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Written by:
Ratna Yudhiyati
44047509
Accounting Changes after Global Financial Crisis: A Critical View
Few years ago, business world faced one of the worst financial crisis in history. Now,
almost eight years after the collapse of Lehmann Brothers, business world is still recovering
from this Global Financial Crisis. This crisis brought many changes in economic and
business world. One of the major change it brought is new accounting standards. Many
people believe that these new accounting standards can prevent companies from ‘cooking
their books’ and increase financial statements’ quality. However, many people also believe
that these new standards have no impact to financial statements’ quality, while there are also
some people believe that these new standards are actually counter-productive. The objective
of this paper is to analyze these new accounting standards and compare them to expected
quality of financial statements.
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sudden event, but a disaster waiting to happen since some time ago. It did not only happened
in US. An independent financial oversight group published a report which explained that
there was almost US$ 1 trillion ‘toxic debt’ in German financial system (Blakenburg &
Parma 2009, p. 532). It means that this problem exist in all Western economy, and its impact
was also experienced by Asian and African economic. It is not an exageration to conclude
that there is something terribly wrong in current system.
People want change. Regulators have to prevent this crisis from happening again.
There was a shift of business paradigm from free market and minimum regulation to control
of law (Davis 2011). New regulations were introduced. One of the changes is new accounting
standards.
There are three main topics and changes covered in IFRS 9. These three topics are
business model view in classification of financial assets and liabilities, forward-looking
impairment model, and improved hedge accounting. There is also additional topic about
treatment for profit and loss because of changes in entities’ own credit risk.
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financial instruments increase significantly, entities also have to recognise full lifetime
expected credit losses (International Accounting Standard Board 2014).
An improvement was made in hedge accounting. IFRS 9 stated that hedge accounting
is applied to all kinds of risk management performed by company. Hedging for non-financial
items are included in new accounting standard. An example is fuel hedging performed by
airlines company.
Other topic covered by IFRS 9 is treatment for profit and loss because of changes in
entities’ own credit risk. According to IFRS 9, all gain or loss obtained by company because
of changes in its own credit risk will be stated in other comprehensive income (OCI), instead
of profit and loss (International Accounting Standard Board 2014).
Iatridis (2010) used two indicators of financial quality in his research. First quality is
earning management. High quality financial statements should be free from possible earning
management. Accounting standards should be designed to prevent management from
manipulating company’s performance. Second quality is value relevance. Value relevance
can be defined as the ability of accounting measures to explain a company’s economic value,
reflected by its share price (Hung & Subramanyam 2007, p. 639). Hung & Subramanyam
(2007) explained that there are two accounting measure used to measure company’s market
value. They are book value and net income.
This paper would review IFRS 9 to find whether the standard can fulfill several
relevant indicators of high quality financial statements; (1) financial statement should be free
from earning management, (2) accounting number stated in financial statement should be
able to explain company’s market value and economic performance.
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instrument from trading category to held-to-maturity. This reclassification was intended to
avoid recognising loss because of market value decline. IFRS 9 will greatly reduce earning
management by financial assets reclassification and other similar practices.
IFRS 9 also introduced new impairment model and rules. One of main changes in the
new rule is the effect of collateral to credit risk assesment. According to IFRS 9, collateral
attached to financial instruments should not affect credit risk for the financial instruments.
The credit risk assessment for the financial instruments should be free from consideration of
collaterals. This rules simplify credit risk assessment and provide relief to entities which
hold many financial instruments, such as financial insitutions (PwC 2014). This rule reduce
complexity of credit risk assement. When crisis happened or credit risk for certain
instrument increase, companies can not decide low credit risk because there are collaterals
attached to these financial instruments. Additional assesment and judgement for value and
risk of collateral is not necessary. The assessment is more straightforward. This rule reduce
earning management opportunities for credit risk.
However, new problem can rise because of the new classification requirements
described in IFRS 9. According to IFRS 9, financial instruments are recognised based on the
character of cash flow received. If the the cash flow received is solely payments of principals
and interest (SPPI), the financial instrument will be assesed further for its classification.
However, if the finacial instruments do not pass as SPPI, it will be automaticaly recognised
in fair value through profit and loss (FVPL). There are many hybrid financial instruments
as results of financial engineering. Sometimes, it requires difficult assessment and judgement
to define whether the received cash flow is SPPI or not. Different with previous standard,
IFRS 9 put FVPL classification as residual category (PwC 2014). If a company wants to put
its financial instruments as FVPL, it can simply engineer the financial instrument for failing
the requirements of SPPI. This rule bring new possibilities and methods to manipulate profit
and loss statements.
Value Relevance
IFRS 9 bring many improvements to hedge accounting. New standard accomodate
hedging accounting for non-financial items. Airlines companies are allowed to use hedge
accounting for fuel hedging. Other companies are also allowed to use this standard for other
commodities hedging. It means risk management performed by management will be more
accurately reflected in financial statements, both in balance sheets and income statements.
Forward-looking impairment model is a new concept introduced in IFRS 9. This
standard requires companies to recognise 12-month estimated credit loss when they
recognise financial instruments. They will have to recognise both possible credit lost and
provision. Financial instruments risk and possible loss of these instruments will be reflected
more accurately in financial statements.
IFRS 9 also address one of the major problem faced in Global Financial Crisis; gain
from changes of credit risk. During Global Financial Crisis, many companies have liquidity
problems and their credit rate decreased. Because of changes in their own credit risk, the
amount they owed to other companies which hold their debt instrument was decreased, too.
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This difference was recorded as gain. This treatment was greatly disliked by both investors
and regulators. IFRS 9 stated that gain and loss because of changes in company’s own credit
risk should be recorded as in other comprehensive income instead of profit and loss. This
new requirement will reduce volatility of company’s income. Profit and loss statement will
also reflect company’s business and economic condition more accurately.
However, there are several new problems which may rise from IFRS 9. IFRS 9
introduced business-model view as classification guideliness. IFRS 9 assumed that every
entity will only have one main objective. However, it is possible for entitiy to have two
business model. It can concentrate on both trading financial instruments and keep some other
instruments until maturity (PwC 2014). If IFRS 9 is fully implemented, company will have
to choose one kind of business model for accounting treatment when there is other business
model applicable for the entity. Financial statements will not fully explain the entity true
business operation. This is a possible problem for value relevance.
This business-model view classification also bring another question. Different
business model might have similar financial instrument, such as government bond. Consider
the following situation. Division A is a trading division. Most of the financial instruments
kept by the division will be resold to market. However, it also hold some government bonds
as part of diversification portfolio and this bond will be hold until maturity. Division B is an
investment division which concentrate on long-term financial instruments. Most of
instruments it helds will be kept until maturity. It also held some government bonds. This
condition will create complicated situation for IFRS 9. According to IFRS 9, all financial
instruments held by Division A should be recorded as fair value through profit or loss,
despite some of them will be held until maturity. The amount stated in financial statements
will be inaccurate and do not reflect company’s true objective for the financial instruments.
It wil also create inconsistency in accounting treatment.
Conclusion
IASB clearly consider Global Financial Crisis when developing this standard. IFRS
9 have its merits and solve some serious problems. However, these new standards also have
its own flaws and even create possibilities for new problems. This paper conclude that
despite its obvious merits, IFRS 9 does not greatly affect quality of financial statements. It
addressed problems in Global Financial Crisis but it might be not that usefull in general
situations. It also does not consider other problems which might give birth to different kinds
of crisis in future.
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Reference List
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