Global Financial Crisis & Aasb Conceptual Framework

Part b

It has been claimed that the emergence of global financial crisis (GFC) was mainly attributed by the measurements of the fair value accounting (FVA), therefore we should prohibit the application of the FVA in the accounting measurements and its instrumental role. There are lots of troubles caused by the FVA and this topic has been interested by lots of people. In the following paragraphs, this part is going to critically evaluate and discuss the limitations of the FVA by referring to some research literature, and the details will be elaborated in greater details.

It is claimed by Laux and Leuz (2009) that the GFC happened in the 2008 was mainly because of the subprime home loan mortgages, securitizing of the subprime home loan, and credit swaps of default rate of these subprime home loan in the United States market. Furthermore, the FVA aiming to mark to value of the assets to the market price is also the main contributor of the GFC too.

Arnold (2009) explains that the FVA will take into accounts the market value of the assets as the basis to determine the asset value in the financial position, so as to reflect the most current value of the assets as if they are sold immediately. This can be illustrated by revaluation of the fixed assets, like lands and properties, every quarterly by the listed companies, even if the assets are not actually sold in the market in the coming future. Although the value of the assets can be better reflected in the balance sheets and the share prices of the listed companies can be out-performed if there are positive valuation, there are also a greater fluctuation if the revalued assets do fluctuate a lot. These are the main issues by using the FVA in the accounting practice that value can be better reflected in the financial position and share price of the public companies, the value could also vary unexpected if there is some crisis in the market (Arnold 2009).

The issues of the fair value are especially obvious when there are no clear price of the assets in the market, which can lead to unprecedented low price of the assets. This situation did happened when the prices of the securitized assets related to the backed sub-prime home loan are not available in the market or approached zero, when the confidence of the market is extremely low. The financial institutions holding the above mentioned assets could possibly suffer greater losses, and even more seriously may cause great negative effects on their financial abilities to obtain credit in the market by selling their major securitized assets. This eventually leads to liquidity issues of the financial institutions and also caused the crash in the market (Veron 2008).

Even if there was only a frozen market because of any unexpected events in the markets, such as the declaration of bankruptcy of the Lehman Brothers in the GFC, the price of some assets could possibly be valued below the true value of the assets, because of the FVA to mark the assets to the market price. These also caused some banks to approach insolvency because of valuing their major assets as the lowest liquidated prices, and this also cause another fall of assets of other companies in the global financial market too (Watts 2003).