Discuss the crisis of fair value accounting following recent international financial turmoils. It is debatable whether the IFRS accounting standards have contributed to the financial crisis.
The Crisis of Fair Value Accounting Following Recent International Financial Crisis
The current financial crisis has resulted in a vigorous debate regarding advantages and disadvantages of the fair value accounting. Such debate indicates an increased challenge for the fair value accounting as a standard setter along with extending it into several areas (Acharya and Ryan 2016). It is observed that there are certain legitimate reasons regarding marking to market at the time of the financial crisis. Moreover, the recent financial crisis has turned it focus on the fair value accounting that resulted in major policy debate among the banking and accounting regulators all over the world (Balakrishnan, Watts and Zuo 2016). In this essay it will be analyzed that the market prices gradually deviated from the fundamental values at the time of the financial crisis along with analyzing the poly-cyclicality of asset values and bank lending contributing to financial crisis. The objective of the essay is to analyses the ways in which the current IFRS accounting requirements contributes to the financial crisis. Moreover, the concept of financial crisis is also explained through this essay.
A global financial crisis is deemed as a business environment which is difficult to succeed as the potential consumers are likely to decrease their purchases of services and goods till the economic condition improves (Biddle et al. 2016). The financial crisis that too place in the year 2007-2008 is also indicated as international financial crisis that was considered to be worst global economic situation. Such global financial crisis initiated in the year 2007 when the extremely high home prices within United States turned out to be decisively downward that spread rapidly within the US financial sector and then to the international financial market (Brusca and Martínez 2016). Such financial crisis negatively affected the international financial market along with the overall investment banking industry, enterprises those are chartered by government to support mortgage lending along with major commercial banks. The banks trusted no one regarding repayment for loans and stopped offering loans those were required by most businesses in maintaining smooth cash flows for operating business profitably. Share prices increased all over the world and a drastic recession followed by such situation (Cerbioni, Fabrizi and Parbonetti 2015). Several nations within Europe dealt with the negative impacts for having dabbled within the American real estate securities. Japan and China attempted to avoid such drastic impacts of global financial crisis but their export based manufacturers dealt with recessions within the major markets in Europe and US that negatively impacted demand for their offerings.
During the international financial crisis the less developed nations lost markets internationally along with their foreign investments on which they have relied a lot regarding capital growth (Christophers 2016). With none of the largest economy prospering as both the private economists along with governments indicated a rough recovery. The insurance industry negatively suffered during the 2008 global financial crisis through trading within “credit default swaps” and in impact the insurance policies stipulated that in lieu of a fee those were deemed by the insurers might assume any losses caused by the defaults of mortgage holder (Cooper 2015). As long the hosing proves were increased everyone attained profit and the mortgage holders having insufficient regular income source could borrow against their increasing home equity. With the burst of the housing bubble, increased number of mortgage holders defaulted on their loans. Considering such situation, there were several theories on the number of pillars of finance crumbled in a t=rapid manner. A debate raised regarding the issuers of subprime mortgages along with the IFRS accounting standards was responsible for such international financial turmoil’s (Goh, Li, Ng, and Yong 2015).
During the international financial crisis FVA was ineffectively understood by the political bodies and regulators that are observed to not a sufficient attribute for the international financial crisis. The US “Financial Accounting Standards Board (IFRS)” and “International Accounting Standards Board (IASB)” was eventually used in analyzing the FVA issues and faults in the accounting standards that resulted in the global financial crisis. It was debated by Li and Yang (2015) that the financial crisis that took place in the year 2008 would not have been drastically severe of there was not existence of a faulty “Fair Value Accounting (FVA)” standard. However it is also argued that the accounting was not just the major cause for such financial crisis. Due to the selective implementation of FVA, it did not in practice result in the pro-cyclicality of the financial system. Such financial crisis negatively affected the international financial market along with the overall investment banking industry, enterprises those are chartered by government to support mortgage lending along with major commercial banks. During the financial crisis, it was claimed by the global financial industry that market-to-market FVA for the short term market prices which considered that the financial assets were marked down at the prices for the time being even if it was considered that prices might recover after the collapse of the crisis and it was also claimed that the FVA market down also resulted in such global financial crisis (Novotny-Farkas 2016). Conversely, the IASB and FASB lost the debate over public relations over FVA technology. There exists no indication that the IASB or IASB is considering restoring the primacy related to quote prices to FVA standards and also there is no indication that they desire to withdraw the malleable version despite its contribution to international financial crisis.
FVA was re-introduced by the IASB accounting standards to serve as a system of constantly re-measuring assets in order to revise their values. Following the crash of the stock market along with the economic depression, FVA was used secretly (Osadchy and Akhmetshin 2015). The financial crises were considered to be the result of the assets overvaluation by the FVA that was haphazardly practiced. FVA has been implicated within two major North American Financial crisis and both had drastic international consequences. Such drastic negative results of FVA turned against the expectations of the supporters those believed that FVA was important in offering more vital information for better financial decision making. The first case of such FVA based financial crisis was the collapse of Enron Corporation in the year 2001, in which FVA was highly important in developing a business outlook of poorly escalating the profit amounts that can be booked by the corporate managers in the short term (Vazquez and Federico 2015). The second financial crisis might be categorized as the continuous of the Enron case and in the year 2008, the international financial crisis resulted in the “sub-prime” episode of the failing financial institutions.
During the global finance crisis the banking groups claimed that a rigorous form of FVA that is mark-to-market accounting had affected the financial assets through bringing them down too drastically at the market value at the time the asset market was thinly traded. However, in contrast, Vazquez and Federico (2015) stated that as per the FVA supporters the fair value assets have been blamed in an unfair manner for the collapse of the financial institutions and they believed that such financial collapses was resultant from banks poor lending policies. In order to bring in recovery within the equity markets after the global financial crisis, the professional accounting literature elaborated that certain changes have been considered within the FASB and IASB accounting standards on FVA that must be followed by nearly immediate along ith considering drastic decrease in the impairment of the financial assets (Osadchy and Akhmetshin 2015). After the financial crises the IFRS accounting standards have changed its paradigm for carrying out finical analysis and for proper asset valuations using FVA so that there are less chances of misuse of such accounting standards. In addition, certain changes were also are within IFRS 7 that considered enabling the reclassification of particular financial instruments from the category “had for trading” along with “financial assets assessable for sale”. Moreover, the market value focused on instruments was recognized as the new amortized cost as the asset value after the financial crisis could not be considered as fair value because it remained undermining for the market price credibility.
The objective of the essay was to analyze the ways in which the current IFRS accounting requirements contributes to the financial crisis. Moreover, the concept of financial crisis is also explained through this essay. It was gathered from the essay that the financial crisis that took place in the year 2008 would not have been drastically severe of there was not existence of a faulty “Fair Value Accounting (FVA)” standard. However it is also argued that the accounting was not just the major cause for such financial crisis. Due to the selective implementation of FVA, it did not in practice result in the pro-cyclicality of the financial system. The professional accounting literature elaborated that certain changes have been considered within the FASB and IASB accounting standards on FVA that must be followed by nearly immediate along ith considering drastic decrease in the impairment of the financial assets.
Acharya, V.V. and Ryan, S.G., 2016. Banks’ financial reporting and financial system stability. Journal of Accounting Research, 54(2), pp.277-340.
Balakrishnan, K., Watts, R. and Zuo, L., 2016. The effect of accounting conservatism on corporate investment during the global financial crisis. Journal of Business Finance & Accounting, 43(5-6), pp.513-542.
Biddle, G.C., Callahan, C.M., Hong, H.A. and Knowles, R.L., 2016. Do Adoptions of International Financial Reporting Standards Enhance Capital Investment Efficiency?.
Brusca, I. and Martínez, J.C., 2016. Adopting International Public Sector Accounting Standards: a challenge for modernizing and harmonizing public sector accounting. International Review of Administrative Sciences, 82(4), pp.724-744.
Cerbioni, F., Fabrizi, M. and Parbonetti, A., 2015, September. Securitizations and the financial crisis: Is accounting the missing link?. In Accounting Forum (Vol. 39, No. 3, pp. 155-175). Elsevier.
Christophers, B., 2016. Geographies of finance III: Regulation and ‘after-crisis’ financial futures. Progress in Human Geography, 40(1), pp.138-148.
Cooper, C., 2015. Accounting for the fictitious: a Marxist contribution to understanding accounting's roles in the financial crisis. Critical Perspectives on Accounting, 30, pp.63-82.
Goh, B.W., Li, D., Ng, J. and Yong, K.O., 2015. Market pricing of banks’ fair value assets reported under SFAS 157 since the 2008 financial crisis. Journal of Accounting and Public Policy, 34(2), pp.129-145.
Li, X. and Yang, H.I., 2015. Mandatory financial reporting and voluntary disclosure: The effect of mandatory IFRS adoption on management forecasts. The Accounting Review, 91(3), pp.933-953.
Novotny-Farkas, Z., 2016. The interaction of the IFRS 9 expected loss approach with supervisory rules and implications for financial stability. Accounting in Europe, 13(2), pp.197-227.
Osadchy, E.A. and Akhmetshin, E.M., 2015. Development of the financial control system in the company in crisis. Mediterranean Journal of Social Sciences, 6(5), p.390.
Vazquez, F. and Federico, P., 2015. Bank funding structures and risk: Evidence from the global financial crisis. Journal of banking & finance, 61, pp.1-14.
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