DEBATING THEME

The main request in recession conditions is having a good cash situation. So, by practicing cash accounting in the mean time with the accrual one is insurance for crisis periods.

In this context, we mustn’t ignore the engagement accounting which offer an economical view for a medium and long term, but once appeared signs of the decline phase those terms should reduce, because now only cash are considered richness for a firm or economy.

In the last six month, since the start of present crisis it is demonstrated that for those conditions using only the accruals is not a solution as long as treasury is that express the financial power of a company.

As long as the engagement accounting expresses only the present incomes and expenses and not the cash inflow – outflow, which are paid or collected by the company, we recommend to record operations basing also on the cash accounting even it isn’t reported, for avoiding the deep dropping.

We must give more attention to cash situation and that doesn’t mean to ignore the accruals because it help us to know the future collects and payments from the past and present records.

So, a good cash situation doesn’t express that a depression will not appear but its consequences may be decreased as possible it is.

Another accounting aspect that it appears in crisis conditions is fair value or mark to market as it is known in the specialty theory. It is quite known that fair value for accounting is an important cause of the world-wide financial crisis during the ‘80s financial crisis. The application of this value on accounting first of the other problems would have been part of the disastrous.

A FASB defense its fair value accounting theory, claiming that “it reflects losses that have been incurred, it does not cause losses.” But in a big financial bust, with a downward spiral of panic and illiquidity, this is manifestly false: accounting has real world effects. The effects of this kind of value in a market panic are why almost all banking is reserved on it.

The FASB sustainers of the fair value accounting say that they are insisting on “the facts” of market prices. Even though they admit that in many cases there is no active market or no market, and this panicked conditions can result in sale prices that will get irrational. So, in a period of disequilibrium and discontinuity, like panic, it adds more problems being worse.

There are some specialists that say that should be suspended the fair value accounting, and others propose that it must be reformed.

For this, is to make a balance sheets and income statements before the fair value days, and after that, a separate fair value balance sheet using the market prices and estimates of what they might obtain in the correspondent market.

Current application of IFRS on fair value accounting was not in fact the first of the causes of the current financial crisis, but was a factor in its occurrence by increasing its impact. The starting point of the current crisis was the dynamic economic events of the past few years.

The application of fair value measurements in these conditions resulted in financial instruments and real estate, in particular, being valued higher for increasing their profitability.

This effect is more pronounced if the reported fair values are determined on the basis of non-realized price changes on markets with little liquidity.

There are some specialists like Wolfgang Sawazki, Head of Research at Sal. Oppenheim who thinks that financial market crisis will not be over for quite some time: “We are currently in the middle of a financial crisis, which has resulted in impairment losses reported by financial institutions in the region of 500 billion dollars”.

These unwished effects of IFRS fair value accounting added to the pro-cyclical supervisory law appear not to be taken into account by the authorities, and other market players (shareholders).

Regarding this aspect, I was myself a sustainer of such evaluation, but we have to practice it only when it is required, and not in excess. Let’s take an example when it is recommended and another one when it gets for supra-evaluating some assets.

So we have to measure the risks in accounting, trying to develop a comparison between historical cost and fair value consequences.

Taking into account that now there are some entities which are using the historical cost for evaluate assets / liabilities achieved in ’90 (especially in the public romaine institutes) at thousand old lei (ROL) we may say it doesn’t reflect an economic reality.

We know that every economic operation (goods acquisitions or services or investment / financing activity, or creating a debt) is generating a plus or minus value and recording and maintaining this measure is not a solution to express the real economy.

Another factor is the rate of inflation. Consider it as a passive monthly monetary depreciation of the economic assets (and liabilities) it has some influences for the financial statement when it has big figures.

Let’s take a look over the next situation. It is presenting the rate of inflation evolution for eighteen years in Romania.

Table 1:The rate of inflation for 1991 – 2008 in Romania

ANUL 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 RATA

INFLATIE

I-% 170.2 210.4 256.1 136.7 32.3 38.8 154.8 59.1 45.8 45.7 34.5 22.5 15.3 11.9 9 6.56 4.84 7.85

(Source : http ://www.insse.ro/)

So, as it appears from this evolution, is recommended to update the value (generally the historical cost) by applying for example the fair values according to the markets requests. So, we mustn’t abolish it because there are times when is recommended to use it for bring some asset’s values to the real. In spite of these reasons of sustaining the fair value there exist also negative consequences when it is used.

If we take into consideration just the real estate we realize that the market prices have touched enormous and unjustified values, driving to an inexistent richness of global economy, like 80 years ago.

Also, we must remark in the financial and capital market where some companies were increasing their capital by issuance of new shares with bigger values as market was requesting.

We mustn’t consider that the fair value may resolve any evaluation problems for the financial statements, but we have to say that choosing a model we must take in account the impact on the results and the risk management required by using one of them.

This has direct consequences for investors, banks, banking supervisors and the accounting standard makers, for reduce the risks of financial and economic crises in the future.

From some specialists point of view accounting should continue to be based on fair values since it remains the most convincingly method of representing the economic situation.

IASB should restructure the way that results are reported, regarding the performance reporting by fair value accounting of financial liabilities which is not good in times of crisis.

For investors, IFRS fair value accounting means that overstatements on the equities and securities markets are increasing, valuations are being revised downwards and that historically developed measurement methods are no longer used.

“The focus should be more clearly on normalized profits and cash flow factors,” advises Dr. Sawazki. Investors should increasingly analyze all asset changes in financials – including equity impacts “looking at profit reported as insufficient”. He continued that the financial crisis will enter into a new phase during the coming months.

“The crisis has reached its peak but the pain is growing”

In such period of crisis the stabilization efforts by governments and central banks are essential, as is regulatory intervention by the supervisory authorities and standard setters.

After the economic decline of the 2008 financial crises, the inevitable search for causes and cures has started. Politicians, economists and all observers have presented critiques of the manner that business was practiced in credit, capital and insurance markets, and the ineffectiveness of government regulation of certain financial products, transactions and players in those markets.

There are few arguments that for example fair value accounting caused part of the economic crises, and inflate the credit bubble and increased destructive effects.

FAS 157 is an accounting standard issued in September 2006 with the objective of defining fair value, presenting a framework for measuring it. It was intended to achieve greater consistency and comparability in fair value measurements and to provide better information, and more transparency. It is defines as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”

So, the standard requires that assets and liabilities must be valued at a price in a hypothetical market transaction based upon the assumptions of a current market participant who is independent and able to transact.

In response to the concerns over the application of mark-to-market accounting, on September, 2008 the SEC and FASB issued a joint clarification regarding the implementation of it. So, on October 10, 2008 is presented the FASB Staff Position 157-3, which offered an illustrative example of how the fair value of a financial asset is to be determined when the market for such asset is inactive.

We think that financial reporting implications of the credit crisis will continue to be a main concern and that accounting issues will continue to require supervision by special committees.

It is recommended a professional debate and companies must continue to discuss on some accounting standards.

4. CONCLUSION

Accounting is too vital for the economy and everyone's finances to have been left to the experts, whether they are professors, auditors, analysts, investment bankers, or any international committees. We must accord more attention to this aspect because even if accounting is a theory, it is also a practice and was demonstrate that has it own influences in the recession period.

Present article research is not a view of the depression literature and not a theory, but it is a description of some events and issues of interest, regarding some accounting aspects on economical and financial crisis.

It was expressed that a strong cash situation for a company and also economy is an advantage in such a period of crisis. Also it was discuss the irrational using of fair value according to the market requests when that market is not so well formed.

So, that, accounting doesn’t make any exception of economical decline process. It is a part of it. But we don’t have to consider that crisis is generated just from it, being other factors that contribute and make it inevitable. So, we must learn from the history for avoiding some negative aspects and be prepare for those that are new to eliminate also.

REFERENCES

1. Ludwic von Mises Institute - Jesus Huerta de Soto, Financial Crisis: The Failure of Accounting Reform, April, 2009 - http://mises.org/story/3301 - available on-line;

2. Alex J. Pollock, House Committee on Financial Services (Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises), Reform of "Fair Value" Accounting - March, 2009 - http://www.aei.org/publications - available on-line;

3. Richard Spinogatti and Robert McGrail, Financial Crisis - Law Firms Mark-To-Market Accounting, Proskauer Rose LLP;

4. Sal. Oppenheim in cooperation with prof. Bernhard Pellens - Fair value accounting intensifies the crisis – study warns of need for quick reform – study 2008;