Reforms in Accounting Over the Research Paper

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With them saying in their first quarter 2008 earnings report that they had: a liquidity pool of $34 billion, unencumbered assets of $64 billion and $99 billion in regulated assets. At the same time they affirmed the Moody's credit rating of A1, on the basis of the company's capital basis and liquidity. (Kuhlengisa, 2008) This is problematic, because when looking at this statement and considering what would happen a few months later, it was obvious that managers / executives knew something was wrong. Instead of disclosing this fact to investors, they continued to play down the effects on its overall bottom line, until it could no longer be hidden. The way the accounting industry would help to perpetuate the collapse, is by having independent auditors making conservative estimates on those assets that were frozen. Using the Lehman Brothers statement, the $64 billion in unencumbered assets was more than likely a conservative estimate. Where, many firms would have two different ways of attempting to value these investments (market value or fair value). Normally market values will provide the most accurate picture, as to the underlying value of the investment. The problem is that when you reduce regulations that curtail risk taking; large boom and bust cycles are created in the economy. This would cause the market value of these securities, to become grossly over inflated. Once the economy began to slow, there was no way to accurately value these assets, as the credit markets became frozen. Fair value is more conservative. Yet, the problem with using this standard is the board must determine what would apply. This can vary from one company to the next. Evidence of this can be seen by looking no further than RMBS (a subprime mortgage security that Lehman Brother had valued in the weeks before its collapse). Where, it would have the fair value of the investment listed at $.39 cents on the dollar, while AIG (the company insuring the mortgage) would value it at $.69 cents on the dollar. This is because the lack of having a standard for valuing these investments would only make the situation worse; as a more optimistic view could be presented than what was really occurring. (Brown, 2009, pp. 401 -- 431)

Another way that the accounting industry may have helped indirectly contribute to the financial crisis is not enforcing the law. When firms like Lehman Brothers were making statements that were not true, auditors had a duty to report to regulators that the firm was having financial difficulties. Under the Securities and Exchange Act of 1934, it requires all companies that are publically traded, which have information that could impact shareholders, are required to disclose this information to the SEC immediately. The fact that executives did not do so, was reflecting that they did not want to see the price of the stock fall or receive negative publicity from their announcement. This is in volition of the Securities and Exchange Act of 1934, which requires them to disclose such information. (Francis, 2000, pp. 86 -- 94) Using the Lehman Brothers example, if an investment is being valued at $.39 cents on the dollar and cannot be sold immediately, this could impact the financial position of the company. Any executive or CEO that knows what they are doing would say that this is a very disturbing sign. The problem is that SEC has trouble effectively prosecuting these individuals. As the differences in accounting standards, would be used to show, that executives were following the law by valuing the investment more conservatively. Therefore, if Lehman Brother executives could be charged anyone who makes these claims should be as well. When facing these kinds of situations, the odds are small that executives who make such statements will be prosecuted, as the standard for showing that they violated law (when they really did) was too cumbersome.

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For the accounting industry, this would set the standard that they should be loyal to the firms they are auditing, because making such claims could be irresponsible. As result, an atmosphere develops, where everyone will keep quite over what is occurring. Then, once the situation become so bad; the truth will be revealed.

Possible Ways that the Laws can be changed to Address these Issues

The obvious disparities in the law show how something needs to be done, to address this situation. The problem is that there must be some kind of balance taken, where you want to regulate the industry to prevent irresponsible risk taking. At the same time, you want to give regulations enough flexibility to adapt to the changes that are occurring. This means that an effective accounting standard must be created; for all businesses to follow when they are determining the value of various assets. If such a standard was in place, this would make it easier for: auditors, regulators and investors; to determine a firm's exposure to various amounts of risk. Over the course of time, this would allow for increased transparency, as everyone would know how all of firm's assets are being accounted for. Then, there must be some kind of mechanisms in place to regulate: these new financial products, the markets they trade on and the size that a firm can become. There have been recent changes by the federal government, to address some of the issues that were outlined above in the recent financial reform law. Where, it would cover a number of different elements to include: limiting the size of banks, having an independent board that will monitor the financial system for risk, its increases net capital and it would regulate the subprime mortgage market. (Wagner, 2010) This is significant, because it shows how the law addresses the systematic risk, but it does not address specific accounting issues most notably: what standards are used for valuing different investments and strengthening the provisions for reporting financial irregularities in the Securities and Exchange Act of 1934. This is important, because it shows how the lack of standards would contribute to the situation, by creating a greed run amok mentality. While, there have been significant changes to the law recently, they only address certain parts of the larger financial system as whole. In order to have effective accounting reforms, you must have a way of monitoring and limiting the culture of permissiveness (when it comes auditors and the firms they are working with). Where, auditors do not want to look out for the best interests of the general public, even though they know the company could be making statements that are untrue. Until these issues can be rectified, the financial reforms will be similar to the New Deal, where they will provide increased transparency and help protect against risk. Yet, over the course of time these changes will be ineffective, because they did not address the culture inside Corporate America itself.

Clearly, the accounting industry needs to be reformed, by having improved standards in place that will address how various assets are valued. At the same time, it must provide a mechanism for going after executives that knowingly lie to shareholders, about the financial state of the company. These two issues need to be addressed, because they attack some of the causes of the financial crisis, by preventing greed from becoming out of control. If you can control this emotion, by limiting risk and through effective accounting reforms, you have the ability to increase the transparency and stability of the financial system. Until these issues can be addressed, it means that the culture, which helped contribute to the crisis, will continue to fester in one way or another......

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