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The Significance of Accounting in Resolution of the Financial Crisis

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The Great Recession, which began in 2008, had several impacts on the US economy, as well as on other countries of the globe. This led to a financial crisis that was brought by lax regulation in lending mortgages, an ever-increasing house bubble and unsatisfactory banking practices (Linsmeier, 2011). Some incentives introduced in management and some US accounting standards contributed to the crisis. Some people have also blamed the fair value rules of accounting for aggravating the problem. However, accounting has played and continues to play a vital role in combating the crisis (CFOInnovation Staff, 2009). This paper shows the contribution made by the accounting in resolving the financial crisis.

The Financial Crisis Advisory Group (FCAG) released a report in the past, with the emphasis that improvement in financial reporting will act as a catalyst in improving financial stability, as well as economic growth. The group, which was established by two global accounting regulations setters, the International Accounting Standards Board (IASB) and the U.S. Financial Accounting Standards Board (FASB), plays a key role in providing a financial accounting advice. The group also emphasized that accounting was not a significant cause of the financial crisis (CFOInnovation Staff, 2009). This was put across by the co-chair of the group, Hans Hoogervorsy, who said that “accounting is not a root cause of the financial crisis, but it has an important role to play in its resolution”, in his interview with Reuters.

The financial crisis is characterized by different problems including bubbling and busting of real estate prices, high volatility in the stock markets, freezing of credit markets, failure of the main financial services firms, large bailouts of banks by various governments and inadequate reforms in the financial markets (Linsmeier, 2011).

The role played by accounting in resolving this financial crisis has often been undermined. It is visible in substantial financial events that discuss the financial crisis, nationally as well as globally. It is imperative to note that some of the major causes of the financial crisis arise from ignorance of implementing accounting theories, practice and standards. It is upon the organizations to have this in mind and act by upholding these accounting issues, so as to fix the problems associated with the financial crisis. Accounting plays a leading role in finding and getting figures of transactions in the market to assess, evaluate and make sound judgments in the on-going financial crisis (Kothari & Lester, 2011). This helps in the formulation and adoption of policies that help to mitigate the impact of the crisis. The main objects of finance are largely determined by accounting. These include stocks, deposits and bonds. They can never exist without accounting, and they contribute to the understanding of world markets.

Some people argue that accounting also contributed to the crisis through its lax fair-value rules (Young & Miller, 2008). Fair value accounting came into force in 2006 as the US accounting standard FAS 157. It required assets, such as mortgage securities, to be valued with regard to their current market values as opposed to past or future values. Later on, the market for these assets turned out to be volatile and later collapsed. This had a positive impact on the firms that were holding the assets. Although people tend to blame fair value, the key problem is not in the standards (Myring & Shortridge, 2004). The blame should lie on the companies, which implement measures that do not disclose all relevant information to investors. Financial reporting often fails to deliver necessary information to the investors. Fair value accounting provides the required information to stakeholders. The management, which fails to disclose full information in the financial report, should carry the blame of the crisis (Kasznik, 1996). During the crisis, fair value accounting communicated the impact of poor decisions such as the move to grant subprime loans and swaps in the credit defaults (Laux & Leuz, 2010). The fact that it brought such decisions into the limelight of the society should not be addressed to crisis. Otherwise, if these remained written in the books or on the electronic records, investors could never learn about the looming financial crisis.

The role of an auditor is directly associated with the accounting standards (Myring & Shortridge, 2004). Thus, one cannot look at the impact of accounting on the financial crisis without considering the role played by auditors. Auditors play a crucial role in remarkable operations of the public companies as well as financial markets. They act as checks and balances by regularly monitoring the management of firms. Good auditing gives investors a reason to smile, as far as investing is concerned (Kroeker, 2011). It assures them that their money is in worthy hands, and they can continue investing in that firm. Therefore, accounting reverses the crisis by acting as a watchdog or gatekeeper in different firms. Auditing also helps to minimize the financial reporting risk by providing investors with necessary information in the capital markets (Linsmeier, 2011). This helps investors to make sound decisions regarding the firm’s progress.

Mark-to-market accounting is essential even in today’s financial difficulties. Key aim of accounting, which is availing fair value information to capital providers as well as any other user of financial statements, plays a leading role in investment (Linsmeier, 2011). For instance, when banks mark their bonds, investors can be certain about asset values. This would go a long way in recapitalizing the institutions affected by the financial crisis.

In essence, accounting should not be termed as the root cause of the financial meltdown. Lack of proper accounting and implementation of accounting standards is to blame for the dilemma. Manipulation of financial reports by some managers also contributes to the menace. Furthermore, lack of provision of relevant information to investors also contributes to the crisis. As illustrated in this paper, the role of accounting in resolving the crisis cannot be underrated. It plays a vital role in capital markets and in the economy stimulation.

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