The Fair Value change with respect to the Financial Crisis
The Fair Value change with respect to the Financial Crisis
The world has come under the grips of a global financial crisis. Such events with big accounting and financial impacts are few and forlorn but when they do come, they bring with them uncertainty and pessimism as well as the desire to bring about some change so as to curtail such events from taking place in the future.
With regards to standard setting, this is being achieved through the debate surrounding fair value reporting. Banks and many other troubled financial institutions that bore the brunt of the tidal wave of the credit crunch are calling on the Financial Accounting Standards Board to ease their stance in relation to fair value accounting whereas investors and financial analysts are standing forward to block this move.
Fair value accounting had been brought into place after much deliberation by standard setters over the years. Its application worldwide was a reflection of the need for financial statements to reflect the assets held by firm on their balance sheets at prices they could be realized at today in the markets, in a fair deal and an arm’s length transaction.
This was recognized as something that provided a fair outlook of the current financial position of banks and other institutions and was held very closely guarded by the FASB (Katz 2009). The chairman of the board’s adherence to the need for fair value to continue and his defense of the methodology in a testimony before the US House of Representatives Financial Services Subcommittee in March of 2009 is a strong indicator of where standard setters actually fall in the debate.
However, in April of 2009 the board voted to relax the fair value rules under strong political pressure and in an uncharacteristically rapid fashion for a body that is known to engage in long debates and continued discussion before enacting any changes in the accounting standards.
This change has sparked unique responses from the two sides of the debate. Banks and other financial institutions have been delighted with the measure. They had come out in open opposition to fair value rules following the financial crisis stating that it unfairly influenced their accounts. They argued that the use of the fair value criteria resulted in them show items in their balance sheet as significantly lower value than they would be actually realized at, thereby giving them a relatively bleak financial outlook with very pessimistic figures (Katz 2009).
The impetus for the move was that if this could be alleviated to some extent, then banks would be better able to report their true financial situation and reduce some of the write-offs that have wrecked the industry, thereby even putting them in a better position to issue more loans and perhaps precipitate faster recovery from the crisis. The optimism of the banks with regards to the proposed shift by the FASB was reflected in the markets as the stocks of major banks such as Citibank and Bank of America went up in the New York Stock Exchange.
Investors and financial analysts however have been strongly against the move being put forward by the FASB in April. They argue that fair value accounting results in showing the actual financial health of the financial institution and changing the rules would result in a distorted perspective being put forward to the investors. It is further seen as being a highly transparent view of the financial health as it leads to assets being valued at the amount they could be traded today which is a reflection of the economic times as well as the trend of decision making that has been going on in the industry.
Thus after the changes have been brought into place, investor group are showing growing unhappiness at what is viewed as something potentially harmful. They were also wary of the involvement of political pressure in the move, which if freely allowed to influence international standard setting would compromise the integrity of the field and harm investor confidence as well.
The FASB did come out in support of the investor though by additionally requiring more disclosure of the methodology employed by firm for valuation after the FASB allowed them significantly more room for judgment regarding it through relaxation of the rules. It further did not allow the financial institutions to apply the changes retrospectively which would have altered their 2008 statements as well. It also restricted the application of some proposed changes such as those relating to valuing impaired securities by keeping it only for debt securities.
FASB’s shift has been in a manner that can be considered characteristically different from its formal procedure. The world of standard setting has been slow with prolonged discussions before any changes are brought forward. With regards to the current change, it was made considerably rapidly by bringing in remarks for discussion, pursuing a review of one day and then handing out the proposed changes which is a testament to the tricky financial times and political pressure.
The shift that was brought about included allowing the firms considerable room for “judgment” with regards to gauging prices of some of their investments represented on the financial statement as well as those for mortgage backed securities (Katz 2009). This did meet with opposition from other bodies such as the CFA Institute and investors groups, the former arguing that such arbitrary changes damage their credibility while the latter is in woe of the difficulties investors will face now.
They have even gone out to condemn to some extent the U-turn taken by the chairman of the FASB whereby he shunned the changes proposed to fair value methodology in front of congressional subcommittee but then agreed to put in place the same measures hardly a month later.
Thus it can be seen that the current financial crisis has altered the direction standard setting in accounting has taken. It can be said that this is a fairly damaging trend. While it may result in short term gains for fighting the financial crisis and help shore up loans and lending, it could be damaging in the long run as political pressures and advocacy groups may damage the credibility and transparency of standard setting and financial statements presentation. It could also be adverse for the investor who may not trust the standards as providing fair information and affect their behavior. Furthermore, the integrity of the institute may well have been compromised in this case by the u-turns being adopted by the chairman of the FASB.
Katz, Ian (2009, April 2). FASB Eases Fair-Value Rules Amid Lawmaker Pressure. Retrieved June 17, 2009, from Bloomberg Web site: http://www.bloomberg.com
Subject: Financial crisis,
University/College: University of Arkansas System
Type of paper: Thesis/Dissertation Chapter
Date: 28 September 2016
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