Financial reporting has a responsibility to communicate the economic condition and functioning of an enterprise. This has to be accurate, reliable and comply by the accounting standards. Effective financial reporting is essential in maintaining confidence in an economy and encouraging investors to invest.
Towards the end of 2008, the financial sector across the world was becoming increasingly unstable. Lehman Brothers had been declared bankrupt, Various allegations towards accounting standards have been made in relation to the financial crisis.
A lot of banks worldwide valued most of their financial assets at historic
cost, the cost at which the assets were initially bought at. These figures
were not adjusted to the current market values, and therefore were over
estimated on the financial accounts.
The ‘incurred loss model,’ was also heavily criticised. This model required only those losses
to be recorded which would have a damaging result on future cash flows. The damaging
result would have to be reliably estimated. This model did not permit the effects of future
losses to be acknowledged, which was one of the reasons why losses were being severely
Had these banks valued their financial assets at fair-value cost, then the
accounts of the companies would have been giving a more realistic
Picture of profits & losses, and maybe the crisis would have been
Recognised earlier in time.
Off-balance sheet standards have also been blamed for covering company
losses. Off-balance sheet asset/liabilities are those which are exempt
from appearing on the balance sheet. It has been put forward by the
Financial Crisis Advisory Group that the off-balance sheet standards may
have hidden losses, therefore the overall effect was losses were under
Another allegation made towards accounting standards was the complexity of the IAS 39.
This is the financial instruments recognition and measurement policy, adopted by the
International Accounting Standards Board.
It has been criticised for being far too complex, as different financial
instruments have to valued using different techniques. This has been
stated in the Report of the Financial Crisis Advisory Group:
“Some financial instruments are measured at fair value with changes reflected in earnings;
other instruments are measured at fair value with changes outside of earnings; and still
others are measured on a historic cost basis (amortized cost). The category to which a
particular instrument is assigned is dependant not only on its intrinsic
characteristics but also on the reporting entity’s business model. There are multiple and
inconsistent impairment approaches, complicated rules...