IFRS outlook
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The accounting profession responds to the credit crisis
Introduction
The last few weeks have seen significant developments in the global credit crisis, which had its origins in the large-scale securitisation of United States (US) sub-prime mortgages. One of the issues has been finding a reliable basis for the valuation of financial instruments as market liquidity disappeared. Alternative valuation techniques had to be applied in place of quoted prices from liquid markets. And when comparable transactions are available, some have questioned whether these are representative of normal, active markets, or of distressed sales and, therefore, whether these could be ignored for valuation purposes under US Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). As a result, there is uncertainty whether the ongoing large quarterly write-downs by many major banks resulted from continued market declines, or the valuation techniquesused, or both.
Following the rescue of Northern Rock in the UK in late 2007 and Bear Sterns in the US earlier this year, and the bankruptcy of Lehman Brothers, many feared a total collapse of the banking sector. Since then, the list of institutions requiring some kind of rescue around the world has grown.
On 3 October 2008, the US responded with the controversial Emergency Economic Stabilization Act of 2008 which authorised the US Treasury Department to establish and manage a Troubled Assets Relief Plan (TARP) to purchase troubled assets from the US banks by using US$700bn of government funds. The European G8 leaders met on 4 October 2008 to consider further action, the UK government is to recapitalise the UK banks using public funds, and a number of other European governments took steps to fully guarantee retail savings.
During these deliberations some politicians and commentators have suggested that fair value accounting under US GAAP and IFRS has triggered the crisis, or at least exacerbated it, and that temporary relief from its rigours should be provided as part of the response to the continuing crisis.
Call to align IFRS with US GAAP
Prior to the 13 October amendment (refer to discussion below), IAS 39 Financial Instruments: Recognition and Measurement did not permit reclassification of financial instruments into or out of fair value through profit or loss. European G8 leaders have called for the same rules to reclassify financial instruments to be applied to European entities as are applied under US GAAP. In particular, FAS 65 Accounting for Certain Mortgage Banking Activities allows loans (one class of financial instruments) that were classified as held for sale (where they are carried at the lower of cost or market value) to be reclassified to a category to be measured at amortised cost, if management intention changes with respect to these loans. However, for the remaining categories of financial instruments, other US GAAP standards apply where transfers out of a held for trading category (where they are carried at fair value through profit or loss) can be reclassified only in rare circumstances.
Response from the accounting profession
On 3 October 2008 the IASB announced a summary of the current status of their responses to the credit crisis and their next steps. The IASB stated that they are closely monitoring developments in the US and other jurisdictions. In particular, the IASB committed to undertake the following:
- Consistency of fair value measurement guidance between IFRS and US GAAP: It was noted that earlier this year, the IASB had convened an Expert Advisory Panel to provide guidance on measuring and disclosing the fair value of financial instruments in markets that are no longer active. Refer to the September 2008 edition of IFRS outlook for more information. The IASB will continue to ensure that any IFRS guidance is consistent with the US GAAP clarifying guidance recently issued by the SEC and the FASB.
- Consider possible impact of the US Emergency Economic Stabilization Act of 2008 (the Act) and other similar programmes: Work with the FASB to develop a common approach to the valuation of any financial assets and liabilities purchased under the Act and any similar programmes.
- Immediate consideration of reclassification: Immediately consider the suitability of adopting certain provisions in US GAAP which permit reclassification, in certain circumstances, of financial instruments into and out of categories fair valued through profit or loss (refer to discussions below).
- Participate in any study on the impact of accounting in the credit crisis: The IASB will continue to consider principles for accounting for financial instruments and will participate in any study. This would be in addition to a Discussion Paper issued earlier this year by the IASB, Reducing Complexity in Reporting Financial Instruments, as a starting point to consider replacing IAS 39.
On 13 October 2008, the IASB published Amendments to IAS 39 Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures. The amendments to IAS 39 introduce the possibility of reclassifying some financial instruments out of a category carried at fair value, into a category carried at amortised cost. For further information, refer to our Supplement to IFRS outlook Issue 16: Reclassification of financial assets on this topic.
Conclusion
These recent events have renewed the debate about the use of fair values for accounting for financial instruments. The US Congress has called for the SEC to conduct a study about the use of fair value, and the European Commission has called for discussions about the requirements of IAS 39. It is therefore quite possible that we may see further changes in accounting for financial instruments.
