Analysis of Fair Value Accounting's Contribution to Financial Crises

This essay examines the impact of fair value accounting on the occurrence of global financial crises, particularly focusing on the 2009 financial crisis. It explores the drawbacks of fair value accounting, highlighting how it can lead to the misrepresentation of financial information for end-users. The essay discusses the role of large estimates in determining fair value, as per current IFRS standards, and how this can contribute to financial instability. It provides an overview of financial crises and the current IFRS requirements that can exacerbate these situations. The analysis includes the impact of financial crises on the global economy, the criticism of fair value accounting by financial analysts, and the limitations of current IFRS standards. The essay concludes by emphasizing the need for improved regulatory focus and the development of high-quality financial statements to mitigate the risks associated with fair value accounting.

Financial Accounting for Business Combinations

Abstract
The present essay is developed to examine the contribution of fair value accounting
towards the occurrence of global financial crisis. This has been carried out by discussing the
drawbacks of fair value accounting that lead to misrepresentation of financial formation to the
end-users. The use of large estimates in determining the fair value of assets and liabilities is
largely responsible for the occurrence of financial crisis as identified from the essay due to
current IFRS standard requirements.

Introduction
The international accounting standards prepared by the IASB provide standard
accounting rules and guidelines to the professional accountants worldwide for developing and
presenting their financial statements. The standards are developed to ensure that end-users
receive reliable and faithful information that facilitates them in their decision-making process.
However, at present there is increased debate relating to the contribution of IFRS towards the
occurrence of financial crisis. For example, the occurrence of global financial crisis in the year
2009 was largely accounted due to the use of fair value accounting standards provided by IFRS
(Laux and Leuz, 2010). In this context, the present essay is developed for discussing the issues in
the method of fair value accounting that can lead to the occurrence of global financial crisis. In
this regard, it provides a discussion of the financial crisis and the current IFRS requirements that
can contribute towards the financial crisis.
Financial Crises meaning and its impact
Financial crises refer to the period or situation of economic downturn faced by the market
and consumers. It is very difficult to succeed in the situation of the global financial crises as
potential consumers tend to reduce their purchase of goods and services due to poor economic
conditions. The global economy was largely impacted by the financial crisis of the year 2008-
2010 that led to the downfall of the develop markets. The overall financial distress in the market
situation has led to the downfall of the global economic market. In the situation like financial
crises the value of assets or financial institutions drops at very rapid speed as there are no buyers
and investors when financial crises occur. The financial crises led to the panic situation where
investors sell off the assets and withdraw money from the saving accounts as they believe that
value of assets will drop quickly and there are chances that banking system can breakdown
(Zimmerman and Yahya-Zadeh, 2011).
The financial crisis has resulted in the collapse of large financial institutions due to
fraudulent business practices such as mis-representation of financial information. The collapse of
the mortgage market is responsible for bankruptcy large financial institutions in the USA during
the period 2008-2009. This in turn also led to the breakdown of financial system in other parts
of the world and it became first global financial crises that have resulted in the slower economic

growth and development. The financial crisis has been initiated downfall of housing market in
the US and also has significantly impacted the growth and development of other economies. The
bursting of the house bubble has caused in collapse of price of loans and other financial
instruments. This has led to slow economy growth in the global economy with the breakdown of
many large financial institutions such as Lehman Brothers. The deregulation in the financial
industry is attributed to be the main cause of occurrence of financial crisis. This has resulted in
providing the freedom to banks for involving in hedging and derivatives trading. Bank has
undertaken more mortgages for supporting the profitable sale of the derivatives and this lead to
the occurrence of financial crisis due to great recession (Landsman, 2010).
Current Requirements of IFRS Accounting Standards Contributing to Financial Crisis
The global financial crisis in the year 2009 has led to the debates regarding the
contribution of fair value accounting for the emergence of such situations. The financial analysts
have pointed that US GAAP and IFRS standards have stated the valuation of certain assets and
liabilities at fair value to be recognized in the profit and loss statement. Fair value as per the
IFRS standards can be regarded as the price that would be realized by selling an asset or will be
paid for transferring liability in an ordered transaction between the participants of the market on
the date of measurement (Pozen, 2009).
The use of fair value accounting principle provided by the IFRS standards has been
criticized widely by the financial analysts as they has regarded to be a major factor towards the
global financial turmoil. The main point of criticism is that the use of such accounting method is
that it is not able to present decision-useful information to the users of financial statement. This
is mainly due to use of estimates in predicting the fair value of assets and liabilities that can lead
to lack of reliability and accuracy in the financial information. The management is provided the
freedom to manipulate the estimates as per their personal objective in the use of fair value
accounting and therefore it can result in providing false information to the end-users. The use of
fair value accounting is responsible to large extent for the occurrence of fraudulent practices
within an organization. This is because management can realize personal gains with the use of
such accounting method by disclosing falsie information that can negatively impact the interests
of the end-users mainly investors, creditors and lenders (Laux and Leuz, 2010).

The financial crisis of the year 2009 has a wide impact on the financial markets around
the world. It has pointed the inappropriateness of the IASB in developing effective international
standards and regulations to protect the interests of end-users. The measurement of assets and
liabilities at the fair value has the drawback of not being sufficiently informative for the investors
and other users of financial statement. This is because it can lead to the occurrence of unrealized
gains or losses and thus makes the financial statements extremely volatile. This is due to the
measurement error that occurs in identifying and recognizing the value of assets and liabilities
due to use of estimates in reporting of financial information. Thus, in the situations of market
instability the use of fair value method can cause lack of relevance and reliability in the financial
statements with the use of fair value accounting methods (Menicucci, 2016).
The large criticism of the accounting method to identify and recognize the assets and
liabilities at fair value by the accounting professionals has raised questions on the efficiency of
the current IFRS standards to protect the interests of end-users. The development of Fair Value
Measurements has provided the guidelines relating to estimating the fair value and thus
restricting the management ability to manipulate the estimates used in measuring the assets and
liabilities value. However, the applicability of IFRS standards for providing reliable and faithful
presentation to the end-users is becoming a major issue of concern for the investors. In this
context, the IASB is placing large emphasis on improving the reliability and relevancy of IFRS
standards to avoid the occurrence of situations of financial crisis in the future context. The
conceptual accounting framework has being established by the IASB for improving the
qualitative characteristics of financial information disclosed to the end-users (Zimmerman and
Yahya-Zadeh, 2011).
The qualitative characteristics of financial information are relevance, faithful
presentation, understandability, comparability, timeliness and verifiability. This is necessary for
increased regulatory focus on the financial reporting process of business entities to protect the
interests of end-users. IASB is also emphasizing on adoption of uniform accounting standards
across the world for minimizing the asymmetry in financial reporting. IASB has also established
a Financial Stability Board (FSB) for monitoring the accounting standards effectiveness in
presenting true and fair view of the financial condition of a business entity (Baker and Nofsinger,
2010). Also, in this direction, IASB is emphasising on establishing an International Integrated

Reporting Committee for driving concise, clear and more comprehensive business reporting
towards the stakeholders of a business entity. IASB has provided increased guidance to the
business entities during reporting of their financial information under the situations of market
instability after the global financial crisis of the year 2009. It has also facilitated the
reclassification of certain assets and liabilities from preventing the occurrence of mark-to-market
losses. As such, all these current measures undertaken by IASB after the occurrence of global
financial crisis will result in development of high quality financial statements and reduce the
chances of occurrence of materialistic error (British Accounting Association, 2011).
However, IASB still need to place emphasis on improving the regulatory focus on the
financial reporting process for reducing the chances of occurrence of any crisis situation. This is
because increased market volatility and procyclical effects introduced by the use of fair value
accounting method is associated with increased changes of misrepresentation of financial
information. The fair value accounting amplified the procyclicality as auditors under the method
are required reporting low values of the financial assets and thus amplifying the asset
impairments. Thus, IASB need to implement strong measures for reducing the volatility and
cyclical effects introduced by the use of approach of fair value in financial reporting (Castleden,
2009).
Conclusion
It can be stated from the overall discussion held in the essay that fair value accounting is
associated with the drawback of reporting misinterpreted financial information during the
condition of instability within the financial market. As such, IASB need to implement strong
measures for reducing the measurement error that can occur with the use of fair value accounting
method.

References
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