In: Accounting
Topic of essay: During the Global Financial Crisis of 2008/9, it was claimed that IFRS fair value accounting techniques used in corporate reports had distorted financial reality and caused the crisis.
(a) Describe those alleged problematic fair value accounting techniques and standards, and state if you agree with the criticisms and why (300 words).
(b) In the period 2009-2020 do you think IFRS fair value standards have improved? State your reasons and evidence (300 words).
(c) In the event of a major economic downturn in 2020 or later do you think assets will be appropriately measured by IFRS fair value accounting standards? Explain (400 words).
General requirements Label each section clearly. In each section, get straight to the point of the argument and do not waste space with ‘general background information’ etc.
International Financial Reporting Standards (IFRS) is a set of accounting standards developed by an independent, not-for-profit organization called the International Accounting Standards Board (IASB).The purpose of IFRS is to create an accounting framework that all companies in the world can follow in order to increase comparability of companies located in different countries.
a) The main issue with fair value techniques under IFRS was that companies were inflating their assets (and earnings) by marking certain assets at fair value only because their fair value had increased and not because it was more representative information for shareholders. For instance, companies could have increased the value of their factory building to their fair value instead of using amortized cost so that their depreciation expense would be lesser and they would have a gain on revaluation. Whether these practices were problematic or not depends on whether the use of fair value accounting was representative, which was different for every company.
b) Yes, absolutely. For instance, when using the fair value technique under IAS 16, companies must now post any gains to Other Comprehensive Income and can only record their gains to net income to the extent of any previous revaluation losses on that same asset. This implies that companies cannot overstate their net income due to the revaluation election under IAS 16.
c) If there is a major economic downturn, more companies will be reporting their assets at fair value simply because those who elected that practice at the beginning must continue following it and companies that have their assets at amortized cost might need to mark down to fair value due to impairment testing in an economic downturn. Therefore, it can be summarized that the risk of misleading fair value accounting is naturally lower in a major economic downturn that during a time of prosperity since fair values are lower.