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This paper sets out a framework for understanding the measurement and disclosure in financial reporting in view of author's contributions and the issues raised in the article "How to fix financial Reporting". The International Accounting Standards Board (IASB) succeeded the International Accounting Standards Committee (IASC) in 2001. The (IASB) is an independent private sector body that is well structure and its encourage international co-operation in developing consistent worldwide accounting principles.
Financial statements is very important in a company because it provide useful information about the financial position, performance and the changes in financial position of an entity that is relevant to a wide range of users in making economic decisions. The economic resources can easily affects the financial structure, liquidity and solvency and its ability to adapt to changes in the environment in which the firm operates. The primary motive of a business entity is to earn profit on the resources that have been invested by the investors. Information on the amounts and variability of profit earned will help the firm in forecasting future cash flows from the firm's existing resources and in forecasting potential additional cash flows from the additional resources that might be invested in the firm.
Financial Accounting Standards (No. 157) September 2006 explained "Fair value measurements" as an extensive study of fair value and its uses. Therefore fair-value is the basic method of measuring assets and liabilities. Fair value is also 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. The financial Accounting reports is very important in a business firm because it reflect the effectiveness and efficiency with which the resources contributed by the investors have been used by the firm and it also reflect how well the complex objectives of a business firm are met. Accounting information is widely used by investors because it serves as a guide and determines the merits of investment opportunities before investing in a company. The information shows the financial statements and balance sheet which clearly showed the liquidity of the company.
This report will help investors to see how companies play games with their numbers and it also show how to analyze the number in a financial report in order to determine a company's true financial health.
STAGE 1: SUMMARY OF THE ARTICLE
Bogoslaw, D. (2008). "How to fix Financial Reporting" expressed his opinion on the essential need for transparency and accuracy in company's financial information reporting in order to boost shareholders'/investors' confidence. The recent financial crisis in the world economy and on-going recession has been attributed to the lack of transparency and inaccuracy in financial reporting by companies across the globe. The crisis which started from America had a global effect on the world economy reaching as far as Iceland, Russia and Korea. This has therefore prompted a call for restructuring and complete overhaul in the set up and regulation of the capital and mortgage markets worldwide. There is however uncertainty presently as to the extent of the changes to be reflected in their financial reporting. The main cause of the crisis has been attributed to confusing accounting practices such as incomplete and inaccurate picture of the financial standing of companies by their management, deficient disclosures of asset values creating an illusionary earning and overall risk on corporate balance sheets. Other causes have been blamed on the financial Accounting Standard's board 15 year rule that required that assets be valued based on their current market value even where market for them has vanished temporarily. According to William Isaac, a former chairman of Federal Deposit Insurance Corp (FDIC), this rule has forced companies to write down asset values, thereby destroying their equity and impending the bank's lending ability.
Suggestions being proffered by financial experts include; shift in how companies work with the capital market. Paul Miller, an accounting professor at the University of Colorado states that companies value and know the importance of good relationship between their customers, employees and supply chains in achieving smooth work-flow, productivity and good profit which has not been transferred to their dealings with the capital market. This lack of transparency evident in the companies dealing with the capital market tends to hurt management's reputation and leads to a discounting of their company's stock prices by Asset managers who are experienced and have a variety of choices as regards companies to invest in. Another solution that has been proffered has been transparency as the only way to gain back shattered investor confidence in the wake of this crisis and this is expected to form part of the discussion at the meeting of finance ministers from the world's twenty wealthiest countries scheduled to hold in Washington on November 15th. According to Miller, a reform of two key financial reporting practices should be made and they include; the treatment under United States Generally Accepted Accounting Principles (GAAP) of off-balance sheet financing and pension-fund accounting which under this present rule requires companies to disclose only their net liabilities and assets which in the case of operating leases distorts their balance sheet and confuses investors. Two standard setting organizations; the FASB and the International Accounting Standards Board London have been working together on a project that would require the capitalizing of all leases on companies' balance sheets. A second project between them towards this has already produced accounting standard FAS 158 in the U.S that made the reporting of pension-fund assets and liabilities as a net amount and not on the footnote of the balance sheets.
However some market strategies are of the opinion that banks will probably have to revert to offering simpler investment products/packages rather than the sophisticated ones that have been seen in more recent times till investors' confidence is restored in the market. A professor at Stanford University's law school and a senior research fellow at the Hoover Institution, Kenneth Scot is of the opinion that the mistrust for securitized assets such as the collateralized mortgage obligations(CMO's) can be alleviated by raising transparency around these assets. As defaults mounted and losses piled up, there were questions regarding the value of these assorted securities as it became obvious the impossibility of calculating the impact of losses within the pool of collateralized assets on tranches of lower quality loans which might not be high on the securitization chain. It is suggested that the structure of these securitized assets could be made more transparent through the use of a data bank carrying all the asset pools. Creation of such database is highly unlikely. In views of financial analyst opinion, he clearly stated that the discussion was to improve the global financial system crisis, a number of issues were raised such as the need for better governing regulations for companies financial information reporting which trade publicly. The governing regulations will checkmate the company against misuse of public fund.
The financial analyst also raised the issue of 'risky investments' by banks and other financial institutions which mainly affected their balance sheets resulting in financial crisis. The financial experts suggested the necessities for companies to show complete and accurate illustration of their financial statements, which clearly signify the financial standing of the company to an investors' by knowing the company's disclosures of assets, liabilities and the overall risk in corporate balance sheet.
In view of the appeal for transparency, banks have requested that for the credit markets to release more there is need to defer the "fair-value accounting". Conclusively, the main purpose of the article was to improve financial reporting in aspects of transparency and accuracy in order to reinstate the investors' confidence with the prime aim to invest more funds in the company so as to reduce the global economic financial breakdown.
STAGE 2: IDENTIFY FOUR SUBSTANTIVE ISSUES
Elliott B & Elliott J (2008) describe financial statements as a subject that is being governed by accounting standards bodies such as IAS, IFRS, and SSAP among other standard bodies in the world. Their aims are transparency, consistency and spotlight for financial reporting. However these rules are assessed when there is some internal crisis affecting companies subject to analysis.
Moreover, 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 set by several regulations bodies. In cognisance of these views, there are a number of issues raised in the article which show the result of companies, banks and financial institution with the desire to implement some of these accounting standards were faced with certain difficulties which resulted to financial crisis in the systems and this in turn affected investors' confidence.
There are four substantive issues namely as:-
Off-balance sheet financing and pension fund accounting
Fair value accounting for impaired assets
The above four issues will be critically analyze in view of conflicting opinion and suggestions from different articles and journals written by accounting scholars and practitioners.
La Porta, Lopez-de-Silanes, Shleifer and Vishny (2000) define corporate governance as" a set of mechanisms through which outside investors protect themselves against expropriation by the insiders". 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. John Flaherty a contributor from Accountancy Magazine article, October 2009 edition, "codes on corporate governance have come under the closest scrutiny in the wake of the financial crisis". He assumed that such a code may have been broken and caused problem in the system.
Recent reviews show that UK combined code on corporate governance and the organisation for Economic Co-operation and Development Principles of corporate governance that even if the crisis is attributed to weak corporate governance by companies, it will not seem that the combined 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 order to meet the vigorous business environment. They further developed a new model and framework for governing regulations and request policy makers to engage in this new model and confirm its assumption.
Gompers, Ishii, and Metrick (2001) argue the strength of these methods is determined by securities regulation, corporate law and bylaws, charter provisions, and other rules. Taken together, these regulations, laws, and provisions"define the power-sharing relationship between investors and managers". In Germany the typical approach to corporate governance is concentrated ownership of large investors, typically banks. While 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 the shareholders and managers.
OFF-BALANCE SHEET FINANCING AND PENSION-FUND ACCOUNTING
Miller in the article believes that 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. The recent research by IASB (www.iasb.org) showed two relevant projects on accounting for off balance sheet. Project 1 is called consolidation. This project is for entities to account for other entities they control, especially the ones used for securitisation transactions. While Project 2 is called de-recognition; 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 (www.pwr.com).
FAIR VALUE ACCOUNTING FOR IMPAIRED ASSESTS
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.
In view 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, September 2009 page 100-135). 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 June 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. This was also supported by Huffpo, he suggested that fair value should 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 (www.pwc.com/fairvalue) suggests that refining the accounting for impaired bonds should deal with the challenges of fair value reporting in illiquid markets.
In the article, Cindy Fornelli states 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. 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) www.fasri.net 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.
In addition recent article from Fasri website, 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 (www.fasb.org ) stated that 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 providing capital to companies.
STAGE 3: CRITICISMS OF CORPORATE FINANCIAL REPORT
The economic global crisis has caused many critics to be aware of the issues that arise in the light of corporate financial reporting. Major critics focused mainly on the four substantial issues as regards to the problems faced by companies while initiating the accountancy standards as formed by the standard bodies which amount to financial incapacitator in the system. 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.
Apparently off-balance sheet financing is a problem that needs to be focused on because investors need to be aware of their invested fund, taking into considerations risky investments which can lead to collapse 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 September 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.
Conclusively, there is need for government intervention in the conceptual framework in order to rebuild investors' confidence in investing their funds in a company and also to reduce economic recession in the financial sector.