Standard setters: Please don’t deflate asset bubbles
Accounting should reflect asset bubbles, market growth trends, volatility and crisis as and when they unfold. The timeliness of financial information forms the bedrock of market integrity. Frontloading of losses (ie, prudence) does not represent reality, nor does it ensure the solvency of the underlying businesses.
You might also be interested in
Replies (7)
Please login or register to join the discussion.
"Information about business solvency could be best provided by credit rating agencies"
Afraid post 2008 I am not convinced, their ability to rate the various say CDO tranches was not stunning. (Or maybe it was stunning, just not in a good way, more akin to being hit over the head by a very large object falling from a great height)
I appreciate the article but in essence I think it boils down to the purpose of accounts and their users.
When you get a packet of cold tablets it says on the box do not take more than x in a day etc, this x is never the real limit , it is the likely prudent limit (or very prudent limit), we accept this as it is to protect the user, why not similar re accounts?
In accounts we do have similar, those like myself flocking in and out the stockmarket try to make purchase/sale decisions based in part on reported performance, the market does not want a load of widows and orphans wiped out so we tolerate prudence as a partial protection, this may impact economic performance, it may sway business investment decisions, but it gives a small downside safety measure to these users of accounts- should this not be considered reasonable?
What you possibly are seeking is the Holy Grail of Accountancy, accounts that do everything.
These debates raged through the 1960s, 1970s and into the 1980s, I spent happy hours at university in the mid 1980s considering various models/ variants of revaluation in accounting, SSAP16 and other variants of same within academic articles (Thank you Professor Weetman, you were an excellent teacher of accounting thought as against mere execution) , but short of producing myriad different sets of statutory financial data (and we pretty much have that already with EPS measurement) I do not believe you can get all desired results .
The risk to me seems to be that once you decide on multiple reporting approaches you will have a dogfight re which set becomes the lead actor and which the supporting actors which may not end where the academics want it to, the market, not them,will then decide which reporting metrics they follow and which they more ignore (cast into the back of the cupboard) which may have unfortunate consequences.
Thanks for reading and commenting on my article.
Credit Rating Agencies or separate prudential regulatory disclosures.
In regards to your comment around 'prudence', I would like all users to have financial reporting providing them with current values and then a separate prudential disclosure which provides them with the most conservative view. I believe this will enhance transparency for all investors and provide them with a better visibility around measurement uncertainty.
My concern is that prudential regulators are influencing changes in reporting from financial stability perspective. They are welcome to implement these policies but these should be independent of accounting in a separate section.
Hope this helps.
What are current values?
We studied a fair number of approaches to current cost accounting (in effect current values) at university, it was studied through the prism of the just past 1970s and its high inflation distorting reporting, whilst the individual approaches now escape me re detail the fact that there were lots of variants, and each impacted reporting in different ways, I do still recall.
For instance once you start are you revaluing stock at each balance sheet, dropping prudent lower of cost and NRV, are you happy for the impact of this adjusting through the I & E or do you want a reserves adjustment, what about plant, do you want to value at replacement value re it or current realisable, are you happy with impact on depreciation in I & E based on these different bases of asset valuation etc.
I am maybe old and cynical (not sure I need the maybe) but I rather like Dear Prudence (I even miss SSAP2) and think accounting would be poorer without her, I am also not fully convinced dual (or triple if we are possibly to include carbon) reporting is the correct way forward.
I do recall one book that gave a number of perspectives was Scapens, "Accounting in an Inflationary Environment" , must now see if I can pick up a copy as I promised myself that when I retired I would keep the gears ticking by actually doing so reading re accounting theory .
Please let me know you contact details - I am very interested to have a chat with you to discuss your points.
In regards to 'revaluing stock ' or 'revaluing PPE' at each balance sheet - as an investor - I would like to know both upside or downside swings, whatever the case maybe. What goes in measurment and what goes in disclosure is a separate discussion. And, I am very happy to chat about this as well.
Hope this helps.
I think the key sentence I disagree with is this one "Standard-setters should avoid artificially deflating asset bubbles in financial reporting, which they did not create, and thus cannot remedy. "
If we define a bubble as an unsustainably high market valuation of an asset, standard setters aren't actually trying to deflate those asset bubbles. As you rightly say, that's not their calling. All standard setters are looking to do is to ensure assets are reported at a more objectively correct valuation.
Thanks for reading and commenting on my article.
I think 'objectively correct valuation' has to be based on a standard. Those standards are set by IVSC. You are welcome to disagree and provide them feedback if you believe they need improvement.
Nevertheless, the key quesiton is should they faithfully and fairly represent what is happening in the market or should be restrained based on a prudent filter. This is where I am making a point that investors would find both set of information helpful but these two set of information should be kept separate in annual reports.
Hope this helps.