Assignment Topic: Accounting Management Essay on Financial Environment of New Zealand
This assignment should cover learning objective “to critically evaluate the New Zealand financial reporting environment with a particular emphasis on corporate regulatory requirements”, and learning goal 2 “critical thinking”.
Accounting Management Essay Review Analysis:
INTRODUCTION
The magnitude of destruction of the global financial crisis is comparable to that of the great depression of the 1930s. The breakdown of big financial institutions, collapse of stock markets worldwide, bank bailouts were some of the numbing consequences of the crisis (Arnold, 2009). Many major businesses were forcibly shut down. Unemployment, foreclosures and reduction in wealth was rampant.
Needless to say New Zealand was not spared from the grasp of this crisis. New Zealand had been severely affected by four crisis in the last four decades (Rudd, 2009). These were the debt crisis, the Mexican crisis, the Asian crisis and the Brazilian crisis in the 1980s, 1994, 1997 and 1999 respectively. The financial crisis of 2006 was the worst of them all. It had forced more than 40 finance companies into liquidation. As a post mortem was carried out many weaknesses were exposed. One of these was the financial reporting environment of New Zealand. Hence, a plethora of reforms were brought about in the financial reporting system.
FAULTS IN THE ACCOUNTING SYSTEM
It has turned out that the epicentre of the crisis was not the accounting system. However, it cannot be denied that the vulnerability and low standards of the accounting system were revealed. There was loss of confidence in the financial reporting system. The major weaknesses that came to the fore were- the difficulty faced in the use of fair value accounting in illiquid markets; the time delay in realising losses linked with loans and other financial instruments; wide range of off-balance sheet financing institutions; complex accounting standards .
NEED FOR CHANGE
The crash of the stock market in 1987 was an eye opener for financial planners. The exigency for transparency and a better accounting system became prominent. The recent emergence of capital markets globally and the credit crunch bolstered the requirement of top quality financial reporting.
There have been many changes in the New Zealand’s financial reporting arena following the adoption of IFRS in 2002. there has been an upsurge in the number of entities adopting IFRS (Goldschmid and Hoogervorst, 2009). The International Accounting Standards Board (IASB) also released the International Financial Reporting Standards for Small and Medium Entities (IFRS for SMEs) and it is being adapted by many countries worldwide (Jermakowicz, Gornik-Tomaszewski, 2006).
The proposals of IFRS were not intended to replace the framework for corporate governance of 1990s. It was merely a better version of the existing framework.
One of the major changes in the accounting system that the IFRS has brought about is the shift in the emphasis from Historic Cost model to Fair Value Accounting.
CHANGES BROUGHT ABOUT
The Ministry of Economic Development (MED) and the Accounting Standards Review Board (ASRB) released a new framework for financial reporting in New Zealand. One of the major aims of these changes was to bring down drastically the compliance costs for small and medium sized companies. It would enable New Zealand to recoup itself and emerge as a paragon of efficient financial reporting in the world arena.
The proposals intended to create a reporting system that was:
CLEAR- Clear definitions must be given of the reports and the assurance obligations.
COHERENT- The framework must be set on principles which are coherent.
CONSISTENT- Entities that have similar needs must have the same reporting obligations.
COST EFFECTIVE- the cost-benefit trade-off must be borne in mind while preparing the financial reports.
The proposals looked at harmonising with Australia with the goals of a ‘Single Economic Market’. It also looked at the dynamic needs of the environment and that a rapid response would be enabled to altering market conditions.
The key principles on which the framework was based were”:
- the financial reporting principle
- the principle of the needs of users
- the cost-benefit principle
Convergence of Accounting Standards :
A synthesis of accounting standards worldwide is unavoidable due to the global character of financial institutions. It is required that high quality reporting standards be met, which are highly standardised, consistent and pertinent. It must be independent of the location of the reporting authority.
Standard Setter Independence and Accountability
The reporting system must be totally independent from any form of commercial or political influence. Appropriate processes must be followed with proper involvement and communication with the stake holders.
SHIFT FROM HISTORIC COST TO FAIR VALUE ACCOUNTING
Historic Cost:
Historical cost refers to the original value of any item in monetary terms (Blanchard, 2000). The assumption is the stable measuring unit. There are certain cases of accounting where depreciation or appreciation are not taken into consideration and assets or liabilities are shown on the balance sheet with unchanged value from the date of its acquisition. Hence, the value of the item on the balance sheet nay not be the same as its true value.
Thus, one of the biggest criticisms that this accounting method faces is its inaccuracy in depicting the actual value of any economic good. Many of the accounting systems still use this method of accounting. However, in recent times there has been a significant shift of attention towards another method of accounting known as the Fair Value Accounting. Following the norms of the IFRS, there has been a paradigm proclivity towards FVA in New Zealand’s accounting structure as well.
Fair Value Accounting:
Fair value is used to refer to an estimate of the amount of money that would be realized upon selling an asset or on relieving a liability (Reis and Stocken, 2007). Fair value measurements are used for many financial instruments, e.g., stocks or shares traded via an exchange, derivatives, debt securities, etc.
ARGUMENTS IN FAVOUR OF FVA AND THE CHANGE IN THE FINANCIAL REPORTING REGIME
Financial reporting plays a key role in the financial system. The financial crisis has brought top the fore, the importance of efficient financial reporting. Financial reporting must me effective (Ball, 2006). It must provide an unprejudiced and transparent information about the economics performance of a particular business (Maggi, 1999). Accounting standards must be of the top quality. These standards must be duly enforced and complemented with independent auditing (Daske et. al, 2007).
The market participants rely heavily on financial reports for their resource allocation decisions. For long run economic growth and global financial stability, it is imperative that the market participants enjoy total confidence in the integrity of these reports.
The focal point of the triggered collapse is considered to be the bursting of the housing bubble of The United States of America.
Preceding the crisis, there were arguments regarding the over valuation of profits by fair value accounting. However, at the time of the crisis, it caused an over valuation of losses. What thus followed was a vicious cycle of events. Asset prices fell which led to accounting losses, this caused selling of assets by institutions which further enforced fall of prices.
The supporters of fair value system maintain their position by pointing out that cyclical fluctuations in the market are a routine affair. This accounting method does not re enforce these cyclical effects. Infact, they serve as a premonition of an economic crisis by revealing bad market conditions via an inflation in asset values. Hence, it would serve better for crisis management.
Fair value vs Historical cost
The supporters of fair value method substantiate its use by highlighting its transparent nature and its relevance to users of financial statements. In a survey conducted by the CFA institute, 79% of the participants believed that the fair value method enhanced transparency as well as better understanding of financial institutions (CFA Institute Centre, 2008). It gives the investors a clearer picture of the company’s current value. This was reflected in the financial statements of companies such as Rubicon Ltd and Sanford Ltd. However, there are certain concerns which cannot be over ruled such as its reliability and susceptibility to manipulations .Reliability issues have been a cause of trouble among its users (Ernst & Young, 2005). Schipper has debated that fair value accounting is independent of any contemporary market being reliable.
CONCLUSION
Having evaluated both the pros and cons of Fair Value Accounting system, I am of the opinion that the changes in the New Zealand financial reporting environment are a positive one. It is quite clear that FVA did not have a crucial role to play in the credit crisis that took place. The origin of the crisis is attributable to numerous other factors as discussed earlier. The new Conceptual Framework for Financial Reporting (NZ Framework 2010), the proposals of IFRS, IFAC 2004 and FCAG 2008 clearly enumerate the radical change that is being brought about in the accounting arena. FVA is more a function of the assets which are being valued as much as how they are being valued. Hence, the FASB should propose guidelines for a better understanding of its use.
The limitations of financial reporting must also be borne in mind. Financial reporting only provides a still picture of economic performances. It does not take into account dynamism. Also, it is a function of data sources available from functional markets enjoying proper infrastructure. It depends upon the proper usage of price verifications and valuation systems by the business regulatories. Hence, the application of the current accounting system in a responsible manner, without any corporate or political influence should bring success to the New Zealand financial system.
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