(The article featured
below is a selection from International
Securities and Financial Reporting Update, which is available to subscribers
of that publication.)
U.K. Regulator Rejects Idea of Using Accounting Standards to Promote
Stability
In an effort to refute the growing global consensus
that financial accounting must change because its pro-cyclicality contributed to
the financial crisis, the U.K. accounting overseer said that people proposing to
amend accounting rules to make them less pro-cyclical must believe that
investors cannot be trusted with the unadjusted numbers produced by the
application of accounting standards. In remarks at the Financial Reporting
Council's annual meeting, CEO Paul Boyle emphasized that it is dangerous to give
accounting an explicit role in promoting financial stability in addition to its
traditional role of providing useful information to investors to inform their
investment decisions.
One may just as well argue that house price statistics
are pro-cyclical, he said, since reports of rising prices drive consumers to
make purchases at higher values, thereby further driving up prices, with reports
of falling prices having the opposite effect. While acknowledging that current
accounting standards need improvement, he urged regulators and policy makers to
assess any proposed changes with a clear understanding of the purposes of
financial accounting.
In that regard, he said that financial accounting
rules and standards are designed to measure the financial performance of a
company in as neutral a way as possible. It is not surprising that banks report
substantial profits during good times and losses during bad times. This is the
job of financial accounting, to reflect the economic cycle, he noted, which is a
good characteristic of a financial measurement system. It is not in the public
interest to adjust the numbers in the interest of financial stability, he said.
Further, the way in which investors will react to
accounting information is not easy to determine in advance since it will be
influenced by a number of variables. Thus, it is not reasonable to ask FASB and
the IASB to predict those reactions or to predict whether those reactions are
good, in making their measurement choices.
Boyle's defense of traditional accounting come against
the backdrop of efforts by U.S., Chinese and EU regulators and policy makers to
lessen the pro-cyclical effect of certain accounting standards. For example, the
Obama Administration's blueprint for reform noted that certain aspects of
accounting standards have had pro-cyclical tendencies, meaning that they have
tended to amplify business cycles, adding that the interpretation and
application of fair value accounting standards during the crisis raised
significant pro-cyclicality concern. Similarly, the Governor of the People's
Bank of China identified fair value accounting as a factor that worked to
exacerbate the financial crisis.
At a meeting of G-20 central bankers, Zhou Xiaochuan
said that the problems of fair value accounting have been exposed by the current
crisis. Governor Zhou recommended implementation of circuit-breakers to stem the
pro-cyclicality caused by mark-to-market and fair value accounting in specific
situations. Axel Weber, President of the Deutsche Bundesbank indicated that
effective reform must also address fair value accounting which, in his view,
amplifies the cyclicality of leverage.
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