Valuation for financial reporting
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ABSTRACT
The report has been prepared to highlight various
measurement techniques involved in accounting measurements while preparing
financial statements. This report focus on insight knowledge of fair value
measurements used in accounting measurements. It outlines the Global Crisis and
its effect on the world economy. The report outlines the benefit achieved by
fair value measurement in financial report preparations. The objective of this
report is to discuss if the Fair Value Accounting is responsible for global
crisis. This report highlights new development taken by accounting standards in
wake of global financial crisis. At last we will focus on Green Accounting
model which measures the cost and benefits of environmental friendly products.
INTRODUCTION
Accounting measurement is computation of accounting
values in the form of money or units. Based on historical costs, transactions
are recorded in the accounts in dollars. Other accounting measurements can be
represented in volume like hours spent in direct labor and this can be used to
calculate overhead in a cost accounting system.
to help you
with your studies. This is not an example
The standard accounting setters are feeling the
necessity of having financial statement preparers so as to move ahead from
historical cost accounting to calculating fair value measurement for assets and
liabilities. Fair value measurement sets a framework that can be used to for measuring
fair value of assets and it discloses details of the fair value measures.
Following complex matters need to be judged before estimating the fair value
using standard procedure-
- Need
to check if an active market exists for the asset and liability and if
exists we must be aware of pricing assumptions used by market
participants.
- Appropriate
model should be decided for estimating the fair value if the active market
doesn't exists.
- Most
appropriate of the three acceptable valuation techniques need to be
decided for measuring the fair value of the assets or liabilities.
- We
need to analyze level of subjectivity of inputs used in calculating fair
value.
Seeing to the current turbulent financial situations,
the issues related to measurements of the fair value accounting was gradually
attracting the attention of governments sectors, policy makers, practitioners,
regulators, and the media. The role of standard setters and accounting
principles were placed at the centre of the controversy after global crisis.
GLOBAL FINANCIAL CRISIS
The temporary solutions that governed the global
economy since 1980 broke down during the global financial crisis. There are
number of dimensions involved in the crisis but three of them are most critical
described as below -
- Built
up of debt which includes both corporate and household debt
- International
monetary instability
- Effect
of ecological crisis on the world economy
The second half of 2008 showed even worst debt
situations and hence becoming the prime culprit in financial crisis. The
accumulation of debt in the system was much more than previously thought and
hence leading to confusion amongst the ruling class as how to react to
increasing number of loans defaults. Mortgage companies Fannie Mae and Freddie
Mac were unwillingly forced to nationalise and financial crisis lead to
collapse of leading investment bank like Lehman Brothers. The banking crisis
resulted in crisis of rest of the economy and as result more general economic
crisis started emerging. There was large pressure built due to high rate of
recession faced by the people.
FAIR VALUE MEASUREMENT TO IMPROVE
FINANCIAL REPORTING
The fair value defines a framework for measuring fair
value of asset or liabilities based on generally accepted accounting principles
(GAAP) and disclosures about fair value measurements. The Board had concluded
that fair value is the relevant measurement attribute in previously accounting
pronouncements. The definition of fair value along with the framework for
measuring fair value leads to increase comparability and consistency in fair
value measurements. The detailed disclosures about the process to calculate
fair value of the assets and liabilities enhances the knowledge and
understanding of the users of financial statements. On gaining detailed
information of fair value and the extent to which it is used to estimate
recognized assets and liabilities, the users analyzes the inputs in better way
to develop the measurements and the effect of measurements on earnings over a
period.
Is Fair Value Accounting
responsible for the Financial Crisis?
One of the causes identified responsible for global
financial securities was Fair value accounting. It was unfair to accountants,
academics, bookkeepers and auditors for making solely responsible for the
global financial crisis. The fair value accounting is pro-cyclical i.e. in
times of growth, rising value support each other. Financial instruments like
Asset backed securities have been benefited by raising shares and bonds values.
The increase in value of financial instruments contributes to increase in share
prices which reflect as stronger performance of companies hence improving
company ratings and freeing up more capitals for further investments. The
managers are benefited from good performance indicators and dividends for the
company are high. The profit distribution is not calculated on realized gains
rather it is derived from a firm's fair value. During the crises situations
falling prices lead to reduce balance sheet values and write downs. Due to
depreciating assets values the markets for financial instruments faced a down
turn or collapsed. This the time organizations challenged market that it didn't
showed fair value. The organizations didn't have problems while paying out
manager compensation and dividends out of unrealized gains. The collapse of
global economy is interpreted as the "inactivity" of markets.
According to Herz, Chairman of Financial Accounting
Standard Board (FASB), there is confusion in media about the relationship
between financial institution and accounting standards. According to him FASB
is not responsible in determining the capital levels a bank need to maintain, but
as per stated in laws during any saving or loan crisis the bank regulators need
to determine regulatory capital starting with GAAP numbers. The bank regulators
have the authorization to adjust the GAAP figures, and they have other tools
which can address liquidity issues, capital adequacy and concentrations of risk
at regulated institutions. The focus of accounting standard setters is to
communicate reliable, transparent, relevant, unbiased and timely financial
report of corporate performance and financial situations faced by corporate to
capital market and investors. The transparency provided in the financial report
results in financial market stability and hence reducing the level of ambiguity
in the market and lack of transparency hides the risks factors involved in
financial institutions from investors as well as regulators.
This
Recent developments in response to
the credit crisis
Accounting standards can't be criticized or blamed for
the global crisis, but there is still space for accounting standard to improve.
In fair value measurement model it revealed the financial report quickly to the
policy markets and investors and hence decreasing the asset value and related
economic. This model followed a transparent approach and informed the user of
financial statements about the current scenario. The current financial global
crisis has challenged the current standard and their assumptions and
highlighted the problem of using fair value measurement in illiquid markets. In
response to the global financial crisis, the US Financial Accounting Standards
Board (FASB) and the International Accounting Standards Board (IASB) took
several measurements that impacted on fair value accounting. Following are
lists of initiatives taken -
- Financial
Crisis Advisory Group was set up by IASB and FASB that identifies major
accounting issues which require immediate and urgent response by board.
- IASB
issued reclassification of the amendment to IAS 39 which introduces the
concept of reclassifications of some financial instrument in certain
scenarios.
- Financial
accounting standards provided the guidance that allows some relaxation of
the rules used for calculating the fair value for assets and liabilities.
Its gives more freedom to the institutions to use its own evaluation model
instead of current market price in the crisis when the market has become
illiquid.
GREEN ACCOUNTING MODEL
The increasing demand to save the environment and
promoting environment friendly products and services have boosted the need for
better identification and evaluation of the costs and associated variables.
This in turn enhances the managerial decision making, planning and controlling
and better assessment of financial report and their impact on the corporation
financial stability. The frameworks that can measure green accounting include
inflows and outflows or additional cost involved as well as costs and revenue
saved. The cost side will include the environmental, economic, regulatory,
community, social and environmental cost involved in production of the product.
The inflows measure the additional revenues and profits received, saving,
regulatory cost obviated and grants received by the organization. Green Cost
Accounting model ensures including all variables to accurately measure benefit
and cost of environmental project. Organizations are encouraged to abide with
environment regulations and laws.
CONCLUSION
Every financial institution uses accounting
measurements to prepare their financial statements. With the span of time the
standard accounting setters realized of moving ahead of historical accounting
standard to fair value measurement of assets and liabilities. Fair value
accounting measurement plays an important role in financial reporting of an
institution. Global crisis was the worst turmoil faced by world economy and
this was the time when Fair Value Accounting measurements faced the heat of the
global crisis. According to Financial Accounting Standard Board the fair value
measurement was not the sole contributor for the collapse of world economy. Green
Accounting model follows new measurement techniques while calculating the costs
and benefits of the environmental project.
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