Financial Crises meaning and its impact
Discuss about the Financial Crisis And The Current IFRS Requirements.
The international accounting standards prepared by the IASB provide standard accounting rules and guidelines to the professional accountants worldwide for developing and presenting their financial statements. The standards are developed to ensure that end-users receive reliable and faithful information that facilitates them in their decision-making process. However, at present there is increased debate relating to the contribution of IFRS towards the occurrence of financial crisis. For example, the occurrence of global financial crisis in the year 2009 was largely accounted due to the use of fair value accounting standards provided by IFRS (Laux and Leuz, 2010). In this context, the present essay is developed for discussing the issues in the method of fair value accounting that can lead to the occurrence of global financial crisis. In this regard, it provides a discussion of the financial crisis and the current IFRS requirements that can contribute towards the financial crisis.
Financial crises refer to the period or situation of economic downturn faced by the market and consumers. It is very difficult to succeed in the situation of the global financial crises as potential consumers tend to reduce their purchase of goods and services due to poor economic conditions. The global economy was largely impacted by the financial crisis of the year 2008-2010 that led to the downfall of the develop markets. The overall financial distress in the market situation has led to the downfall of the global economic market. In the situation like financial crises the value of assets or financial institutions drops at very rapid speed as there are no buyers and investors when financial crises occur. The financial crises led to the panic situation where investors sell off the assets and withdraw money from the saving accounts as they believe that value of assets will drop quickly and there are chances that banking system can breakdown (Zimmerman and Yahya-Zadeh, 2011).
The financial crisis has resulted in the collapse of large financial institutions due to fraudulent business practices such as mis-representation of financial information. The collapse of the mortgage market is responsible for bankruptcy large financial institutions in the USA during the period 2008-2009. This in turn also led to the breakdown of financial system in other parts of the world and it became first global financial crises that have resulted in the slower economic growth and development. The financial crisis has been initiated downfall of housing market in the US and also has significantly impacted the growth and development of other economies. The bursting of the house bubble has caused in collapse of price of loans and other financial instruments. This has led to slow economy growth in the global economy with the breakdown of many large financial institutions such as Lehman Brothers. The deregulation in the financial industry is attributed to be the main cause of occurrence of financial crisis. This has resulted in providing the freedom to banks for involving in hedging and derivatives trading. Bank has undertaken more mortgages for supporting the profitable sale of the derivatives and this lead to the occurrence of financial crisis due to great recession (Landsman, 2010).
Current Requirements of IFRS Accounting Standards Contributing to Financial Crisis
The global financial crisis in the year 2009 has led to the debates regarding the contribution of fair value accounting for the emergence of such situations. The financial analysts have pointed that US GAAP and IFRS standards have stated the valuation of certain assets and liabilities at fair value to be recognized in the profit and loss statement. Fair value as per the IFRS standards can be regarded as the price that would be realized by selling an asset or will be paid for transferring liability in an ordered transaction between the participants of the market on the date of measurement (Pozen, 2009).
The use of fair value accounting principle provided by the IFRS standards has been criticized widely by the financial analysts as they has regarded to be a major factor towards the global financial turmoil. The main point of criticism is that the use of such accounting method is that it is not able to present decision-useful information to the users of financial statement. This is mainly due to use of estimates in predicting the fair value of assets and liabilities that can lead to lack of reliability and accuracy in the financial information. The management is provided the freedom to manipulate the estimates as per their personal objective in the use of fair value accounting and therefore it can result in providing false information to the end-users. The use of fair value accounting is responsible to large extent for the occurrence of fraudulent practices within an organization. This is because management can realize personal gains with the use of such accounting method by disclosing falsie information that can negatively impact the interests of the end-users mainly investors, creditors and lenders (Laux and Leuz, 2010).
The financial crisis of the year 2009 has a wide impact on the financial markets around the world. It has pointed the inappropriateness of the IASB in developing effective international standards and regulations to protect the interests of end-users. The measurement of assets and liabilities at the fair value has the drawback of not being sufficiently informative for the investors and other users of financial statement. This is because it can lead to the occurrence of unrealized gains or losses and thus makes the financial statements extremely volatile. This is due to the measurement error that occurs in identifying and recognizing the value of assets and liabilities due to use of estimates in reporting of financial information. Thus, in the situations of market instability the use of fair value method can cause lack of relevance and reliability in the financial statements with the use of fair value accounting methods (Menicucci, 2016).
The large criticism of the accounting method to identify and recognize the assets and liabilities at fair value by the accounting professionals has raised questions on the efficiency of the current IFRS standards to protect the interests of end-users. The development of Fair Value Measurements has provided the guidelines relating to estimating the fair value and thus restricting the management ability to manipulate the estimates used in measuring the assets and liabilities value. However, the applicability of IFRS standards for providing reliable and faithful presentation to the end-users is becoming a major issue of concern for the investors. In this context, the IASB is placing large emphasis on improving the reliability and relevancy of IFRS standards to avoid the occurrence of situations of financial crisis in the future context. The conceptual accounting framework has being established by the IASB for improving the qualitative characteristics of financial information disclosed to the end-users (Zimmerman and Yahya-Zadeh, 2011).
The qualitative characteristics of financial information are relevance, faithful presentation, understandability, comparability, timeliness and verifiability. This is necessary for increased regulatory focus on the financial reporting process of business entities to protect the interests of end-users. IASB is also emphasizing on adoption of uniform accounting standards across the world for minimizing the asymmetry in financial reporting. IASB has also established a Financial Stability Board (FSB) for monitoring the accounting standards effectiveness in presenting true and fair view of the financial condition of a business entity (Baker and Nofsinger, 2010). Also, in this direction, IASB is emphasising on establishing an International Integrated Reporting Committee for driving concise, clear and more comprehensive business reporting towards the stakeholders of a business entity. IASB has provided increased guidance to the business entities during reporting of their financial information under the situations of market instability after the global financial crisis of the year 2009. It has also facilitated the reclassification of certain assets and liabilities from preventing the occurrence of mark-to-market losses. As such, all these current measures undertaken by IASB after the occurrence of global financial crisis will result in development of high quality financial statements and reduce the chances of occurrence of materialistic error (British Accounting Association, 2011).
However, IASB still need to place emphasis on improving the regulatory focus on the financial reporting process for reducing the chances of occurrence of any crisis situation. This is because increased market volatility and procyclical effects introduced by the use of fair value accounting method is associated with increased changes of misrepresentation of financial information. The fair value accounting amplified the procyclicality as auditors under the method are required reporting low values of the financial assets and thus amplifying the asset impairments. Thus, IASB need to implement strong measures for reducing the volatility and cyclical effects introduced by the use of approach of fair value in financial reporting (Castleden, 2009).
Conclusion
It can be stated from the overall discussion held in the essay that fair value accounting is associated with the drawback of reporting misinterpreted financial information during the condition of instability within the financial market. As such, IASB need to implement strong measures for reducing the measurement error that can occur with the use of fair value accounting method.
References
Baker, H.K. and Nofsinger, J.R. 2010. Behavioral Finance: Investors, Corporations, and Markets. John Wiley & Sons.
British Accounting Association. 2011. The future of financial reporting 2011: global crisis and accounting at a crossroads. [Online]. Available at: https://www.accaglobal.com/content/dam/acca/global/PDF-technical/financial-reporting/tech-tp-farsig11.pdf [Accessed on: 8 April 2018].
Castleden, D. 2009. Are accounting standards responsible for the global financial crisis? [Online]. Available at: https://www.gaaaccounting.com/are-accounting-standards-responsible-for-the-global-financial-crisis/ [Accessed on: 8 April 2018].
Landsman, W. 2010. How Did Financial Reporting Contribute to the Financial Crisis? European Accounting Review 19(3), pp. 399-423.
Laux, C. and Leuz, C. 2010. Did Fair-Value Accounting Contribute to the Financial Crisis? CFA Digest 40(2), pp. 93-118.
Menicucci, E. 2016. Fair value accounting and the financial crisis: a literature-based analysis. Journal of Financial Reporting and Accounting 14 (1), pp.49-71.
Pozen, R. 2009. Is it Fair to Blame Fair Value Accounting for the Financial Crisis. [Online]. Available at: https://hbr.org/2009/11/is-it-fair-to-blame-fair-value-accounting-for-the-financial-crisis [Accessed on: 8 April 2018].
Zimmerman, J.L. and Yahya-Zadeh, M. 2011. Accounting for decision making and control. Issues in Accounting and Finance Education, 26(1), pp.258-259.
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