards that are set. It is of merit to note that the Chairman is against any interventions by the Senate since they may look attractive in the short-run but in the end may hurt the investors, creditors and the U.S economy at large (Herz, 2009). At this point, it is important to establish the process by which FASB sets accounting standards. Given that the standards set by FASB affect many organizations, the organizations needs to be as objective as possible and includes all the views of the interested parties. The process involves public meetings, public roundtables and liaison meetings among others. A final decision on the standards to be set is only made after careful consideration of all the input by the interested parties. The Chairman goes further and gives the fundamental difference between accounting standard setters and prudential regulators in terms of their roles. Whilst the standard setters focus on coming up with accounting standards that provide transparency, the prudential regulators ensure that the financial markets are sound. It is important to note that fair value accounting does not apply to all financial instruments and its application depend on the type of financial instrument. Additionally, fair value accounting is use to recognize impairments in the value of financial assets (Herz, 2009). In current times, there have been calls to do away with fair value accounting. The proponents of the calls argue that fair value accounting causes unnecessary pro-cyclical behavior that may exaggerate losses. Nevertheless, the Chairman recognizes that the standards may lead to such pro-cyclical behaviors; it is the role of FASB to counter such effects. He questions why the proponents of the calls to suspend fair value accounting have highlighted the problem since it may erode investor confidence who will in turn sell their stocks. In terms of the impact of fair value accounting on financial institutions, FASB conducted research to ascertain the impact. On completion of the research, FASB found out that fair value accounting did not play any role in the recent banking failures. For example, in one study conducted by SEC on the failure of banks, it was found out that fair value accounting had only been applied in its minimum. One of the issues that have faced a lot of criticisms in recent times is the introduction of statement 157. The Chairman sought to clarify the notion that Statement 157 had introduced mark-to-market accounting rather it was introduced as a way of improving consistency. Statement 157 also defines fair value as an exit price; ‘’for an asset, fair value estimate is arrived at by position to the price that would be received in an orderly transaction for the asset at the measurement date.’’ Summary of Statement by Chairman of PACB The next panelist started his presentation by thanking the Chairman of the Congress Subcommittee for calling the meeting. He notes that PACB has been carefully watching the debate around fair value accounting, mark-to-market accounting and OTTI. Moreover, he notes that the banks have firsthand experience with the rules and hopes that his presentation will help in rectifying the current situation. His presentation is based on the recommendations made by a PACB committee formed to investigate the issue (Bailey, 2009). With the present economic crisis in the country, the application of the accounting rules such as fair value only serves to accelerate the crisis. Moreover, the panelist notes that those who serve in FASB and SEC must be held tom account on the current crisis facing the country since they did not take enough action to prevent it. Although PACB supports transparency of financial statements, they find that the application of mark-to-market accounting rules only served to distort the true picture of financial institutions. It is also critical to establish how fair value accounting works in the current market conditions. For example, fair value is deemed to be difficult when operating an illiquid market. Furthermore, many of the markets on the books of banks are simply not working in the current market conditions (Bailey, 2009). The panelist also talks about the negative impact of the accounting rules and notes that they are hurting the market’s capability to revitalize and institute market-driven pricing. Moreover, financial institutions are not willing to risk purchasing assets that could result in future. The other negative impact is that the rules make it hard to sale any assets. Even though PACB believes that Congress should not be writing accounting standards, it should hold FASB accountable for letting the situation happen in the first place. FASB should also focus on arriving at solution that will be suitable for all the interested parties. Summary of Statement by Chairman of Congress Subcommittee The agenda of today’s meeting is to examine the mark-to-market accounting rules that have been hotly debated in recent times. The Chairman of the Committee also notes that it is his hope that the discussion will be constructive. Moreover, he goes further and reiterates his position on the issue; it his view Congress should not get in the way of establishing accounting rules and it is best if this is left to the standard setters. Nevertheless, the unintended consequences of mark-to market accounting rules cannot go unseen. This calls for the congress to take action because the standard setters have failed to act. However, it is of merit to note that congress will not call for the outright suspension of the mark-to-market accounting rules but it has to be eased. Although mark-to-market accounting provides transparency to the investors, its application in the current market environment is uncalled for (Karjonski, 2009). Fair value accounting applies to different sectors in different ways and the Chairman reminds the panelist to keep in mind that they must propose solutions that will work for the various sectors. Moreover, he reminds the regulators and standard setters that the country can wait no more and a solution had to be found as soon as possible. He then concludes his opening statement by noting that mark-to-market accounting did not cause the whole crisis but it altering it will not be solution to the crisis (Karjonski, 2009). Question 2 At this point, it is important to gain an understanding of fair value accounting which has several subsets with mar-to-market accounting being one of the subsets. Fair value accounting entails the valuation of assets as well as liabilities with reference to some objective that can be relied upon by the market. FVA was promulgated by FASB under FAS 157 and it is based on an exit price. Moreover, it also provides an hierarchy of inputs that are used when measuring fair value (Cotton, 2009). The global financial crisis of 2008 turned attention to the role of financial reporting in times of economic downturn. I agree to some extent that fair value accounting contributed the crisis. Menicucci (2014) notes that when analyzing the crisis, many commentators attributed blame to FVA especially because of pro-cyclical effects it could introduce in banks financial statements. For example, I find that it is during an economic crisis that the pro-cyclical impact of FVA on banks financial statements and more specifically on the valuation of financial instruments. Furthermore, despite the merits of FVA, the concept has been subject to criticism during economic crises. Broden and Olvosson (2008) in their thesis argue that FVA contributed to the crisis as financial institutions were required to record the declining value of their assets. Moreover, the stringent rules of fair value accounting such as mark-to-market accounting also contributed to the crisis. Moreover, FVA increases the volatility of reported income. In his thesis Van Schijndel concluded that only level 3 valuations could not be blamed for the current economic crisis. Nevertheless, I tend to agree with other scholars who hold the view that fair value accounting did not lead to the economic crisis of 2008. Some argue that FVA is just used by critics of the concept as a scapegoat to redirect attention from the real causes of economic crisis. For example, critics argue that FVA required them to write down their asset at very low market prices even when the financial institutions had no intention of selling the assets. Supporters of FVA counter the argument by the critics by restating that FVA provisions are limited and they are not likely to lead to pro-cyclical effects. Furthermore, the defenders put forward the fact that most of the banks’ assets are not fair valued (Badertscher, Burks & Easton, 2010). Based on the diverse views presented in this paper, I find it necessary to partly blame the stringent accounting rules for playing a role in the global financial crisis. Question 3 Shortly after the Congress hearing on the various view of mark-to-market accounting, FASB made a decision to ease the accounting rules. Although this may have helped the situation then, this should be a cause of concern not only to FASB but also other stakeholders along with other independent bodies. Although the Congress had the right to intervene and salvage the situation, they ended up influencing FASB decision to ease the accounting rules even though the latter is an independent organization that is free from any undue influence. It is of merit to note that concerns over FASB independence are not new. Baker and Anderson (2010) explain that in the 1990s, FASB proposed a number of controversial accounting pronouncements that were rejected by companies. With such situations, FASB independence is called into question. This should be a cause of concern since the decision to ease the rules was made just after the conclusion of the Congress hearing. The questions that arise in this case are why FASB had failed to call a meeting with all stakeholders since it had every right to do so. Rather than calling for the meeting, FASB had to wait for the Congress to call for the meeting hence calling into question how it practices its independence. Moreover, a question arises if such a situation come up in future, will FASB wait for another Congress hearing to act. Furthermore, FASB should practice its authority and be careful not to be influenced by any other body. If this happens, it is the view of this paper that any subsequent standards set by FASB will not be taken seriously. For example, those who are supposed to follow the standards may not do so because they know they will influence FASB to change the accounting rules to suit them. The other reason as to why this should be a cause of concern is because the standards that are set are supposed to be uniform. However, if each interested party will demand that their views be included in the standard, then this will be a source of concern. Such actions are detrimental to the independence of FASB. In general, the action by FASB to ease the rules to suit the market conditions is a source of concern. Conclusion In conclusion, effective financial reporting depends on high quality accounting standards along with an audit and rigorous enforcement. Accounting standards try to achieve a consistent and significant assessment of the financial conditions. It is of merit to note that accounting standard setter such as FASB have continuously tried to keep standards up to date with the ever-developing markets to encourage the diffusions of high quality information. FVA has received particular attention in the role it played in the global economic crisis of 2008 with various parties presenting their views on the subject. This paper summarized some of those views and specifically the hearing held by the senate on the issue. Moreover, the paper has also given its views on fair value accounting and whether it played a role in the economic crisis of 2008. The other aspect that has been analyzed by the paper is the issue of the independence of FASB. References Badertscher, B., Burks, J., & Easton, P. (2012). A Convenient Scapegoat: Fair Value Accounting by Commercial Banks during the Financial Crisis. The Accounting Review, 87(1), 59-90. doi:10.2308/accr-10166 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 Baker, H., & Anderson, R. (2010). Corporate Governance: A Synthesis of Theory, Research, and Practice. Hoboken, NJ: John Wiley & Sons. Broden, D., & Olovsson, K. (2015). Fair Value Accounting and Procyclical Behavior in the Swedish Banking Sector (Master's). University of Gothenburg. 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 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 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 Menicucci, E. (2014). Fair value accounting. Basingstoke: Palgrave Macmillan. Van Schijndel, R. (2010). Fair value accounting and pro-cyclicality (Masters). Erasmus University Rotterdam. Read More