Effects of the Global Financial Crisis on the International Accounting Standards
Abstract Since July 2007, leading economist believe that this has been the worst financial crisis since the great depression.
This essay outlines various viewpoints and influences in respect to the paradigm. Firstly it defines, Global Financial Crisis (GFC) and the impact it has had on International Accounting Standards in regards to implementation and use of their accounting regulations. It also examines The Fair Value Measurement in accordance to the effect it has on the GFC and how the interpretation of fair value is the problem not the method itself.The Positive Accounting Theory (PAT) is also discussed and analysed in terms of it being the dominant theory to justify accounting regulations and standards (Anonymous. 2008a). Introduction Due to the impact that the Global Financial Crisis (GFC) has had on the economy around the world, there has been doubt concerning the use and implementation of the International Accounting Standards.
A number of people have blamed and criticised the International Accounting Standard Board (IASB) and their regulations. Retrospectively there are some that defend the IASB and believe it has no negative effect on the crisis.An area that has been deeply criticised is the Fair Value Measurement and blames it for the negative effects felt during the financial crisis.
Particular individuals believe there is no alternative but to use the Fair Value Measurement. This view is opposed by others who believe it should be changed all together and then the view that there should be modifications made to the fair value regulations to help solve the problems. The Global Financial Crisis The Global financial crisis (GFC) is described as an “economic scarcity where there exists a continuous drawback against strategic stable economic growth in the world” (Anonymous.
009b). Smith (2009) depicts that the financial crisis was created by the real estate bubble burst in the U. S. A, in which caused banks to lower their lending standards and which their capital was depreciated fast, stating a big loss on mortgage loans. This ultimately led to uncertainty in the market because banks did not know who had what and who had the bad loans. Banks also constricted credits to customers which therefore customers stop buying and corporation stopped investing.
Due to all these causes the stock market around the world deteriorated and many people lost their jobs. Use and implementation of international accounting standards The impact of the GFC on the use and implementation of international accounting standards has also been heavily criticised. The IASB has been forced to examine specific accounting standards and make appropriate alterations to regulations that require amendments. The aim of the IASB is to build confidence in investors and reduce the level of difficulty that is involved with accounting during the economic downturn.Many have blamed the use of Fair Value for the effects of the GFC and for the devaluation of the financial assets, which has caused large write offs of banks and financial service groups.
Although after all this criticising of the Fair value measurement, there is no practical approach. Instead of modifying the entirety of the international accounting standards, there have been particular amendments made to demonstrate a more simple way of valuing an asset which will hopefully result in increasing investor’s confidence (McCafferty, 2008). It is evident that, accounting standards which adopt an active and liquid character work more efficiently.However in the circumstances of a GFC, the regulations and standards are inefficient and impractical in nature (Berman, 2008). There has been immense pressure put on the IASB to alter and amend a number of the regulations that control the accounting procedure.
Many parties are putting pressure on the IASB; however the main ones are the large banks and financial service businesses that have experienced huge losses during the recession. Consequently the IASB has had to take action and consider changes that have been put forward by the G20 leaders at a meeting in Washington on November 2008.These areas have been underlined, as well as the accounting regulations, due to the economic difficulty that has been experienced and for the IASB to take a course of action to try re-gaining the trust of investors and large organisations. The amendments made by the IASB consist of: impairments, connecting gaps involving different accounting standards which apply to similar circumstances, financial instruments, changes in the area of consolidation, derecognizing, and improving the accounting for the off balance sheet items (IASB, 2009). ).The issue of bridging the gap between accounting standards has gone through some transition. Initially accounting regulations were able to use various techniques, in which increased the difficulty of compatibility. This was highlighted by the European Unions request for changes in re-classifying financial assets, analogous to the stance taken in the US, namely the Generally Accepted Accounting Policies (IAS) Fair Value Measurement According to IAS 39 (2009), fair value is: ‘The amount for which an asset could be exchanged or a liability settled, between knowledgeable, willing parties in an arm length transaction.
In fact if there is an effective market, then the fair value would be equal to the current market price. However this is subject to the requirement that it must reflect the wishes of the parties. The reason why fair value measurement is partly liable for the GFC is because when using fair value, items cannot be measured precisely and as a result a biased estimate is used which a market participant may particularly disagree with, which potentially can mean that items are valued differently (Trussel and Rose 2009, 27).Also another factor that’s argued is that when there is little to no market, the fair value measurement method results to companies undervaluing or distorting their assets (Berman 2008). Banks further state that the use of amortization or historical cost value of measurement would have not led us to the crisis we are in, because items would have been recorded as a gain or loss only when they were actually sold (Trussel and Rose 2009, 27). This is different compared to the fair value where the current price of an item must be suitably adjusted, and as the alue of items are lowered the potential net worth of an organisation would be lower as well. Due to these problems, banks are arguing that they would have been bankrupt, because there was a low realisable net work and so they had to sell items to increase the net wroth.
This gives us an understanding that various organisations had to sell their items using the rule of supply and demand; the more sellers in the market in contrast to buyers, the lower the price would be, until the price is acceptable to buyers. This would result to a lower net worth in an organisation.This was the main reason why banks demanded for change in the international standards, because had it continued with the historical cost measurement, the organisations mark-to-market would have appeared better and the sales that had been forced, would had not been made. (Trussel and Rose 2009,27). However this lead to further dispute from other sources, as they argued that employing the fair value method is accurate in some way, because it seems to show more of the ‘truth’ of an organisation instead of concealing it with the historical cost method.King (2009) stated that “knowing the truth is better than disguising things to simply make it look better. ” King (2009) describes arguing that fair value method should be used; it’s hard to contradict, as he states: ‘Not disclosing current prices is like breaking a thermometer if you think the temperature is too hot. It’s the heat, not the thermometer, which causes discomfort.
’ This reinforces the fact that the fair value method is not at fault and that there is no need for change in policy but a modification of its definition.The motive of this would be because fair value does not estimate accurately and display a true figure. Due to people’s information, understanding of the ‘market’ and its market price, is how they will measure an item, in which its expected range is to be within 10% even when the information is obtained by the two parties valuating the market price. Therefore if there is no specific guideline on how to valuate an item moderately, which can’t be done without any subjective information, is where the GAAP demonstrates a lack of knowledge on how appraisers really value particular items. This is the ationale to why the GFC may have occurred and how certain item may be valued differently compared to other parties (King, 2009).
Positive Accounting Theory During the 1970’s, the accounting theory was changed back to the experimental methodology, which is also known as positive methodology or positive accounting theory (PAT). Godffrey et al (2006) describes that the objective of the positive theory “is to explain and predict accounting practices. ” This means that an examination of the accounting theories and hypothesis are imperative. This would allow for a comparison between such theory and facts of the real world.
However in today’s society the theory is generally concerned with ‘clarifying’ the basis of practices and ‘forecasting’ the tasks of accounting of an individual, organization or any other party economic decision, that associate with the operations of the market place and the economy. The use of this method is to test theories that presume that accounting information is an economic and political product and that people act to benefit themselves (Godffrey et al, 2006). While the 1960’s PAT was the dominant theory in explaining all accounting methods (Watts and Zimmerman 1990, 132).Therefore relating back to the GFC it is reasonable to say that the critiquing of banks and demand of resorting to the original cost value would have lessened the degree of the crisis. This reinforces the case of a normative theory, in which it focuses on what ‘should’ had been done opposed to what ‘has’ been done (Godfrey, Hodgson, Holmes and Tarca 2006). I believe that PAT is still the dominant theory and should therefore not be detained as an accounting practice.
It should be looked at in regards to other theories such as the normative theory.By witnessing what the GFC caused and to assume motives as to why it occurred, PAT is vital in containing ideas that fair value may have uncovered. This includes hiding techniques used by banks, along with the lowered lending standards offered by banks, which may have caused the dramatic effects of the GFC. Taking on the PAT, it reasons as to the economic downturn on a ‘play-by-play’ basis, which was accomplished and the next goal was to come up with an answer to the problem. This is where normative theory may come about by solving what should have been done on these circumstances.Once accomplished PAT then normative theory does not differ in any significant way, whereby any solution will be applied. Although in terms of the GFC there is no realistic or practical solution to fix this and where there are still various points of views as to what caused the GFC (Godfrey, Hodgson, Holmes and Tarca 2006).
Conclusion Positive Accounting Theory is a rational and pragmatic tool adopted by entities worldwide. Its application has shaped the internal accounting practice of many firms and continues to be favored as a dominant premise.However should this Positive Accounting Theory be the one and only tool governing accounting systems worldwide? This paper has addressed how such a theory has endowed accountants with the knowledge required to advance in this 21st century. However emphasis should be brought to the Normative Theory which has been the backbone of the Positive Accounting Theory. Standard settlers may formulate solutions regarding ‘when’, ‘where’, and ‘why’ problems have occurred in the past and endeavor to set new guidelines as to the future. The fair value approach has been heavily scrutinised and attributed to the Global Financial Crisis by many organisations.
However this paper accentuates that the fair value system is not the primary cause of the financial downturn, but it’s definition; the definition which has been adopted and encouraged such a line of reasoning. In order for the accounting standards and practice to remain a viable and positive option for commercial entities worldwide, it is imperative that firms employ this central theorem in reference to the normative theory. This approach is sure to highlight this accounting mechanism as the ‘new wave’ in the regulation of policies now and in the foreseeable future.