Economics essay on: Effects of GFC

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Introduction

The effects of GFC which swept throughout the world in year 2008 -2009 are difficult. The implementation of assets at the fair value referred as the contributing factor to quick emergence of obstacle from the subprime mortgage of US to the entire world and exacerbating the crisis depth. Accounting standards (especially (FAS) No. 157 measurements of fair value- measures of comparative accounting in IAS 39) needed reductions in the investments value hold by the banks throughout the turbulent conditions of the market.  These reductions restricted the entities capability to create loans; creating financial assets to the market impacted the asset area of the borrowing company, balance sheet limiting their capability to borrow and propagation of fallacy of market value has created the huge contribution to pension crisis and housing bubble.

The Concept of IAS 39

The purpose of IAS 39 is to form the principles for measuring and recognizing financial liabilities and assets and few contracts to sell or buy the non financial components (Spooner & Andrew, 2008). Requirements for providing information about the financial instruments are offered in IAS 32 and requirements for disclosing the information about the financial instrument in IFRS7. IAS 39 does not relate to employers obligations and rights under the plans of employee benefit to which IAS Worker Benefits relates and does not relate to financial contracts, instruments and obligations throughout the transactions of share-related payment to which the IFRS 2 relates, except for restricted exceptions which are deemed throughout the range of the IAS 39. IAS 39 is not applicable to the financial instruments formulated by entity which fulfill the description of the equity instruments which are needed to be grouped as instruments of equity by issuer in relation to IAS 32.

IAS 39 forms the rules for measuring and recognising the financial liabilities and assets and liabilities and few contracts to sell or purchase the non financial components. IAS 39 comprises provisions about the categorization of the financial components, their continuing measurement, when the financial components must be recognized, de-recognized and requirements of hedge accounting.The IAS 39 divides the financial components into following 4 categories.

The financial liability and asset at the fair value with the help of loss and profit

• HTM investments
• Receivables and loans
• Financial assets are available for the sale.

As per IAS 39 all liabilities and assets, comprising derivatives must be understood on financial statements and assets must be hold at the fair value except can be hold at the amortized cost.

• Receivables are originated by enterprise not used for trading
• HTM investments
• Assets which fair value may not be evaluated reliably.

The Potential Problems Associated with the Accounting Standards

The IAS 39 adoption in EU has been the greatly politicised process. The response of the IAS39 between few European organizations was significantly negative. The concept of comprising like Germany and France where practice of the accounting was conservative, implementation of principle of the historical cost in the upward assets and liabilities revaluation not broadly practised (Spooner & Andrew, 2008).  Companies aimed to potential subjectivity initiated into measurement of the accounting and estimated volatility in the reported earnings. In, fact representatives of the bank disputed that they could be pressurized to follow rules of the accounting that did not show the underlying actuality of the business, creating information of the accounting less, as compared to more, applicable for the decision making. In Europe, the insurance companies and banks were resisting the implementation of the IAS 39 in year 2005 with IAS with no any concession to minimize or remove the volatility they estimate it will insert into their account. They complained about the accounting of asset –liability for financial liabilities and assets is complex and confusing from conventional point of view destructive to the accountability.The Japanese and French have been specifically did not like the idea of permitting the free decision of which liabilities and assets they responsible for implementing fair value. They worried that this kind of approach was open for the manipulation and send the message that IASB was making standards which catered to the purposes of the management as compared to the financial reporting. They worried that permitting entities to the free decision of the fair value might lead to the management of the earnings. In reaction to the concerns of the securities companies, bankers and insurers, the IASB published the exposure draft in Mar of year 2004 implementing the option of fair value to restrict its use and maintain the basic advantages of option in simplifying the fair value application in specific situations by (a) restricting the kinds of the financial liabilities and assets to which the management may apply the alternatives (b) the fair value designation with the help of loss and profit is at the election of the entity, it needs that the alternative might be related only to the financial liabilities and assets whose the fair value is identifiable. The investments of held to maturity are the financial assets with determinable or fixed payments and fixed maturity, management has capability to held to the maturity against the subjective foundation for classification. In US various commentators argued that the accounting of fair value for the financial components could obscure the outcomes of few companies by making spurious equity and income volatility (Spooner & Andrew, 2008). It might lead to the enhanced fluctuation or volatility in reported outcomes and obscure underlying developments impacting the performance and condition of the firm. Traditional accountants think that the financial accounting has been designed to offer stewardship accounts, not to assist investors value Company. IAS 39 not only fail to accomplish the aim but in process of minimizing comparability and objectivity.

It needs subjective judgements to categorize the components measured for at fair values and cost.

It encourages and permits the implementation of non adequately sensible fair values

It permits mismatches among assets computed at the fair value & liability at the cost.

It has confused rules of de-recognition which don’t always make apparent when the sales take place.

It has confused the rules of hedge accounting making the management to create judgements of choices.

The accounting of the fair value is sufficient for financial components which are held for purposes of the trading. For liabilities and assets who are not related around short period trading or HTM like deposits, receivables and loans- measurement of fair value leads to volatility of the income statement. For derivative and trading items, the losses and gains go to loss and profit. The IASB moved further and changed IAS 39 in year 2004 to allow the business entity to decide to evaluate various financial assets at the fair value. These called as fair value designation with the help of loss or profit. This type of issue cased the disagreement with EU that was solved by IASB limiting this category. Once the financial asset is place into the initial recognition category, the accounting standard may comprise rules which prohibit re-classification. Treating of financial asset as trading sometimes becomes not popular when prices of the market reduce dramatically as they happened in year 2008-2009 (Spooner & Andrew, 2008).In general, IAS 39 needs that all kinds of derivatives in the principle are computed at their worth followed to the initial recognition. The financial derivatives measurement at the fair value referred as the controversial issue. The obstacles are

Fair value is calculated by the model of valuation is not essentially value –applicable in the non active place of market.

In non active place of market the fair value determination under active market fiction has inherent inadequacy that not all relevant knowledge is taken in the consideration.

This has 2 effects first, the value of the firm shows the value of the company from perspective of factious participant of the market in the market condition which does not prevail at the date of balance sheet. Second, the companies have flexibility in finding out fair value as it may choose the information that lies under the model of the valuation. IAS 39 offers the general, as compared to the detailed suggestion on fair values specification (Bookstaber & Richard, 2008).  If the price of the market prevails in the active place of market, fair value considered as the price of the market. In active kind of markets, fair value is value relevant and well defined. As per the IAS 39, the model of the valuation is presumed to be implemented to find out the stock option fair value in non active place of markets. It is viewed that IAS 39 and amendments to the IAS 39 don’t mention the kinds of pricing models of option that must be implemented in the non active place of market (Brummer & Alex, 2008).  As per IAS 39 in non active place of market, one may implement models of option pricing to find out the value of assets. Financial derivative fair value is not applicable in the simple positioning of the non active place of market. The IASB replied as best to the concerns, but was dedicated to the standards related on principle of measurement and recognition of the financial instruments at the fair value.

How and Why IASB Amended IAS 39 During the Crisis?The accounting of fair value performed the small or no any role in the global financial crisis, however information transparency related with derivatives and asset securitization probably was not sufficient for the investors to analyse properly the riskiness and values of the assets and liabilities of the bank (Schipper & Katherine, 2007)  It can be possible that apparent financial reporting by the banks have reduced the extent of subsequent bust and housing boom which precipitated the global financial crisis. During the crisis, the IASB has taken some steps to enhance financial needs associating to derivatives and asset securitizations and offer extra suggestion for standards application in the illiquid market. The global financial crisis resulted in IASB altering IAS 39 to permit companies the decision of reclassifying few financial components from categories where measurement of fair value relates to categories where things are calculated on the amortized cost.

Derivatives and asset securitizations are the focus of credit crisis of year 2007-2008. IASB has taken some actions to enhance disclosures associating to derivatives and asset securitizations, the method for the accounting securitizations in the exposure draft of IASB which would need banks to understand whatever liabilities and assets they had after securitization is implemented better show the prevailing economics of securitization transaction. In Oct 2008, the IASB published alterations to IAS 39 and IFRS7 (Brummer & Alex, 2008).  The changes to the IAS 39 present the reclassifications possibility for the companies applying IFRS in very less situations. These changes are a group of steps that IASB has taken to react to the crisis of the credit. The IASB worked with the number of international and regional bodies, comprising the forum of financial stability to resolve the issues of financial reporting related with credit crisis. The IASB altered the regulations for reclassification of financial assets so that loss from alterations in market value on assets would be treated distinctly. Prior to rule change, the global standards needed such loss to be taken with the help of income statement. After rule change, assets may be reclassified under various situations averting mark to market loss to income statement.  There were rule changes requiring improved financial instruments disclosures and the impacts of income statement reclassification. These alterations were created through changes to IFRS 7 and IAS 39. The changes to standard allow the business entity to reclassify the non-derivative assets out of fair value with the help of loss or profit category in specific situations. The changes also allows the entity to move from category of available for sale to category of receivables and loans, the financial asset which would have fulfil the receivables and loans definition, if the business entity has the ability and intention to support that the financial asset for foreseeable future.

The changes bring the IAS 39 into relation with US GAAP principles and are objected at assisting minimize the risk in the global markets.

Companies implementing IFRS may implement the reclassified standard effective from July 2008. Now, in both IAS 39 and GAAP

In rare situations, securities reclassification out of category of the trading is allowed

Loan category reclassification, if the business entity tries and is capable to support the assets for predictable future

In July year 2009, under stress from regulators and governments to simplify the IAS 39, the IASB published the exposure draft that implemented to eliminate the complications in standard.

 The significance of liabilities and assets measurement and recognition has been pointed out with the help of events of subprime crisis that arrived in US in mid of year 2007 and made the international market turmoil and more economic crisis (Bruemmer, Russell & Andrew, 2008). The major function of the financial instruments in the financial crisis is financial components are regulated under the scrutiny by the wide variety of parties. The appropriate standards of FASB and IASB were placed under the changes created to simplify the consequence of mark to market accounting for components with no any liquid markets.

The IASB issued the exposure draft associated to financial instruments de-recognition of the financial components in March of year 2009. Changes are made to the IAS 39 financial instruments Disclosures and Recognition & IFRS 7 Financial Component: Disclosure.

The exposure draft implements to maintain the fundamental approach to IAS 39 de-recognition. In general, exposure draft also provides the alternative approach that would need transferors and banks to de-recognize the transfer assets and understand as liabilities and assets all the obligations and rights either obtained or retained in transfer, comprising puts, guarantees and disproportionate involvement in respect to transfer cash flow as its fair values. The method could result in understanding the obligations and rights as if transferred asset had not earlier been owned. IASB is in the process of enhancing the information transparency associating to the derivatives. In the project of de-recognition, the IASB implements the new procedure for de-recognition related upon the single control concept as compared to multiple concepts. In addition to this, disclosure shall be improved and extended so that the users may better recognize the association of transferred liabilities and assets so as to evaluate the exposure of the risk. It is viewed that exposure draft implemented changes intended to simplify the hedge accounting and enhance financial reporting. The staffs of FASB and IASB presented comments summaries obtained on discussion paper on minimizing the complexity and draft of the exposure on the hedging. IFRS 9 financial instrument was issued in Nov 2009 and comprised requirements for the financial assets (Bookstaber & Richard, 2008). Requirements for the financial liability were added to the IFRS 9 in Oct 2010. Various requirements for the financial assets were taken forward unchanged from the IAS 39. Some amendments were created to the option of fair value for the financial liabilities to resolve the matter of credit risk. The IASB objects to substitute all needs of the IAS 39 by 2^nd half of year 2011.

The IASB’s Actions Impact on Global Financial StabilityIt is viewed that IASB has taken some steps with the vision to facilitate the adjustment and reducing the effect on the actual economy. Stress from stakeholder was place on IASB to permit re-classification out of the trading below rare situation. The impact of emphasized rule alter on creditability of the IASB was profound. It is agreed that combined project on presentation of the financial statement shall considerably enhance and improve how users see the statements of finance. It is agreed that the mixed model must be reviewed and boards must refer simplifying the guidance of the impairment (Bianco & Katalina, 2008).

The actions of the IASB significantly minimize the accounting standards complexity for instruments of finance, increasing accounting identification of provisions of loan loss by incorporating the wider variety of the credit information, enhance standards of the accounting for provisioning, exposures of off balance sheet and the valuation certainty , accomplish consistency and clarity in submission of the valuation standards globally, operating with supervisors create considerable progress towards the single group of high excellence international accounting standards and throughout the framework of the process of the independent accounting standards, enhance stakeholders involvement, comprising emerging markets and prudential regulators with the help of constitutional review of the IASB. These actions assist to work towards the global and convergence consistency in the accounting standard.

The IASB re-established confidence in the reliability of financial institutions and markets, large minimizing complexity in the financial reporting and averting information overload, enhancing financial report accuracy, rebuild financial reporting credibility to investors, therefore could enhance confidence of the investors and stability of the capital market.

Conclusion

Overall, the concentration of the accounting of the fair value has the possibility to divert the attention from underlying effects of GFC. The accounting of the fair value creates the obstacles with values of the assets transparent and did not make the banks to alter their models of the business in early 2000. The financial confusion was effected by policies of international macro liquidity and poor framework of regulatory. These factors given to bubbles of the asset and extra leverage which was coordinated to mortgage securitisation and activity off balance sheet and started well before year 2007. This kind of analysis is same to that created by SEC in year 2008 examination of the mark to the market accounting.It is viewed that, financial statements should serve the objective of assisting users in creating informed actions by offering transparent information, to enhance the action usefulness and financial reporting relevance for basic stakeholders. The objective of the financial reporting is directed towards the investors that comprise a wide variety of the stakeholders, comprising investors, lenders and creditors. It could not search regulators as main users of statements of finance and therefore stability of the finance was not the purpose of the financial reporting. It is the responsibility of prudential regulator to make sure monetary stability and integrating monetary stability in the statements of the finance could jeopardize the transparency, therefore accounting must be neutral & it neither could avert the upcoming crises nor must be implemented to act pro-cyclicality.

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