THE IMAGE PRESENTED BY FINANCIAL STATEMENTS INFLUENCES THE ANALYSIS OF ECONOMIC DATA AND TRANSACTIONAL EXCHANGES
No longer used as a reference for monetary valuation, and with gold ranked at the front, precious metals represent only a fraction of contemporary currency instruments, pegged at less than $1 trillion in commodity market-defined metal value – compared with an annual global world GDP of $73.9 trillion (2013 source IMF). As already stated, the nominal values stamped on the face of coins, printed on bills issued by central banks and shown on private instruments (notes, cheques, etc.) are now associated with accounting standards that standardize their recognition and relative numerical value denominations.
The role of accounting, as well as the worldwide corporate-centred enterprise of issuing bank financials and current account statements, has reached the scale of major trading economies. Today's monetary instruments and virtual money constitute the only remaining observable image of currency expression, raising the question of the required stability of the monetary unit being used (besides, in South America, inflation accounting to address the high inflation context was never really developed and has never been shown to be a realistic answer to the negative effects volatile currencies have on the economy). As such, individuals, as well as enterprises and corporations, can only comprehend their capacity to trade by using books that record nominal values corresponding to the “price” of transactions. Ledgers showing these transactional exchanges and their prices constitute decisive monetary and financial evidence – the balances depicted and reflecting the occurrence and results of deposits, loans, revenues, expenditures and withdrawals serve to determine the owner's capabilities to collect or withdraw money.
Other major operational consequences have resulted recently from the generalization of the following accounting rules:
■ Fair value. Fair value is defined 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 (i.e. an exit price)” (extract from IFRS Foundation, technical summary) on IFRS 13 (not yet fully adopted and delayed for full implementation, if ever, until 2017). The fair value standard, when applicable, obliges the replacement of historical value by “fair value” grounded on a market-based measurement referential. As a result, an entity's intention to hold an asset or to settle or otherwise fulfil a liability is not relevant when measuring fair value.[1] Consequently, a change in value for an already posted transaction (for instance representing a receivable, a debt or other assets) will generate uncertainty as regards a resulting determination of balances (see our previous comments on the double-posting rule and accounting identity). In theory, if recorded as directed for financial instruments using the fair value[2] standard in the P&L account, either a profit or loss will be generated (depending on whether a rise or decline of value is involved).
■ Balancing. A very important topic is the offset of hedging instruments or debit balances from credit balances of similar nature, or reverse. This is, in Europe, the topic of IFRS 7, which has been applicable since January 1, 2013, and the revised IFRS 32. Simply because of the fair valuation standard now appraising counterparty risk, and the fact that the valuation methodology may differ and follow three different patterns depending on whether a reference fluid market exists (level one method), some markets exist that may be used as reference for valuation (level two method) or no market exists (and a modelling approach should be found – level three method), there is a problem in balancing. Balancing is an attraction for a lot of institutions, especially the financial ones submitted to prudential regulations, as it will change their ratios and balance sheet image as well as their profitability ratios. This topic is still under fierce discussion and the only exit found was to make detailed exhibits compulsory (IFRS 13). It is a major topic for the determination of M5 and M6. Moreover, any change in value should logically generate a corresponding equivalent potential gain or loss in the counterparty's section of his own balance sheet. Even disputed by standard setters, the issue at stake is to decide if changes in value are to be posted as a gain or loss in the P & L, or directly posted on the balance sheet as a change in equity. Nevertheless with IFRS 9 being adopted[3] one of the major dyfunctions of the fair value standard, the total lack of transparency about what in the P & L is or not deriving from value variations and what comes from transactions as well as the reconciliation with the equity variation over an accounting period has been fixed. Through “other comprehensive income” value variations may not go directly into the profits or losses but be recycled later on after closings. Therefore variation in net equity for a period can be reconciled with profit and losses and nature of the value variations in outstanding assets and liabilities.
■ Impairment tests. Both international standards setters adopted the concept of impairment testing. The methodologies to assess values for both non-financial and financial assets are well developed when not referring to financial instruments as we define them (see Chapter 5). However, for financial instruments, if they do not fall under fair market, the topic is still disputed.
In both situations, if the change involves a decline in value, then – even if not posted as losses – it will trigger a notion in the analyst's mind that the indebted entity may not be able to repay its debts (if profits are insufficient to cover the unrealized loss). The idea that a debt may be worth less than its nominal commitment if financially demonstrated is the admittance at macroeconomic level when spread that the financial system has failed and that the ultimate holder of the debt will, when it has matured, not be reimbursed. It also carries the underlying idea that at such a level the government or the central bank will have to pay for the default and the currency to be wiped off as public debt. Either it will be a tax payers' expense or a monetary collapse or sequences of both. Anyway at the end of a cycle when the level of debt is too high compared with potential flows it means that the debts won't be claimable any longer especially its central (central bank and governmental) component and by interconnection with holders (for instance, long term insurance savings and banking reserves to comply with surveillance regulation) the entire system. It is a redistribution process threatening private property showing a kind of collusion between standard accounting setters and investors' powers. As the holders may not be knowledgeable and the reciprocity rule in accounting translating the law that a debtor owes the same amount as the corresponding creditor it is unfair. The matters will be out before the collapse if macroeconomic imbalances are not fixed. The change of values on books to market values is just misleading about the commitments. In the absence of inflation it is a mere lie. The knowledge of the discrepancy on the balance sheets between nominal values for debts or historical values for equity and the market values is, of course, necessary. It is a mark-up of the monetary risks. We will see that in Chapter 8.
Almost all monetary flow transactions are now processed through electronic exchanges, and their evidentiary proof is confirmed by book postings that in turn characterize the ownership rights of each individual or enterprise. Notwithstanding, private individuals are not expected to maintain books and records that are sensitive to changes caused by electronic exchanges; whereas financial statements that are delivered to individuals (bank statements, card statements, automatic wire transfers and withholdings, etc.) are expected to remain relatively stable in the face of outside market-driven change caused by the flow of monetary transactions.
Indisputably a transnational financial sector player in its present-day scope, accounting has become the universal language of currency and monetary exchange. It should not be falsified, it should be recognizable, and financial statements resulting from its standardized implementation should be comparable across markets, financial institutions, international monetary systems, regional economies and national borders. Serious and widespread doubt as to the quality of bank statements or financial statements would trigger immediate defiance from concerned economic agents, and could have a devastating effect on both transactional dynamics and economic stability. Amplifying even limited doubts about the soundness of the financial sector or either micro- or macroeconomic conditions, random financial rumours can develop without control on financial markets – a major origin point for refinancing of our economies. With rumours driving any market, serious agents would abstain from participation, leading to suppression of monetary velocity in conjunction with freezing of transactional flow and subsequent risk of recession or full-scale participatory regression from economic participation. Constituting a potential direct threat to social stability, such potential scenarios remain a major challenge for modem economies on the world stage. Ultimately, however, when all is said and done, the recording and analysis of financial statements has emerged as the primary factor determining whether today's financial transactions will be conducted and successfully closed. It is unlikely that such a determination will be impacted by the opinion or intervention of rating agencies.
- [1] Extract from IFRS Foundation, summary of IFRS 13 release.
- [2] See IFRS 13 measurement to apply to IFRS that require or permit fair value measurements or disclosures, and provide a single IFRS framework for measuring fair value and requiring disclosures about fair value measurement. IFRS 13 does not apply to share-based payment transactions, leasing transactions and when impairment is the standard to apply. IFRS 39, the standard which will be replaced by now adopted IFRS 9, addresses the matter of classification of financial instruments. The standard defines fair value as the concept of cost price notion at the time of the transaction or measurement. The concept of fair value that causes changes in value for many posted financial instruments has been adopted by both international standards setters; the FASB and IASB, however, totally disagree on the implementation and model to be used by private-sector companies (IAS no. 9). The new standard provides for an exemption to instruments to be kept until maturation that may be valued at amortized cost (to be recorded in the “banking book” as opposed to the "trading book" for trading transactions). Both institutions differ on when to account for loss expectancy (from the beginning for FASB's current position) or when the solvency status of the issuer changes (loss given approach); IASB and Basel Ill's current position with a prospective reserve for losses within the 12 months following closing. The new standard also adds a new category of portfolios; the ones that are to be hold until maturity but might be sold as they are to be "reserve of liquidities”. For implicitly or legally being guaranteed by governments, regulated loans are excluded from the reserve determination system provided. This system is based on the accepted classification between performing, underperforming, nonperforming originally determined by the number of days there has been a default. The related amounts are important (may be 900 billion) but far less than the Fanny May and Freddy Mac US Agencies amounts of guarantees ranking in trillion that are different but in essence similar.
- [3] As of May 2014 waiting to be endorsed by the European Commission.
