Accounting And Financial Management: Fiscal Crisis Essay

Question:

Discuss about the Accounting and Financial Management for Fiscal Crisis.

Answer:

The recent fiscal crisis has resulted in huge debate concerning the fair value accounting. Several critics have put forward their argument by stating that fair value accounting which is often known as market-to-market accounting that has considerably contributed to the fiscal crisis or have at least aggravated it brutality (Rey, 2015). Fair value accounting generally consists of reporting of assets and liabilities on the balance sheet at their given value and recognizing the changes in the fair amount in the form of gains and losses in the income statement. When marketplace is used in the determination of fair value then it is known as market value accounting.

Critiques have put forward their argument that fair value accounting was majorly responsible for global financial crisis. The major accusations are that fair value accounting attributes significant amount of leverage during the boom period and results in extreme amount of write-down in busts. The write-down generally leads to declining marketplace prices, which ultimately depletes the bank capital by setting a descending spiral since banks were forced to dispose off their assets based on fire sale prices (Haas & Lelyveld, 2014). This in turn results in contamination as the price asset fire sales of one bank turns out to be relevant in the other banks. Commencing from 2007 falling house prices arising out of the defaulting sub-prime borrowers, closure of mortgage fraud have resulted in problems relating to mortgage securities. This ultimately results in making the mortgage instrument complex.

As the housing prices began to fall and default rate of mortgage started to increase since the marketplace for such kinds of securities have dried out for causes that was not related to accounting. As the rate of defaulters began to increase, due to the commencement of crisis these hedge funds noticed a large amount of outflow of capital during the middle 2007 (B?n?trix et al., 2015). Large number of organizations originated these kinds of investment funds stopped the process of withdrawals and did not allowed redemptions of their investment funds.

One may argue by stating that fair value accounting player a significant role in the conclusion of monetary institution so that they can bail out their investment funds. Supposedly, monetary organizations have expressed their fear by stating that trading on asset funds and assets in the illiquid market might have led to depression in prices and may have forced writing off assets that are held by the other asset funds or by themselves (Reddy et al., 2014). The fear of contamination may have played an important role in the decision-making but it is in doubt whether this was the first order that affected the investment bank.

For investment banks concerns regarding their reputations, as they doubted that if one funds fails there might be the fear for further withdrawal of funds which were of great importance. To be more precise, the monetary problems of investment bank at the time of crisis are understood as the outcome of insufficient investments, short-term financing and high leverage. The shareholders have expressed their concern regarding the worth of fundamental assets instead of violent writing down of assets forced by the fair value accounting (Claessens & Van, 2015). Finally, to conclude with it is improbable that fair value book-keeping stimulated global financial crisis since researchers have formed a positive association by stating that financial crisis was mainly determined by short term collateralized borrowing.

During the beginning phase of the global financial crisis the controllers have looked accounting standards setters especially the IASB and FASB concerning the involvement, which it had made in the measurement of fair value of fiscal instrument, had on the fiscal crisis (Cavusgil et al., 2014). During calculation of fair value measurement inadequate considerations was regularly given to the various factors the instrument of fair value. Realistic problems have originated in the determination of fair value instrument particularly in the cases where marketplace have either distorted or vanished.

Several observers have criticised that there is inadequate guidance particularly in the face of illiquid market. The criticism consisted of inadequate viewing of the inputs and models, which was used to conclude the fair value of instrument. Widespread leadership has been consequently released on the assessment of fair value in the illiquid marketplace and the policies containing risk, which is recommended in the determination of the fair value (Goh et al., 2015). The abundance of exotic products in the form of collaterized debt obligations were necessarily required to measure the fair value of chosen by the organization to be held at fair value which might help in recognising the instability of profit and loss.

A huge amount of criticism was drawn at the IASB since several stakeholders were in the opinion that inadequate revelation was provided on numerous elements in the measurement of fair value. This included the sensitivity of inputs in the assessment of the fair value along with the impact of fair value measurement on the profit and loss (Bowen & Khan, 2014). IASB has of late issued amendments to the current IFRS 7 that was based on the disclosure of financial statement. The amended disclosure, which was necessary for the entities with the financial reporting periods commenced on or after the 1st January 2009, and it is based on the US GAAP standard FAS 157, fair value measurement. The alterations to the IFRS comprised of the necessity of classification in the fair value measurement of the financial instrument under the three stage hierarchies of measurement. The three stages of fair value measurement hierarchies where level one consisted of obtaining fair value directly from the market price (Blankespoor et al., 2013). The second level comprised of deriving fair value mainly from the marketplace prices but with minimum amount of unobservable marketplace inputs. The third level of the hierarchy consisted of principally deriving value of instrument from the unobservable market inputs, which included valued off models.

The modifications that were made to the standard comprised of making revelation of alterations among the three levels of dimensional hierarchies along with the detailed understanding of the sum that was recognised in the third level financial instrument identified at fair value. It also consists of making revelation of sensitivities to alterations in inputs based on the fair value assessment of fiscal instrument (Amel er al., 2016). The volume of work that is required to act in accordance with the standard and must not be undervalued since it need categorization and revelation of all fiscal instruments.

In the decline of 2008, unstable financial markets have prompted actions by Australian Accounting Standard Board and the International Accounting Standard. One of important issues that was addressed by AASB was based on the off-setting the balance sheet accounting that was widely used in securitization (Hull & White, 2014). The current accounting standard officially recognized off-balance sheet for passive entities and special purpose enterprise that existed in order to hold the incoming payment on those assets and passing down the payment to investors in the securities of those entities.

The setters of standard have been criticised as why the accounting standards authorized definite dealings to be derecognised from the balance sheet and providing allowance to special purpose vehicle, which is established by the group not to be consolidated. This ultimately resulted in loan obligations, associated financial assets and profits or losses arising out of this vehicle not being included in the financial results of the group. In order to assess whether the control existed, a legalistic approach was followed which resulted in positive commitments. In relation to de-recognition of financial instrument, the current standard was written by the IASB and FASB comprised of multifaceted set of rules, which resulted organisations to assess precise transactions. To de-recognise the financial instrument off their balance sheet AASB has constantly attempted to create a principle based standards (Ettredge et al., 2014). Furthermore, an exposure draft was issued by AASB, which included the procedure of determination of fair value of financial liabilities.

In adopting the IASB’s standard, the overall approach of AASB is to converge the content and wording of AASB. The convergence of IASB included emphasis on the profit making entities. AASB was accountable for setting up the accounting standard of all types for reporting entities. It is found that AASB standards have dealt with limited cases where there was a need to have different or supplementary requirements for non-profit making entities. The additions that were made did not create an impact on the requirements of the profit entities (Bischof et al., 2014). In developing the new or amended IFRS, the AASB released its exposure draft that contained those proposed changes and exclusively provides an invitation for comments from Australian equivalent to an IFRS, which is affected by the Australian environment.

The influence of IASB led to AASB to adopt several additions and deletion from the standards. This included deletion of optional treatments from the IFRS when the existing standards allowed only one of those treatments. The AASB has undertaken the decision of making the Australian requirements similar to that of the IFRS in respect of the profit entities (DeJager, 2014). To attain this objective AASB has proposed the removal of large number of differences from the IFRS other than those that are dealt in specific non-profit making entity. The AASB proposed an options that presently existed in the IFRS and should be included in the Australian equivalent IFRS with additional disclosure must be eradicated other than those which was considered important in the Australian reporting environment.

Reference List:

Amel-Zadeh, A., Barth, M. E., & Landsman, W. R. (2016). The Contribution of Bank Regulation and Fair Value Accounting to Procyclical Leverage.

B?n?trix, A. S., Lane, P. R., &Shambaugh, J. C. (2015). International currency exposures, valuation effects and the global financial crisis. Journal of International Economics, 96, S98-S109.

Bischof, J., Br?ggemann, U., &Daske, H. (2014). Fair value reclassifications of financial assets during the financial crisis.

Blankespoor, E., Linsmeier, T. J., Petroni, K. R., & Shakespeare, C. (2013). Fair value accounting for financial instruments: Does it improve the association between bank leverage and credit risk?. The Accounting Review, 88(4), 1143-1177.

Bowen, R. M., & Khan, U. (2014). Market reactions to policy deliberations on fair value accounting and impairment rules during the financial crisis of 2008–2009. Journal of Accounting and Public Policy, 33(3), 233-259.

Cavusgil, S. T., Knight, G., Riesenberger, J. R., Rammal, H. G., & Rose, E. L. (2014). International business. Pearson Australia.

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Ettredge, M. L., Xu, Y., & Yi, H. S. (2014). Fair value measurements and audit fees: evidence from the banking industry. Auditing: A Journal of Practice & Theory, 33(3), 33-58.

Goh, B. W., Li, D., Ng, J., & 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), 129-145.

Haas, R., &Lelyveld, I. (2014). Multinational banks and the global financial crisis: Weathering the perfect storm?. Journal of Money, Credit and Banking, 46(s1), 333-364.

Hull, J. C., & White, A. (2014). Valuing derivatives: Funding value adjustments and fair value.

Reddy, K. S., Nangia, V. K., & Agrawal, R. (2014). The 2007–2008 global financial crisis, and cross-border mergers and acquisitions: A 26-nation exploratory study. Global Journal of Emerging Market Economies, 6(3), 257-281.

Rey, H. (2015). Dilemma not trilemma: the global financial cycle and monetary policy independence (No. w21162). National Bureau of Economic Research.

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