Role of Accounting Standards in The Global Financial Crisis - Sample

Question: Discuss about the Response to Global Financial Crisis. Answer: Role of accounting standards in the Global Financial Crisis Global financial crisis was a huge tragedy that has affected most of the countries all over the world. The crisis was initiated in the year 2007 in the US markets. The global financial crisis is believed to be the worst event in the worlds economy. There were various reasons that caused the countries face the adverse impacts of such crisis.Accounting standards prescribed by the regulatory bodies were among the prime reasons that contributed to the occurrence of the critical incident (Kothari Lester, 2012). The approaches followed by theaccounting standard setters were considered to be inappropriate in various situations. To account for the financial instruments various methods were used and those instruments were required to be recognized at the fair value in accordance with theaccounting standards and this fact became the one of the main reasons for the global financial crisis. (Laux Leuz, 2010). At the beginning of emergence of the financial crisis in late 2007 the home loans tha t covered in special purpose vehicles were unable to meet their debt obligations because of sudden decrease in housing prices. As a result of which the financial institutions holding the low credit quality particularly the subordinated loans covered in the special purpose vehicles began to face huge losses. In the initial years the low quality debts had restricted market and huge demands as they were offering higher rate of returns. Consequently, the positive fair value adjustments were reported in the financial statements. However, with the increased pace of diminution in prices of the housing industry, the low quality debt market initiated disappearing leading to sudden decline in the fair values of these debt papers (Shiller, 2012).The overall impact of the subprime crisis had drastically influenced the several economies of world specially those which had purchased the poor quality debt papers. The institutions of finance had already made the securitisation of their mortgages and hence the special purpose vehicles had begun making losses ultimately leading to the financial crisis at the global level (Mishkin, 2011). International Accounting Standard Boards (IASB) response to the Global Financial Crisis The adverse impacts of global financial crisis together with the intense political pressures imposed the serious requirement on the IASB to make revision to its already existing accounting standards and to issue new and relevant standards to as to deal with the severity of the global financial crisis issues. In response to the global issue IASB has formed a Financial Crisis Advisory Group (Ait-Sahalia, 2012). The purpose of FCAG included the consideration of the process used to set the accounting standards. The directions of IFAC also included the possible improvements to be made in accounting standards. Further the group also considered the role of accounting standards in the global financial crisis and the adequacy of fair value accounting for the financial instruments. The FCAG has concluded that the standards of the accounting must be kept free from political interference. It was realised by the FCAG that existing accounting standards were not considering the entitys business mod el. It was held by the group that the major factor that led to the crisis was the approach of legal compliances in place of adhering to the principles of those accounting standards by the reporting entities. Following actions were taken by the IASB in response to the crisis: The amendments made by IASB in the accounting standards required the disclosures of various important elements of fair value accounting. The amendment of IFRS 7 was brought in this context which required the categorisation of fair value measurement of the financial instruments. IASB also published its proposals to improve theaccounting of the off balance sheet items. It also made amendments to the IAS 39 with the intention of reclassifying the financial instruments so as to ensure that the embedded derivatives are separated in the financial assets classification. IASB also attempted to bring the consistency in the accounting treatment between the generally accepted principles of accounting and the IFRS in relation to the credit linked investments. The disclosure requirement with regards to the impairment of financial assets. The IASB is continuously struggling to move rapidly to address the issues of financial reporting as were encountered by the global financial crisis. It is commit ted to develop the globally accepted approaches to maintain the consistency with the approaches followed in the global world (Ojo, 2010). The above mentioned actions provided the appropriate responses to the global financial crisis and the IASB has so far managed overcome the severity of the issue and thereby promoting the financial stability globally. However, looking to the complexities of worlds economy it can be said that the IASBs responsibilities in respect of maintaining the global financial stability has not ended here. It is still required to regularly amend and introduce the relevant standards of accounting on timely basis in order to satisfy the investors and the general public associated with the company. Revision and Introduction of New Accounting Standards By IASB With the occurrence of global financial crisis certain standards issued by the IASB received much attention and as a part of response to the crisis it has brought into the scope the amendment in IAS 39 which allowed the reclassification of financial instruments. As IAS 39 was critically condemned by the banking and other financial institutions for its method of valuing the financial instruments following the mark to market method (Haas Lelyveld, 2014). The banks argued that the mark to market method of measurement does not always provide the correct value of some of the parts of the balance sheets of the banks (Barth Landsman, 2010). Moreover, the earlier version of IAS 39 was also complex enough to deal with as it required classification of financial assets in four categories and the financial liabilities in two categories. Whereas, the revised IAS 39 requires the entities to classify its financial instruments only on two basis i.e. the instruments for which fair value method is u sed for recognition and the instruments for which amortised or historical cost method is used. Further, the IFRS 13: Fair Value Measurement and IFRS 9: Financial Instruments are also issued after the global financial crisis in order to improve the fair value accounting used by entities for measuring and recognising the financial assets and liabilities. Fair value accounting is given so much importance due to the reason that it allows the presentation and delivery of reliable and relevant accounting information to the readers of financial statements (Claessens Kodres, 2014). IFRS 9 is attempting to develop the standards relating to the derivatives, asset impairment and the hedging. With these changes IFRS 9 has reduced the discretion level in terms of classification of financial instruments so as to reduce the complexities of financial reports depicting such instruments. IFRS 9 promotes the uniformity and standardisation in financial reporting of the financial instruments and aims at enhancing the understanding and comparability of financial reports. The overall effect of IFRS is that there can be experienced more concentration on fair value accounting of financial instruments. AASBs response to the Global Financial Crisis The impact of global financial crisis had also touched the Australian economy and made it necessary for the Australian accounting standard setters to take appropriate actions to deal with the critical situation of financial crisis. Australian Accounting Standard Board is the statutory body which functions for the formulation and regulation of accounting standards for the reporting entities of Australia. AASB in response to the crisis introduced the amendments in the Australian accounting standards so as to ensure the consistency between the approaches followed by accounting standard regulators of other countries (Australian Government, 2008). The amendments were aimed at encouraging the Australian business entities to follow such accounting treatment as are globally accepted. AASB quickly responded to the IASBs actions in dealing with global financial crisis and hence made the amendments to the AASB 139 and AASB 7 when changes are made to IAS 39 and IFRS 7. In response to the crisis IASB had organised several round table meetings in the different countries like Tokyo, New York and London (Claessens, 2010). The participant countries were directed to identify the prime accounting issues that needs immediate attention. The chairperson of AASB at that time had also taken participation in these discussions. IASB through its enormous efforts is constantly trying to enhance the trusts of the investors and shareholders of the entities (Bengtsson, 2011). The initiatives that were taken by IASB and the Australian Board of accounting standard has time to time responded to them positively are: The improvement in the disclosures requirement of the off balance sheet items and the provision of clarification about the accounting treatment of financial instruments like embedded derivatives. These AASBs responses were intended to bring the convergence with the IFRS responses. References: Ait-Sahalia, Y., Andritzky, J., Jobst, A., Nowak, S., Tamirisa, N. (2012). Market response to policy initiatives during the global financial crisis.Journal of International Economics,87(1), 162-177. 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