Question

In: Finance

The fallout from the financial crisis of 2008 included an overheated real estate market, fueled by...

The fallout from the financial crisis of 2008 included an overheated real estate market, fueled by home purchase incentives, poor lending practices, and securitization through high-risk, mortgage-backed securities, which led to a near collapse of global capital markets. As a consequence, many have argued that if the financial institutions had been required to report their loans (and loan-backed investments) at fair value instead of cost, large losses would have been reported earlier. This would have signaled regulators to the problems in the mortgage markets and therefore minimized the losses to U.S. taxpayers.

Explain how reported accounting numbers might affect an individual’s perceptions and actions. Cite two examples.

Solutions

Expert Solution

Various elements of the balance sheet are recorded at the historical cost and they will be providing the investor with an idea about the financial performance of the company which is not fair because the valuations of various Assets and liabilities of the companies are significantly changing in the market and it should be recorded on the fair value and the market value in order to present share valuation & the better idea of investment so reported accounting numbers are the basis for the investors in order to invest into the company and it is often leading into a bad decision making because the books of accounts can be significantly manipulated to the benefits of the company or the books of accounts are having various figures represented at the historical cost, which is not a representation of their share market value and hence decision based upon this financial statement can often be leading to disaster.

Two examples-

A. Company having very large amount of Fixed assets on its books will be looking very attractive to the investor because it will be representing the Assets of the company at the historical cost but if these assets are valued lower in the market and they are collateralized against loans then they will be losing all the attractiveness

B. Research and expenditure cost are not represented on the books of accounts and hence these cost are providing with the prospective decision-making because those companies who which are investing into the future are going to grow and those investor who are based upon their analysis over books of accounts are going to miss this companies.


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