IFRS and Fair Value Accounting: Contributors to the Economic Crisis

The essay evaluates the role of IFRS and fair value accounting as the contributor of economic crisis. The essay places emphasis on the impacts of the fiscal reporting systems by the banks and concludes that the fair value accounting may have played an important part in the fiscal crisis. A conclusive recommendation has been provided regarding more disaggregate disclosure of the variables that are sensitive to the fair value changes and market risks variables.

Running head: FINANCIAL ACCOUNTING
Financial Accounting
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Abstract:
The essay evaluates the role of IFRS and fair value accounting as the contributor of economic
crisis. The essay places emphasis on the impacts of the fiscal reporting systems by the banks
and concludes that the fair value accounting may have played an important part in the fiscal
crisis. A conclusive recommendation has been provided regarding more disaggregate
disclosure of the variables that are sensitive to the fair value changes and market risks
variables.

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Introduction:
The financial crisis is regarded as the wide variety of situation where some financial
assets abruptly loses the large portion of nominal value. During the 19th and the 20th centuries
several economic crisis was related with the banking frights and several economic downturns
coincided with the panics (Laux and Leuz 2015). Other instances that is generally known as
financial crisis comprises the crash of stock market and includes the bursting of fiscal
bubbles, money crisis and independent non-payments.
The economic crisis began in the midway of 2007 and extended its run all through the
end of 2008 leading to the fall of several investments and commercial banks. The collapse
also included some of the high profile institutions namely the Lehman Brothers, Bear Stearns
and Merrill Lynch. The crisis led to an almost complete fall of the banking sector based on
which the commercial lending activities were dependent (Chang et al. 2018). Majority of
them believe that the disaster began subsequent to the bursting of housing bubble in US. The
decline of the financial sector also led to the greatest economic contraction which was
witnessed by the US and Europe following the end of Second World War.
Appeals requesting an action to prevent the financial crisis also extended to the IFRS
accounting standards and the role in which the accounting info has subsidised the fiscal
disaster (Magnan, Menini and Parbonetti 2015). In this matter, fair value accounting has
attracted much of attention where several bankers, administrative figures and observers have
opposed that fair value accounting was the main contributing aspect of the pro-cyclical fall in
the assets value of banks along with the stock price of banks when the bubble of housing
market burst. Nevertheless, there are several other aspects of the accounting info that are
instructed by the accounting standard setters have received attention but nevertheless might
have played a noteworthy part in contributing to the Fiscal Crisis.

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Discussion:
Financial reporting scrutiny in the context of financial reporting for the fair values of
the assets of the company, securitisation of the assets and other financial derivatives
instruments have played key role in financial crisis. Transparency in the financial
information presented by the company plays an important role and the same is important for
assessing the risk associated with the company. The current requirement of the IFRS
Accounting promotes fair value accounting and presenting of the information of the various
key assets of the company. Financial derivatives instruments are the key reason that exposes
the assets of the company with high volatile values of the assets of the company.
Transparency and Faithful representation of the financial data and information are the
primary aspects of financial reporting that would reflect current economic reality of the
company (Christensen et al. 2015).
Financial crisis, which started in the midway through 2007, which ended in the year
2008, resulted in the collapse of many financial institutions and investment banks. The banks
and financial institutions were exposed with many financial derivatives instruments like
mortgage backed securities, futures and forwards options. The financial assets of the
company were reported at the cost value and when the same were matched in accordance
with the current accounting policies and standards of IFRS the cost value and fair value
differed with a great extinct (Cooper 2015). The housing price bubble, which took place in
the mid-year of 2007, lead to substantial fall in the fair value of the assets of the company.
Overvaluation of the assets and non-disclosure of financial information with respect
to the financial derivatives instrument was the key reason that resulted in the difference of
value. It is essential as per the IFRS that organisation should reveal all current and potential
sources of information in the financial report of the company so that the investors and
financial users of the company get relevant information on the company for the purpose of

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investment (Saskia 2017). Banks and Financial institutions were not able to adjust to the
rapid development and accounting changes, which showed material impact on the financial
position of the companyin accordance with fair value concept. Faithful representation,
relevance of data, timeliness of the financial report and usefulness of the information
presented are some of the key characteristics of the financial report of the company (Leuz and
Wysocki 2016).
The banking regulators and the accounting standard organisation should have a
common ground for reporting of the financial information and thereby ensuring the financial
stability of the organisations. The current requirement of the IFRS accounting standard
allows the company report fair value accounting so that the financial report of the company
reflects the current economic reality of the company and users of the financial report can use
the same for investment decision (Kim et al. 2016).
Fair value accounting is another factor that has played a crucial part in the fiscal
crisis. One of the primary drawbacks of fair value accounting, as per the critics, is that it is
not the most suitable attribute to convey decision-useful info to the users of the financial
statements. Instead, it has been argued that modified historical cost is a superior measure over
fair value accounting (DeFond et al. 2014). Along with this, it has been argued further that in
the absence of noticeable prices based on which fair value estimations would be made; the
estimates might not be decision useful. This is because the management of any organisation
would have the chance of manipulating the estimates so that their own objectives are met. In
case; the prices are noticeable, the fair value estimates would not depict dimensions of the
values of assets regarding which the management has confidential information.
As per the over-all tenor of the fair value disparagements, the fair value info,
especially from the viewpoint of the fiscal crisis, does not have the required quality to be

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informative to the users of the monetary reports like investors and others. In fair value
accounting, there has been inclusion of unrealised gains and losses in earnings. As a result, it
increases the overall volatility of earnings (Whittington 2015). There are three basic sources
of additional volatility related to accounting amounts based on fair value in comparison to
those ascertained by utilising altered historical cost. The initial source is the fundamental
economic volatility, which is represented in modifications in the fair values of assets and
liabilities. In order to ensure more disclosure of earnings-related information, it is required to
represent this volatility. The second source has induced volatility coming out from utilisation
of a mixed-attribute model of accounting, which might disappear if banks start to gauge all
their financial instruments using fair value, which is allowed under IAS 39. The final source
is the volatility induced due to the error in measuring the estimates of fair value
modifications, which is evident in case of the investment securities of the banks (Filip and
Raffournier 2014).
Moreover, asset securitisation is another element of the IFRS reporting standards and
the role of asset securitisation is at the heart of the credit crisis of 2007-2008. With the
progress in securitisation market, the credit markets made a massive progress, which
eventually resulted in housing boom. This is because the banks could create increased and
riskier loans, which would not have been the situation otherwise. Moreover, there is lack of
information for the investors regarding the loan quality originated by the banks and transfer
to special purpose entities. This has restricted the investors in providing necessary market
discipline for preventing excessive lending (André, Filip and Paugam 2015). Along with this,
the investors had experienced issues in analysing the risks and fair values associated with the
assets of fair value entities after the assets are transferred initially. The problem had been
aggravated further when there had been removal of the assets of special purpose entities

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underlying the securitisations. Thus, all these reporting standards have contributed to the
financial crisis.
Conclusion:
On the conclusive note, the general tenor relating to the criticism of fair value
accounting is that the fair value figures especially in relation to the economic crisis has
lacked the adequate value of the information for the shareholders and users of the monetary
statements. The essay scrutinizes the roles that the monetary reporting concerning the fair
value, asset securitization and the derivatives have contributed to the financial crisis. This is
for the reason that the banks were in the center during the financial crisis.
The essay concludes that the transparency relating to information of measurement and
recognition of financial values and the disclosure of information regarding the securitization
of assets as well as derivatives were inadequate for the investors to evaluate the right values
and perilousness of the exaggerated assets and liabilities of banks. For derivatives it is
recommended that the recommendations comprise of the disaggregated info to allow the
financiers to understand the side of contracts that is held by the banks and who the
counterparties are.

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