Role of Accounting Standards in the Global Financial Crisis
This particular essay attempts to explain the issues surrounding contemporary accounting arguments like fair value accounting in various frameworks using ethical, social, regulatory, economic and global perspective (Arnold, 2012). The essay also demonstrates the understanding of accounting standard and the authoritative impacts that basically underpins reporting and accounting in the global and Australian Regulatory Environment. This assignment incorporates three parts; part A discusses the role of accounting standards in the GFC. Second part analyses the potential problems associated with poor accounting standards and last part discusses the influence of AISB on AASB in pursuing a global convergence of Australian Accounting Standards.
IAS 39 defines Fair Value Accounting as the money that can be paid to basically transfer the obligation to a new debtor or the money that an asset can be traded in a prevailing transaction between enthusiastic parties and the knowledgeable (Chalmers, Godfrey, & Lynch, 2012). The great recession that started in the FY2008 has had a significant effect on the US and the global economy which was estimates that the total amount of Australian wealth lost is about AU$14 Trillion. The Global Financial Crisis impelled some players to criticize the role of fair value accounting that is needed by the accounting guidelines used by the key listed corporations in ASX and the world.
The criticism of fair value accounting is basically considering various problems that includes pro-cyclicality and lack of liquidity that emphasized on the economic stages of recession and expansion. Basically, the fair value accounting standards could not afford and facilitated diverse financial institutions to report inflated profits that related to the home loans without recourse from analysts and auditors (Davies, & Green, 2013). The argument is that fair value accounting allowed diverse financial institutions to intensify their leverage on boom phase that basically, in turn, made the financial systems more susceptible and global economic crisis more severe.
Poor lending practices in Australian basically enhanced subprime mortgages crisis that idealized the crisis conditions. Diverse financial institutions in the country provided cheap loans to individuals and other companies through cheap loan rates (Albu, & Albu, 2011). Due to inactivity in the markets, the major claims are that the fair value accounting basically contributed to undue leverage boom phases and thus led to excessive impossible to perform reliable market valuations for diverse companies. In this case, the valuation issue actually increased the aspect of depreciation for assets in the market. The problem with this particular increase in depreciation is that when the market for an asset that firm values it at fair value, it becomes illiquid. Additionally, during the GFC period, AASB and AISB issued additional guidance that regarded how to account for securities in illiquid, disrupted or distressed financial markets that did not properly evaluated the estimates that management used to value the company liabilities and assets.
Potential Problems Associated with Poor Accounting Standards
Low rates of interest basically inspired many in Australia to pursue homeownership plan which was an objective promulgated and even stimulated by the government as a prudent venture and worthy social goal (Geiger, Raghunandan, & Riccardi, 2013). Easy credit facilities basically provided by agencies in the country facilitated financial institutions to emphasize on the worthwhile subprime mortgage market. Lenders of the mortgage primarily instigated a rising number of new home mortgages many of which were approved to diverse individuals with poor credit ranking who were basically unable to service cyclic mortgage costs once the rate of interest increased.
In this case, the gains created from the securitization of the home mortgages and other incomes on the loan servicing basically inflated the revenues motivating company managers to emphasize on quantity instead of the quality of debtors. In this case, fair value accounting guidelines did not enhance high demand rate since such securities basically received high ratings from experts who did not properly evaluate the underlying default risks (Mala, & Chand, 2012). IASB responded by issuing IFRS 9 that provided guidelines on assets valuations. The standard accentuates that the assets will be categorized into those that are prized at amortized value and those values at fair value.
IASB attempted to control the fully inflated market by setting up diverse guidelines to counter the increasing financial condition by advising diverse financial institutions to decrease the interest rates on mortgages so as to facilitate individuals and companies to repay back the underlying interests and loans. This aspect was done by amending and reclassification of financial instruments (Xu, Carson, Fargher, & Jiang, 2013). The accounting body also attempted to provide strict guidelines to financial agencies that seek to control how mortgage could be offered to new customers. The IASBs actions are basically likely to have an impact on global financial stability as it will assist provide guidelines that must be followed by the financial institutions globally. The IASB action will contain greater significance as it facilitates the stability of the global financial markets.
Prior to the FY2008 global financial crisis, diverse accounting standards were amended to allow for reclassification of financial instruments. Some of the potential problems include, access to capital markets could be restricted, a loss of opportunity to converge the standards (Brown, 2011). Lack of transparency is another potential problem because the issued financial guidelines provided prior to the GFC may not enhance consistency in the fair value accounting. Reclassifying some of the financial statements may basically lead to inconsistency because the information aggregation notion that basically underlie setters of the accounting standards endorsement of fair value measurements to turn out to be theoretically limited in its applicability and validity.
Influence of AISB on AASB in Pursuing a Global Convergence of Australian Accounting Standards
Fair value based on some of the guidelines are not trustworthy and can be subjected to managerial operation provided with the subjective evaluation incorporated in their estimation. In this case, prices can be misleading by the inefficiencies in the market, investor’s illogicality and liquidity difficulties. Prior accounting standards creates excessive volatility in the financial reports that may lead to significant effect on the company’s financial records (Adams, & Simnett, 2011). Another potential problem is that fair value perception fundamentally controverts the going concern hypothesis that basically states that a firm is required to continue in its business operations for a prolonged period of time whereas fair value is exit amount, so the statement of financial position is basically liquidation statement of financial position. Improving fair value accounting has also remained criticized because of its association with high costs of implementation.
Setters of the standards are faced with the well-known and classic trade-off between reliability and relevance; model-based fair values might be more significant in certain circumstances, but the market prices are easy to authenticate and difficult to manipulate (Arnold, 2012). Another possible problem is that improving fair value accounting introduces volatility in the financial statements. This is because while fair value accounting identifies losses quick, thereby compelling companies to take suitable actions early and making it hard to hide any probable problems. This difficulties arises when an asset utilized in the company do not produce distinct cash flows. IASBs basically took this particular step to improve fair value accounting because the accounting body stressed on the significance of the financial statement users and the manner in which the offered information would be used to make diverse decisions (Brown, 2011). IASB also recognized the significance of the accounting and the custodial responsibilities entrusted to diverse accountants due to their duties in maintaining record and reporting the outcomes of economic activity by improving fair value accounting.
The Australian Accounting Standards Board reacted to the global financial crisis by implementing numerous stricter accounting principles including the IFRS and GAAP accounting systems. This action was basically done so as to prevent such financial crisis and its ill impacts in the future (Tarca, 2012). AASB basically responded to the GFC by introducing the following measurements based on the US GAAP:
- Present value measurement
- Historical cost
- Acquisition cost for non-financial or intangible assets
- Depreciation
- Fair value measurement
Basically, implementing the International Financial Reporting Standards (IFRS) is considered to be a significant idea since it would be compatible with all accounting guidelines and acceptable to stakeholders, merchants and also companies. But this practices has been designed from the English perceptions and is not related to the US GAAP Australian or the GAAP. Its implementation would basically face a lot of resistance (Adams, & Simnett, 2011). There may be a lot of initial resistance and hiccups. Furthermore changing from one model to another brings in a lot of problems in the preliminary stages, as there will be uncertainty about how to carry over the preceding financial year balances. This aspect will interrupt the global trading accounting and practices of multi-national firms because basically, its implementation is a challenging activity, but it is beneficial in the long run.
References
Adams, S., & Simnett, R. (2011). Integrated Reporting: An opportunity for Australia’s not?for?profit sector. Australian Accounting Review, 21(3), 292-301.
Albu, N., & Albu, C. N. (2012). International Financial Reporting Standards in an emerging economy: lessons from Romania. Australian Accounting Review, 22(4), 341-352.
Arnold, P. J. (2012). The political economy of financial harmonization: The East Asian financial crisis and the rise of international accounting standards. Accounting, Organizations and Society, 37(6), 361-381.
Brown, P. (2011). International Financial Reporting Standards: what are the benefits?. Accounting and business research, 41(3), 269-285.
Chalmers, K., Godfrey, J. M., & Lynch, B. (2012). Regulatory theory insights into the past, present and future of general purpose water accounting standard setting. Accounting, Auditing & Accountability Journal, 25(6), 1001-1024.
Davies, H., & Green, D. (2013). Global Financial Regulation: The Essential Guide (Now with a Revised Introduction). John Wiley & Sons.
Geiger, M. A., Raghunandan, K., & Riccardi, W. (2013). The global financial crisis: US bankruptcies and going-concern audit opinions. Accounting Horizons, 28(1), 59-75.
Mala, R., & Chand, P. (2012). Effect of the global financial crisis on accounting convergence. Accounting & Finance, 52(1), 21-46.
Tarca, A. (2012). The case for global accounting standards: Arguments and evidence.
Xu, Y., Carson, E., Fargher, N., & Jiang, L. (2013). Responses by Australian auditors to the global financial crisis. Accounting & Finance, 53(1), 301-338.
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