Have accounting standards contributed to the global markets turmoil?

The action taken by the International Accounting Standards Board (IASB) on 13 October to ’relax’ the requirements to apply market value accounting, is unprecedented. It begs the question: Has fair value (mark-to-market) accounting gone too far in promoting volatility? Some of the corporate media have argued "yes".

The IASB, which holds itself as a strong independent accounting standards setter, has been perceived by some commentators to have bowed to demands from the European community to bring its standards into line with US Standards. The rationale was so that European banks are able to transfer some assets out of fair value through the profit and loss account into an amortized cost with an impairment model that is allowable under US (FASB) standards.

The IASB meeting noted that this issue is a political one, and the solution which is retrospective back to 1 July 2008, is designed to allow a level playing field at the global level. However, the later debate at the IASB meeting noted that the impairment requirements between the IASB and US Standards are not quite so similar, so true global harmony is still some way off.

Even the US Congress and the 2 contenders for President have become involved in accounting issues. Following the US Government’s legislation enacted on 3 October to help stabilize financial markets, the Securites and Exchange Commission is required to conduct a study of mark-to-market accounting. The study is to be completed by 2 January 2009, in consultation with the Secretary of the Treasury and the Board of Governors of the Federal Reserve System. The study will focus on:

1. The effects of such accounting standards on a financial institution's balance sheet
2. The impacts of such accounting on bank failures in 2008
3. The impact of such standards on the quality of financial information available to investors
4. The process used by the Financial Accounting Standards Board (FASB) in developing accounting standards
5. The advisability and feasibility of modifications to such standards
6. Alternative accounting standards to those provided in FASB Statement Number 157 (ie other than market-to-market)

So the question remains – have International Accounting Standards, which are used by Australia and many other countries, in some way added to the turmoil?

Not according to the accountants who say that all fair value is doing is making current market values transparent. The financial crisis is seen as an economic consequence of many unstated factors. But whether they have led to real economic loss in all cases is the question, particularly when the specific assets have not been disposed of, and may not be realized until market prices recover.

Certainly the accounting model which requires the use of fair values describes the losses as such, and the fair value model will continue to show both write-downs and writeups of financial assets over time as reflective of the continuing change in asset values and market conditions. However, investor confidence, market confidence and the availability of capital support from banks and  Governments, are significantly influenced by changes in fair values of assets that are disclosed in financial statements released to the market.

The Australian Government’s announcement that it will guarantee the deposits made to regulated entities such as banks, building societies and credit unions has generally been welcomed. Not so much from an Australian confidence perspective, but rather recognition from the global market that our regulated institutions are a safe haven for deposits.

So is the IASB’s decision to allow reclassification of some financial assets and liabilities from a fair value model enough? Given that the market has been perceived by some to have been spooked by what are in many cases unrealized losses, it can be argued there's a need for better disclosure of exactly what such losses represent.

The IASB’s much delayed (7 years) ‘performance reporting project’ now renamed 'financial statements presentation' has just been released in Discussion Paper format and it does propose a disaggregation of fair value changes. Whether such disclosure in the notes to the financial statements is sufficient, or whether the reported profit in the profit & loss statement needs an additional column to readily compare realized and unrealized results, is open to debate. What is not open to debate is the need to provide such information quickly via amendments to existing standards. Given the current market turmoil, this needs to be quickly introduced in Standards format by both the IASB and the FASB.

Never before have accounting standards been placed under so much scrutiny and so much interest, and the debate has only just started.

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