The Impact of Accounting Standards on the Global Financial Crisis

This report comprehensively analyzes the role of accounting standards in the Global Financial Crisis (GFC), initiated in 2007. It explores how accounting standards, particularly fair value accounting, contributed to the crisis and details the responses of the International Accounting Standards Boar...Read More

Running Head: Accounting Standard’s Role in GFC
Response to Global
Financial Crisis

Accounting Standard’s Role in GFC 1
GLOBAL FINANCIAL CRISIS
A) Role of accounting standards in the Global Financial Crisis
Global financial crisis was a huge tragedy that has affected most of the countries all over the
world. The crisis was initiated in the year 2007 in the US markets. The global financial crisis
is believed to be the worst event in the world’s economy. There were various reasons that
caused the countries face the adverse impacts of such crisis. Accounting standards prescribed
by the regulatory bodies were among the prime reasons that contributed to the occurrence of
the critical incident (Kothari & Lester, 2012). The approaches followed by the accounting
standard setters were considered to be inappropriate in various situations. To account for the
financial instruments various methods were used and those instruments were required to be
recognized at the fair value in accordance with the accounting standards and this fact became
the one of the main reasons for the global financial crisis. (Laux & Leuz, 2010). At the
beginning of emergence of the financial crisis in late 2007 the home loans that covered in
special purpose vehicles were unable to meet their debt obligations because of sudden
decrease in housing prices. As a result of which the financial institutions holding the low
credit quality particularly the subordinated loans covered in the special purpose vehicles
began to face huge losses. In the initial years the low quality debts had restricted market and
huge demands as they were offering higher rate of returns. Consequently, the positive fair
value adjustments were reported in the financial statements. However, with the increased
pace of diminution in prices of the housing industry, the low quality debt market initiated
disappearing leading to sudden decline in the fair values of these debt papers (Shiller,
2012).The overall impact of the subprime crisis had drastically influenced the several
economies of world specially those which had purchased the poor quality debt papers. The
institutions of finance had already made the securitisation of their mortgages and hence the
special purpose vehicles had begun making losses ultimately leading to the financial crisis at
the global level (Mishkin, 2011).
International Accounting Standard Board’s (IASB) response to the Global Financial
Crisis
The adverse impacts of global financial crisis together with the intense political pressures
imposed the serious requirement on the IASB to make revision to its already existing
accounting standards and to issue new and relevant standards to as to deal with the severity of

Accounting Standard’s Role in GFC 2
the global financial crisis issues. In response to the global issue IASB has formed a Financial
Crisis Advisory Group (Ait-Sahalia, 2012). The purpose of FCAG included the consideration
of the process used to set the accounting standards. The directions of IFAC also included the
possible improvements to be made in accounting standards. Further the group also considered
the role of accounting standards in the global financial crisis and the adequacy of fair value
accounting for the financial instruments. The FCAG has concluded that the standards of the
accounting must be kept free from political interference. It was realised by the FCAG that
existing accounting standards were not considering the entity’s business model. It was held
by the group that the major factor that led to the crisis was the approach of legal compliances
in place of adhering to the principles of those accounting standards by the reporting entities.
Following actions were taken by the IASB in response to the crisis:
The amendments made by IASB in the accounting standards required the disclosures of
various important elements of fair value accounting. The amendment of IFRS 7 was brought
in this context which required the categorisation of fair value measurement of the financial
instruments. IASB also published its proposals to improve the accounting of the off balance
sheet items. It also made amendments to the IAS 39 with the intention of reclassifying the
financial instruments so as to ensure that the embedded derivatives are separated in the
financial assets classification. IASB also attempted to bring the consistency in the accounting
treatment between the generally accepted principles of accounting and the IFRS in relation to
the credit linked investments. The disclosure requirement with regards to the impairment of
financial assets. The IASB is continuously struggling to move rapidly to address the issues of
financial reporting as were encountered by the global financial crisis. It is committed to
develop the globally accepted approaches to maintain the consistency with the approaches
followed in the global world (Ojo, 2010).
The above mentioned actions provided the appropriate responses to the global financial crisis
and the IASB has so far managed overcome the severity of the issue and thereby promoting
the financial stability globally. However, looking to the complexities of world’s economy it
can be said that the IASB’s responsibilities in respect of maintaining the global financial
stability has not ended here. It is still required to regularly amend and introduce the relevant
standards of accounting on timely basis in order to satisfy the investors and the general public
associated with the company.
B) Revision and Introduction of New Accounting Standards By IASB

Accounting Standard’s Role in GFC 3
With the occurrence of global financial crisis certain standards issued by the IASB received
much attention and as a part of response to the crisis it has brought into the scope the
amendment in IAS 39 which allowed the reclassification of financial instruments. As IAS 39
was critically condemned by the banking and other financial institutions for its method of
valuing the financial instruments following the mark to market method (Haas & Lelyveld,
2014). The banks argued that the mark to market method of measurement does not always
provide the correct value of some of the parts of the balance sheets of the banks (Barth &
Landsman, 2010). Moreover, the earlier version of IAS 39 was also complex enough to deal
with as it required classification of financial assets in four categories and the financial
liabilities in two categories. Whereas, the revised IAS 39 requires the entities to classify its
financial instruments only on two basis i.e. the instruments for which fair value method is
used for recognition and the instruments for which amortised or historical cost method is
used.
Further, the IFRS 13: Fair Value Measurement and IFRS 9: Financial Instruments are also
issued after the global financial crisis in order to improve the fair value accounting used by
entities for measuring and recognising the financial assets and liabilities. Fair value
accounting is given so much importance due to the reason that it allows the presentation and
delivery of reliable and relevant accounting information to the readers of financial statements
(Claessens & Kodres, 2014). IFRS 9 is attempting to develop the standards relating to the
derivatives, asset impairment and the hedging. With these changes IFRS 9 has reduced the
discretion level in terms of classification of financial instruments so as to reduce the
complexities of financial reports depicting such instruments. IFRS 9 promotes the uniformity
and standardisation in financial reporting of the financial instruments and aims at enhancing
the understanding and comparability of financial reports. The overall effect of IFRS is that
there can be experienced more concentration on fair value accounting of financial
instruments.
C) AASB’s response to the Global Financial Crisis
The impact of global financial crisis had also touched the Australian economy and made it
necessary for the Australian accounting standard setters to take appropriate actions to deal
with the critical situation of financial crisis. Australian Accounting Standard Board is the
statutory body which functions for the formulation and regulation of accounting standards for

Accounting Standard’s Role in GFC 4
the reporting entities of Australia. AASB in response to the crisis introduced the amendments
in the Australian accounting standards so as to ensure the consistency between the
approaches followed by accounting standard regulators of other countries (Australian
Government, 2008). The amendments were aimed at encouraging the Australian business
entities to follow such accounting treatment as are globally accepted. AASB quickly
responded to the IASB’s actions in dealing with global financial crisis and hence made the
amendments to the AASB 139 and AASB 7 when changes are made to IAS 39 and IFRS 7.
In response to the crisis IASB had organised several round table meetings in the different
countries like Tokyo, New York and London (Claessens, 2010). The participant countries
were directed to identify the prime accounting issues that needs immediate attention. The
chairperson of AASB at that time had also taken participation in these discussions. IASB
through its enormous efforts is constantly trying to enhance the trusts of the investors and
shareholders of the entities (Bengtsson, 2011). The initiatives that were taken by IASB and
the Australian Board of accounting standard has time to time responded to them positively
are: The improvement in the disclosures requirement of the off balance sheet items and the
provision of clarification about the accounting treatment of financial instruments like
embedded derivatives. These AASB’s responses were intended to bring the convergence with
the IFRS responses.

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Accounting Standard’s Role in GFC 6
List of References:
Ait-Sahalia, Y., Andritzky, J., Jobst, A., Nowak, S., & Tamirisa, N. (2012). Market response
to policy initiatives during the global financial crisis. Journal of International
Economics, 87(1), 162-177.
Australian Government. (2008) Australian Accounting Standards Amended in Global Action
to Address Impact of Credit Crisis: available at:
http://ministers.treasury.gov.au/DisplayDocs.aspx?doc=pressreleases/
2008/067.htm&pageID=003&min=njs&Year=&DocType= (assessed on: 29.09.2017)
Barth, M. E., & Landsman, W. R. (2010). How did financial reporting contribute to the
financial crisis?. European accounting review, 19(3), 399-423.
Bengtsson, E. (2011). Repoliticalization of accounting standard setting—The IASB, the EU
and the global financial crisis. Critical Perspectives on Accounting, 22(6), 567-580.
Claessens, S., & Kodres, L. E. (2014). The regulatory responses to the global financial crisis:
Some uncomfortable questions.c
Claessens, S., Dell’Ariccia, G., Igan, D., & Laeven, L. (2010). Cross-country experiences and
policy implications from the global financial crisis. Economic Policy, 25(62), 267-293.
Haas, R., & Lelyveld, I. (2014). Multinational banks and the global financial crisis:
Weathering the perfect storm?. Journal of Money, Credit and Banking, 46(s1), 333-
364.
Kothari, S. P., & Lester, R. (2012). The role of accounting in the financial crisis: Lessons for
the future. Accounting Horizons, 26(2), 335-351.
Laux, C., & Leuz, C. (2010). Did fair-value accounting contribute to the financial crisis?. The
Journal of Economic Perspectives, 24(1), 93-118.
Mishkin, F. S. (2011). Over the cliff: From the subprime to the global financial crisis. The
Journal of Economic Perspectives, 25(1), 49-70.
Ojo, M. (2010). The Role of the IASB and Auditing Standards in the Aftermath of the
2008/2009 Financial Crisis. European Law Journal, 16(5), 604-623.

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Shiller, R. J. (2012). The subprime solution: how today's global financial crisis happened,
and what to do about it. Princeton University Press.