ACC3003 | Accounting | The Descriptive Theory Of An Organisation

Topic:

Laux and Leuz (2009)* discuss the crisis of fair value accounting following recent international financial turmoils. It is debatable whether the IFRS accounting standards have contributed to the financial crisis.

You are required to work in a group of three or four students to

1. Describe what the financial crisis is.
2. Discuss whether the current requirements of IFRS accounting standards contribute to financial crisis.

Introduction

This report focuses on the details study on the financial crises and how it has been impacted the different organizations throughout the time. Financial crisis is an economic disaster for the corporates which not only destruct their business but also put negative impact on the business sustainability of the Organizaiton in long run. It may occur in the situation when the overvaluation of assets has done by the company and it has been deformed by the unexpected investor’s behaviour. It may also occur due to the deregulation in financial industry, Mismatch in liquidity, policies of taxes/subsidies and conflicts of interests. For properly understand the contribution of fair value accounting in financial crisis we will discuss the case of C Laux and C Leuz. This was the well-known case of financial crisis which resulted due to the fair value accounting. The situation is known as financial crisis. In this report we will discuss about the reason of financial crisis and the role of fair value accounting in occurring of financial crisis.. in addition to this, apart from this we would also discuss that how much and up to what extent the IFRS Accounting standards contribute into financial cri

What is Financial Crisis?

The term financial crisis involves a group of situations in which an organization loses the nominal value of its assets. With the decrease in the value of assets of the economic or when the government capital expenditure excess the overall economic budget consistently the it gradually converted into financial crisis. Initially deregulations in business industries caused the financial crisis. Many divestment, liquidation and winding up cases were seen and these all resulted to the financial crises throughout the time. They allowed the bank to involve in trading of derivatives by creating hedge funds. The bank uses the deposits of customers for investing in the securities (Goh, Li, Ng, and Yong, 2015). For the same reason they need more mortgages to increase the beneficial sale of these derivatives. Further when the derivative’s value started to crumble, the bank stopped to lend funds to each other. That converted into financial crisis (Georgiou, and Jack, 2011).The fair value accounting method introduced by IFRS also contributes to the financial crisis. It is concerned with the valuation of assets and their inaccurate valuation results into financial crisis. The changing policies of valuation and imposition of taxes also affects the finance of an entity, which attracts the situation of financial crisis (Arnold, 2009). With the changes in economic policies and international business downfalls, financial crises cases have increased the impacted the various domestic and international organization. If company fails to keep its business transparent then it might deviate the investment decisions of the investors and may also result to destruction of the invested value of the investors (Humphrey, Loft, and Woods, 2009). There are several companies such as HIH insurance, One Tel Company and other big listed companies which have faced liquidation due to the non-effective accounting compliance. These companies went into liquidation as it failed to align its business interest with the society. In the world where scarcity of the resources is there, this liquidation and winding up become the biggest turmoil and reasons for the financial crises. It is analyzed that if company fails to manage its busienss by arranging the proper profitability, financial leverage then it might result to destruction of the busienss. IFRS rules and standards strengthen the reporting framework of organization and it has established with the purpose to remove the inherent problems of the financial reporting but against to the expectations. If company wants to mitigate the negative impact of the financial crises then it will have to focus on establishing the harmonization in its domestic and international reporting frameworks (Power, 2010).

Contribution of IFRS Accounting in Financial Crisis

The international Accounting Standard Board issued International Financial Reporting Standards, introduced the method of fair value accounting. It is also known as the mark-to-market method. It is analyzed that with the ramified economic changes, IASB has been taking the required measures to improve the reporting standards in the contemplation of financial crisisThe fair value accounting method has been used by the companies to assess the current market condition of assets and liabilities. It also reflects the true and fair view of the assets and liabilities of company which strengthen the overall outcomes and business efficiency in long run.Hence it increases the transparency and provides timely information. In contrast, the opponent says that the FAV leads to undesirable actions on the part of companies. Furthermore, they claim that it is not an accurate method as it cannot define the value of assets held for a long term period (Laux, and Leuz, 2009). Every company needs to revaluate the assets and liabilities in its books of accounts to strengthen the overall outcomes and business efficiency in long run. As per the international financial reporting frameworks, each and every organization needs to implement proper impairment test in its business process to evaluate true and fair view of the assets and liabilities. It will allow company to make the business more transparent to its stakeholders.The prices can be crumbled due to the irrational investors, market inefficiency and liquidity issues. Conclusively, they did not found the fair value accounting method reliable. Also it contributes to the financial crisis (Mala, and Chand, 2012). In Laux and Leuz case, the crisis has led due to fair value accounting method. The crisis has led to a cogent issue about the merits and demerits of fair value accounting. The study says that the accounting standards i.e. IRFS enables the management of company to measure the item at their market value, which may not be acceptable in low liquidity market. Hence, the method does not reveal the real value of assets or institution. In such situation, the managers can discrete the values of assets in their favour to receive good results for making incentives (Laux, and Leuz, 2010). It is analyzed that when organization fails to establish harmonization in its domestic and international reporting frameworks then it results to failure of the business and downfall in the economic business environment (Dechow, Myers, and Shakespeare, 2010). In addition to this, failure to adopt the IFRS rules and accounting standards, company might face accounting issues which may negatively impact the business sustainability and long term success of organization.Therefore, it could be inferred that if company does not reflect the true and fair view of the assets then it might destruct the business outcomes and also deviate investors in creating the value on the invested capital (Power, 2010).The failure to comply with the accounting policies and standards has negatively impacted business growth and outcomes which have resulted to their liquidation and winding up. These business failures also negatively impact the economy and resulted to financial crises in long run. Many of the companies such as Dick Smith, ABC learning and One Tel Company have faced issue of the liquidation and winding up due to its failure to comply with the IFRS rules and accounting standards. These companies failed to manage the transparency in its busienss and manipulated its accounting and books of accounts which resulted to ethical and legal compliance misconduct. These all companies went into liquidation and had to distribute all of its assets to its stakeholders. 

Conclusion

In the end, the conclusion of the report says that financial crisis results due to various causes. It may be the policies of taxes/subsidies, conflicts of interests, deregulation in financial industry, Mismatch in liquidity, and fair value accounting method. Fair Value Accounting is beating the convergence of accounting exercise across the world. It has been considered as an important factor contributed to the recent financial crisis. Use of financial value accounting raises the doubts on suitability of IFRS for financial reporting around the world. International Financial Reporting Standards established with the purpose to remove the inherent problems of the financial reporting but against to the expectations it increases the case of financial crisis more than before. Many financial institutions are forcing the International Accounting Standard Board to reform the rules of fair value accounting. Also the IASB has been taking the required measures to improve the reporting standards in the contemplation of financial crisis. Now in the end, it could be inferred that if any economic wants to put a cap on the financial crises cases then it will first have to strengthen the financial reporting framework and transparency. It will eventually lower down the busienss failure and collapse.

References

Arnold, P.J., (2009). Global financial crisis: The challenge to accounting research. Accounting, organizations and society, 34(6-7), pp.803-809.

Dechow, P.M., Myers, L.A. and Shakespeare, C., 2010. Fair value accounting and gains from asset securitizations: A convenient earnings management tool with compensation side-benefits. Journal of accounting and economics, 49(1-2), pp.2-25.

Georgiou, O. and Jack, L., 2011. In pursuit of legitimacy: A history behind fair value accounting. The British Accounting Review, 43(4), pp.311-323.

Goh, B. W., Li, D., Ng, J., and 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.

Humphrey, C., Loft, A. and Woods, M., 2009. The global audit profession and the international financial architecture: Understanding regulatory relationships at a time of financial crisis. Accounting, organizations and society, 34(6-7), pp.810-825.

Laux, C. and Leuz, C., (2009). The crisis of fair-value accounting: Making sense of the recent debate. Accounting, organizations and society, 34(6-7), pp.826-834.

Laux, C., and Leuz, C. (2010). Did fair-value accounting contribute to the financial crisis?. Journal of economic perspectives, 24(1), 93-118.

Mala, R. and Chand, P., 2012. Effect of the global financial crisis on accounting convergence. Accounting & Finance, 52(1), pp.21-46.

Power, M. (2010). Fair value accounting, financial economics and the transformation of reliability. Accounting and Business Research, 40(3), 197-210.