Thursday, September 25, 2008

Crisis Spurs "Special Meeting" for IASB Officials

Sources:, "IASB Calls Special Credit-Crisis Confab"; International Accounting Standards Committee Foundation, "Technical Summary-IFRS 7 Financial Instruments: Disclosures"; International Financial Reporting Standard 7; ACCA, "IAS 39 Financial Instruments"; CUNA Mutual Group Executive Benefits Program, Frequently Asked Questions

On October 2nd, the International Accounting Standards Board (IASB) will be holding an unprecedented "special meeting" to discuss proposed amendments to International Financial Reporting Standard 7 (IFRS 7). IFRS 7 currently requires companies to disclose information regarding, first, how important their financial instruments are to their financial position, and second, the risks that their financial instruments entail and how companies manage those risks. Financial instruments are contracts, such as loans and investments, whereby parties exchange assets and liabilites. The disclosure requirements set forth in IFRS 7 are meant to ensure that companies clearly communicate to investors the risks that will arise out of prospective transactions.

At the October 2nd meeting, IASB officials will specifically discuss whether to amend IFRS 7 to prohibit fair-value accounting. Fair-value accounting, also known as mark-to-market accounting, is the practice of determining the value of a financial istrument by looking at what the instrument is worth on the market at the time of a transaction. Fair-value accounting has been referred to as one of the "lightning rods" that spurred the credit crisis, so the IASB's potential prohibition of the practice is undoubtedly a reaction to the events that have recently taken place.

Supporters of the prohibition against fair-value accounting have suggested that IFRS 7 use banks' estimates of hold-to-maturity prices as replacements for the values that result from fair-value marketing. Hold-to-maturity prices do not reflect fluctuations of the fair value of financial instruments, but are rather reported at amortized cost. Unsurprisingly, banks favor the idea of replacing fair values with hold-to-maturity values, because doing so would give them more power to estimate what instruments are worth without having to take into account fluctuations in the market. Others argue, however, that using hold-to-maturity prices as replacements for fair-value prices would be dangerous to investors who would have to rely on banks' internal estimates of the value of securities. Forcing investors to rely on banks' estimates would shake their confidence and make them less likely to participate in the market.

IASB officials will also discuss off balance-sheet accounting, another so-called "lightning rod" of the credit crisis, during the meeting. Officials will review drafts of proposed standards controlling how parent companies report subsidiaries' results on their balance sheets. These proposed standards specifically address how parent companies report special-purpose and structured-investment vehicles, two items that have played a role in the rise of the credit crisis as well.

While the meeting will be taking place in just a few days, the IASB also hopes to publish the proposed amendments later in the year.

Discussion Questions:

1- The October 2nd meeting is unprecedented. What does the fact that the IASB is holding a "special meeting" tell us about the extent to which the credit crisis has affected the international business community?

2- The choice between preserving fair-value accounting in IFRS 7 and replacing it with hold to maturity values seems to be the choice between what is convenient for investors and what is convenient for banks. Which interest do you think will dominate during the October 2nd meeting?

3- What is so important about reporting a subsidiary company's activities in a parent company's balance sheet? Does transparency in business really lead to more stability, or is there such a thing as "too much information"?

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