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Bogoslaw, D., (2008). 'How to fix financial reporting,' examines the need for transparency and accuracy in financial information reporting so as to enhance investors' confidence.
Considering financial analyst views which was raised from a discussion to enhance the global financial system crisis, a number of issues where raised such as the need for better governing regulations for financial information reporting by companies which publicly trade.
More so, the issue of risky investments by banks and other financial institutions which faulted their balance sheets resulting in financial crisis.
However, the concerns are believed to be in the investors' confidence and this may be extended to the complex and confusing accounting practices employed by a wider range of companies.
Consequently, the main suggestion by this experts is for companies to show complete and accurate illustration of their business standing financially, which can be reflected by disclosures of asset values, liabilities and the corporate balance sheet overall risk.
Notwithstanding the appeal for transparency, banks have requested that for the credit markets to release more there is need to defer the fair-value accounting.
In conclusion, the main purpose of the article was to improve financial reporting in terms of transparency and accuracy so that investors can have confidence with the desire to invest more capital so as to resolve the global economic financial breakdown.
STAGE 2: Four Substantive Issues raised by the article
Financial statements are often subject to accounting standards by bodies such as EU Directives, IAS, and FASB among other standard bodies in the world (Elliott B & Elliott J, 2008). The main aim is for consistency, transparency, and spotlight for financial reporting. However, it is assessed when there is some internal crisis affecting companies subject to analysis.
Consequently, it is fair to observe that substantial issues arises from these various standard bodies in the purpose of achieving transparency and consistency because of the various views attached to several regulations.
With this in mind, there are a number of issues raised in the case article which is as a result of companies, banks and financial institution with the desire to implement some of these accounting standards, are faced with certain difficulties which have outcome of crisis which has affected the confidence of their stakeholders.
There are four substantive issues which have been identified in the article which are:
Fair value accounting for impaired assets
Off balance sheet financing
The above four issues will be examined in terms of conflicting views if any, from different literature by accounting scholars, articles and journals.
Fair value accounting
According to the article, William Isaac, a former chairman of FDIC has blamed the credit crisis on the financial accounting standards which require that assets be valued in terms of their current market value, even if there is no market for them. Their claim was that this caused companies to write down asset values which may inhibit banks' ability to lend.
An insight from Standard & Poor's rating (2008), argues that the current market crisis is an issue of financial institutions complaints about the effect of fair value accounting with an outcry for suspension of the rules. The concerns relate to the accounting rules that have caused financial institution to value their security in a lower price so as to reflect the current price.
More so, from the view point of the Audit Committee Leadership Summit, (2009), suggests that the financial crisis has made the fair value accounting more controversial, adding that the fair value always had its critics, but the crisis has underscored the problems and many observers blame the fair value for down turning balance sheets and reducing asset values.
In October 2008, the IASB had a loud criticism when it amended IAS 39, financial instruments: recognition and measurement, without the normal procedures that allow reclassification of certain assets from 'held for trading' to 'loans and receivables' (Accountancy Magazine, August 2009 page 50)
According to Lucian Samuel as stated from the accountancy magazine, August 2009 page 60, the IASB has a delicate balancing to perform, for it to be the standard-setter of choice. It must be independent and be supported by governments, should it be passed into law. He further claimed that the commentators perceive the IAS 39 amendment as to be putting the interests of politicians and large companies before those of investors.
However, the issue of fair value was addressed by an IASB exposure draft, fair value measurement, issued in May 2009. According to current accounting standards, the measurement of fair value is not well performed, showing that it 'provides neither a clear measurement objective nor a robust measurement framework.'
The IASB responded by proposing a change in the definition of fair value from 'the amount for which an asset could be exchanged, or a liability settled, between knowledge, willing parties in an arm's length transaction' to 'the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.'
Nevertheless, Lucian Samuel (2009) indicates that the financial crisis has demonstrated that the definitions have drawbacks.
According to Tom Selling, writer in the Accounting blog, The Accounting Onion, believes people should move away from the fair value because it is based on exit prices.
Frank-Walter Steinmeir, the social democrat candidate to next German Chancellor criticized fair value as making the balance sheets to be overstated and supports the current write downs.
On the other hand, Huffpo suggested that fair value be suspended for at least two years to enable banks not to write down the assets to false level, implying that the balance sheet will be understated meaning the write downs are not appropriate.
Price water house coopers, suggests that refining the accounting for impaired bonds should deal with the challenges of fair value reporting in illiquid markets. (www.pwc.com/fairvalue, 10/08/09)
Off balance sheet financing
There was an issue raised by Miller in the article that he believes investors should develop trust in the market, and as such there should be a reform of the US Generally Accepted Accounting Principles (GAAP) of off balance sheet financing.
According to the IASB recent research in their website, there are two relevant projects on accounting for off balance sheet. There is project 1 which is called consolidation. The issue is for entities to account for other entities they control, especially the ones used for securitisation transactions. The second project is derecognition, this is the outcome of entities which may have stopped accounting for assets they still control.
The former, according to IASB is to tighten up the definition of control so that entities can account for all entities they control. On the other hand, the latter reviews and clarify when companies should stop accounting for assets transferred to other entities and is reviewing the disclosure requirements.
Gerald & Kathleen, (2008) argues that there are many ways to complete off balance sheet financing by taking advantage of the rules behind the standards. They suggested that if the rules-based accounting is not functioning, there is need for a principle-based accounting to be implemented by the regulatory agencies.
According to a journal by Price water house coopers (2009), criticizes the maintenance of off balance sheet transactions as a mask risk and should be fully exposed as visible. Many believe the structures will be eliminated as a result of initial scandals, but it became controversial during the recent financial crisis. (Price water cooper house, 2009)
A published report by CFO website in October 2009 claims that the SEC and FASB have handed some new rules which is aimed at transparency of financial statements. At the moment, 'the SEC is rewriting its guidance on MD & A disclosure, introducing regulation G, and rewriting its rules governing form 8-k.' Apparently, the idea is to help investors see companies through the 'eyes of management,' critics believe that it may only cloud the issues.
Walter Pagano in the article, raised an issue, that enforcing strict capital requirements and insisting assets be more liquid in companies will help boost investors' confidence.
According to an article by John Flaherty from Accountancy Magazine, October 2009 edition, 'codes on corporate governance have come under the closest scrutiny in the wake of the financial crisis.' The assumption is that something such as a code may have broken and caused the problem.
Recent reviews has UK combined code on Corporate governance and the organisation for Economic Cooperation and Development's Principles of Corporate governance so that even if the crisis is attributed to weak corporate governance by companies, it will not follow that the codes has failed.
Stephen et al.,(2008) suggests that the assumptions and principles of corporate governance are mislay and as such, there should be a wider view of governing process in other to meet the vigorous business environment. They further developed a new model and frame work for governing regulations and request policy makers to engage in this new model and confirm its assumption.
Enriques and Volpin (2007), claims that the US model of corporate governance is the most difficult. They argued that the main problem was the conflict of interest between shareholders and managers.
Sapovadia V.K (2003), believes that positive corporate governance is a tool to strengthening an economy.
The issue of conceptual framework arises from the need for investors to access tools that will enable them understand the financial statement and see the level of details required in assessing a company, according to Cindy Fornelli in the article.
In 1999, the Marxist criticized the FASB's conceptual framework as being based on marginalistic idea of economic value and which is subjective and vague and believes that it should be more of a critical accounting provided with scientific foundation.
An article on Financial Accounting Standards Research Initiative (FASRI) website by Jeffrey Hales in August 2009, criticized the FASB/IASB conceptual framework. He argued that a future standard setting should not be derived from an 'ought not' perspective. In other words, the assertion of a primary function of the framework to restrict standard setters along a particular dimension has little evidence to support the view. He also critique the assertion that the FASB's conceptual framework has not been outstanding and raised example such as the SFAS 146 which corrected the problems raised by EITF 94-3 allowing the recognition of items which failed to meet the definition of a liability in a balance sheet.
Apparently, recent article from FASRI website in October 2009, showed the FASB and IASB 'Asset-Liability Approach,' which is viewed as 'primary' elements of financial statements.
Bratton argues that the conceptual framework of primacy of assets and liabilities has proved the FASB as experts with a coherent model pursuing an overriding goal rather than a political body twisting to varied constituencies.
According to FASB conceptual framework report on their website, November 2009, the recent joint project of IASB and FASB was to develop an enhanced conceptual framework which shows a positive foundation for progressive future accounting standards. They argued that the goal is to develop standards that are 'principles-based, internally consistent and internationally converged' which can achieve financial reporting that will aid investors' decision in terms of capital providers.
STAGE 3: Personal Views on the Criticisms of corporate
Financial Reporting in the Article.
The global crisis has caused many critics to be aware of the issues that arise in the light of corporate financial reporting. Many critics based on stage 2 suggest that the problems faced by entities while initiating the accountancy standards as formed by the standard bodies have caused the financial calamity or breakdown.
In real terms, how accurate is this assumption if one has to relate the concept with the IAS, conceptual framework, objectives and qualitative characteristics of the financial reporting and the underlying assumptions of financial statements and management's responsibilities to investors and markets as a whole.
Considering the criticism on fair value accounting, my view is that the suspension of the fair value accounting as requested by banks in the article will only increase investors' uncertainty. The idea of considering only historic cost which refers only to cost allocation and not the value of the asset when there is the possibility of the current market value either being higher or lower will not meet the IASC framework of reliability of an asset which is very useful to provide information about the financial positions for economic decision making. It is wise to say that the fair value helped to expose and reduce the various credit risks that were run by banks. Conversely, the fair value accounting is an essential assumption of a financial statement which is objectivity, qualitative characteristics of information with accuracy for an efficient presentation for the investors and markets as a whole. On the other hand, based on management's responsibility to investors, it will be very unrealistic for investors to be aware that assets invested in has been affected by the fair value accounting, should the current market value fall below the historic cost. With this, the IAS will have to initiate a type of fair value measurement which will motivate investors to invest. Considerably, the criticism was well justified, there is a need to address the fair value accounting.
Furthermore, based on the critique by Paul Miller on how companies think about the capital markets. My point of view is that companies will have to consider the objectives of a financial statement which is according to IASC to provide information about financial position which is useful for decision making by a wide variety of users. Considering the role of the capital market as a source to raise funds, it will be very unwise to keep them in the dark, as cited from the article. There is need for owners to understand how their investment is being used. My thought is that the actors should be regarded as a whole because every actor's mentality is useful to the progress of the business. The weight of this criticism is important because management has a responsibility not only to maximise shareholder's wealth, but also to build their confidence with transparency and accuracy. Although there can be issues of ownership problems where they feel the management are not capable of risky investment. Meanwhile the more risky an investment, the higher the return, but there is need to address the situation.
In terms of the asset mortgage, my notion will be the investors and credit agencies did not price the risk accurately for this mortgage. More so, the regulatory practice from the government did not consider the 21st century finance market. The government should be able to emerge with corporate governance which will make use of a data bank or an electronic data base format which creates an interactive data protocol such as XBRL. The idea is to create transparency and avoid mistrust from securitized assets. This will show investors a clearer view of the risks.
The issue of off balance sheet financing is a problem that needs to be focused on because investors need to be aware of their funds investment, taking into considerations risky investments which can lead to exit of an entity. The (SAS) No. 59 is expected to be a guideline for Auditors to show the ability for a company to exist. In this view, it is precise for every source of funds to be accounted for either assets or liability in order to foster confidence of the investors or to be aware of growing problem concerns. The recent November 2009, IASB project should help achieve the issues of disclosure requirements by entities. The criticism is valid because there is a need for relevance, reliability and objectivity in the corporate financial reporting.
The subject of aiding investor insight in terms of modernize financial reporting, key performance indicators, rule or framework and broader based practices across the business environment as raised in the article is very essential for fixing financial reporting. My assumption is that the conceptual framework should be referred with the intention of initiating this school of thoughts views. Taking into consideration how stiff or what should be included in the framework is important, also the ability to have coherent qualities between all the standard bodies and the external factors which this bodies relate to, should there be a clear purpose of all this characteristics will help investors have an insight of their investment. In addition, there is need for the government to partake in the conceptual framework because that enforces more authority in concept which will help build stakeholders confidence and as such a positive global economy.
In conclusion, in view of all these criticisms raised in the article, there is need to consider every school of thought because the central idea is the ability to have a transparent and accurate financial statement which can encourage investors to invest and achieve a solution to the economic downturn.