The G20, in its communique at the end of the Summit earlier this month, called for “significant progress towards a single set of high quality global accounting standards.”
Both the International Accounting Standards Board (IASB) and the United States’ Financial Accounting Standards Board (FASB) have responded with great promptness — with a minor difference. Instead of the “high quality accounting standards” demanded by the G20, they are watering down the standards in response to pressure from Brussels and Washington, respectively.
The principal aim seems to be to give a great deal of “flexibility”, particularly to banks, in terms of the fair value accounting standards.
The IASB set the ball rolling last October. To quote form its press statement at that time, “[The Expert Advisory] Panel [the body that has issued educational guidance related to fair value measurement under IFRSs] agreed to emphasise that the objective of a fair value measurement is the price at which an orderly transaction would take place between market participants on the measurement date, not the price that would be achieved in a forced liquidation or distress sale. The Panel reaffirmed that such transactions should not be considered in a fair value measurement, whilst also noting that even in times of market dislocation not all market activity arises from forced liquidations or distress sales.”
The Panel also agreed to emphasise existing guidance within International Financial Reporting Standards (IFRSs) that using the entity’s own assumptions about future cash flows and appropriately risk-adjusted discount rates is acceptable when relevant observable inputs are not available.”
More recently, the FASB Issued Final Staff Positions (FSPs) to Improve Guidance and Disclosures on Fair Value Measurements and Impairment on April 9, and IASB is likely to come out with its revised version later this week.
Without going into too many technicalities, the end result of the changes is that banks would be able to value more of their holdings in the trading book, using their own models rather than market prices. As the Financial Times commented editorially, “the move is part of a worrying pattern of hasty changes in valuation rules that leave companies freer to use their own numbers rather than market prices”. Tomorrow’s Enrons would certainly be happy!
Rather than diluting standards under political pressure, both the bodies would do well to simplify their rules which have become far too complex. (To quote a personal example, I am still struggling with drawing up a policy for using derivatives as cash flow hedges for a bank’s asset: liability management, which can comply with the hedging prescriptions of IAS 39/AS 30.) As Simon Nixon wrote recently in The Wall Street Journal: “The IASB alone has 22 different ways of valuing a financial asset, based on four different categories and seven different impairment methods.”!
In this era of globalisation, we of course cannot afford to be left behind. Through a Gazette Notification, the government has, in effect, suspended up to 2011-12 the mark-to-market provisions of AS 11 in relation to “The Effects of Changes in Foreign Exchange Rates” on the assets and liabilities in foreign currency.
One major difference with both IASB and FASB: Our Institute of Chartered Accountants of India (ICAI) resisted pressure to dilute the provisions, recorded its protest, and now the government itself has had to make the changes; the lobbies must obviously have been strong.
There seems to be another complication in our case; the Supreme Court, earlier this month, decided about the tax deductibility of forex losses, as reported in this paper on April 9th. However, one would need to get a copy of the judgment to understand the full implications.
Now that translation gains/losses on foreign currency loans used to finance fixed assets are to be capitalised, this raises one basic issue: How far is the asset value inflated because of a depreciation of the domestic currency “true and fair”, the mantra auditors are required to sign?
In an era when exchange rate changes basically reflected inflation differentials, there may have been some logic to this. But in an era of floating exchange rates, erratic movements and rapid technological change, is the logic still valid?
Hedging
Recently, a company statement claimed, “The losses were due to … long-term hedging instruments that were bought to reduce the interest costs for the company’s loans.” (Incidentally, if they were genuine hedges, there should be a corresponding gain on the underlying exposure.)
This is, of course, but one instance of how the concept of hedging has been completely misunderstood by corporate managements — and misused by the banking system, who should know better, to sell all kinds of speculative derivatives as “hedges”. (Did the regulator wink, or did not know what was going on?)
In fact, hedging can never be a tool for making money either through reducing cost or increasing earnings. A hedge is actually “a trade designed to reduce risk … goal of a hedging program is to reduce the risk, not to increase expected profits.” (“Risk Management in Financial Institutions” John Hull).
To make money, you need to speculate, take risks, not reduce them by hedging! Confusing the two is dangerous!
