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Governance and audit key to good Fair Value Accounting

30 June 2009

Australian companies should ensure they have the appropriate governance and audit processes in place when using Fair Value Accounting as part of the adoption of global financial reporting standards (IFRS), a visiting academic has warned.

Professor Dan Dhaliwal, an expert on Fair Value Accounting who is visiting Deakin University from the University of Arizona, said concerns about the contribution of Fair Value Accounting to the Global Financial Crisis were unfounded.

“Fair Value Accounting has been in place in the United States for many years,” he told seminar participants.

“Financial Accounting Standards Board (FASB) Statement No. 157 (FAS 157), requires companies to record transactions at fair value ie the price that would be received if an asset was sold or the price that would be paid if a liability was transferred in an orderly transaction between buyers and sellers.

“FAS 157 was criticised because it allowed companies to record the value of assets which did not reflect the real value of the securities on offer, leading to the economy-wide decline in asset values seen during 2008.

“In some ways it is difficult to disentangle whether accounting caused the economic reality or merely reflected it. The weight of evidence shows that Fair Value Accounting did not create the Financial Crisis.

“It was bad credit quality and the lack of appropriate corporate governance mechanisms at the firm level along with laxness in the banking regulatory system which created the problems.”

Professor Dhaliwal encouraged companies which engage in asset securitisation to revisit their bonus compensation schemes.

“These companies will want to provide managerial incentives to ensure that asset securitisation deals are profitable to the company over the longer term,” he said.

“They may wish to tie bonus compensation to deal performance rather than current period net income.”

He warned investors to be wary of the amount an underwriter retained of securitised assets.

“Merrill Lynch reportedly was so enamoured with recording the gains from each securitisation, it was willing to retain more and more of each deal, a cardinal sin in underwriting.”

Professor Dhaliwal said banking regulators may wish to compile a risk profile across industry to assess the correlation of risk between firms.

“Finance academics are also proposing that investors may want to see a ‘risk’ balance sheet to supplement the historical cost and fair value balance sheets already used when assessing companies for investment purposes.

“The FASB may also want to identify any perverse incentives created out of any future standards so that corporate governance systems, auditors and regulators can develop industry and firm-specific safeguards to avoid manipulation by managers.”

News facts
  • Concerns about the contribution of Fair Value Accounting to the Global Financial Crisis unfounded
  • The weight of evidence shows that Fair Value Accounting did not create the Crisis
  • Investors may want to see a ‘risk’ balance sheet in future

Media contact

Sandra Kingston
Deakin Media Relations
03 9246 8221 or 0422 005 485
sandra.kingston@deakin.edu.au

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1st July 2009