Balance Sheet and Accounting

¶ … financial crisis was abusive off-balance sheet accounting. Abusive off-balance sheet accounting led to a daisy chain of ineffective and dysfunctional decision-making because it removed transparency from regulators, investors, and markets. Spread of derivative transactions, bad loans, and securitizations brought a once stable financial system to the edge of ruin. While improvements have been made, the FASB's guidelines suffer from two main flaws. The first is lack of congressional mandate. With no clear congressional mandate, FASB and SEC guidelines remain subject to the same type of interpretation that led to the growth of 'regulatory arbitrage' or what others may pen as financial engineering, meaning shifting debts off-balance sheets. This means a company must consolidate a VIE only when it possesses 'control' and has the right to receive benefits and access to VIE's 'most pertinent activities' making the design of the guidelines qualitative in nature (Stickney, 2010).

The guidelines then require assumptions and judgments and can lead to exclusion of liabilities by companies regarding their financial statements with the only necessary action being description of assumptions and judgments. Actions such as these leads to the unlikelihood of generating transparent financial reporting. This leads to the second fatal flaw; major liabilities will continue to remain off-balance sheet. Therefore, Congress must mandate chances related to VIE transactions. For example, companies when financing assets should remain along with the associated liabilities, on the balance sheet, irrespective of the form used to build these financings.

Off balance sheet financing inflates a company's earnings, misrepresenting their financial positions. However, it permits the company to maintain needed ratios that satisfy debt covenants, allowing the amount of debt to be distorted. Therefore, managers aim to perform off-balance sheet financing because it has its advantages. One of which is financial leverage, meaning offering a better-looking balance sheet that demonstrates a lesser described debt to equity ratio, creating a higher stock price (Stickney, 2010). Nonetheless, the down side is destruction of credibility and shareholder confidence. Recommendation would be to reduce anything that inflates stock prices in favor of building a trust-based relationship with shareholders.

2.

The main differences when it comes to impairment method for long-lived assets is clear. For U.S. GAAP, when an asset's carrying quantity becomes unrecoverable, that is when an impairment is recorded. Additionally, an asset becomes unrecoverable when carrying amount surpasses expected future cash flows derivative of an asset on an undiscounted source. For IFRSs the impairment is recorded in the following scenario: an asset's carrying quantity surpasses the higher of the asset's worth in use as well as fair value expenses are less to sell.

Another key difference is the lowest degree of discernable cash flows. For U.S. GAPP it is termed 'asset group'. For IFRSs it is 'cash-generating unit'. While the difference lays in the terminology, the method remains the same. Furthermore, under U.S. GAAP, some situations may require no record of impairment that would otherwise under IFRSs such as asset group appears less than what s labeled as the carrying amount.

Assets purchased go one of two ways, they either capitalize or expense the purchase. Long-lived assets give the appearance of higher profits for a balance sheet because expenses are allocated throughout a set time like five years or ten. Even though the cash flows remain the same, it gives the illusion of higher profits. Depreciation allows a company to see the 'true' amount needed to allocate each year to maintain and/or replace the company's fixed asset base (Larkin & Ditommaso, 2016). This is a means of seeing the real numbers rather than inflated ones. Depreciation also lends to examination of any underlying trend within the company's fixed asset base.

3.

Fair value accounting means "the practice of measuring assets and liabilities at estimates of their current value -- has been on the ascent. This marks a major departure from the centuries-old tradition of keeping books at historical cost" (Ramanna, 2016). Companies use fair value accounting because it provides higher relevancy to accounting information. A possible reason why some may choose historical cost accounting is due to it being more reliable and conservative. It saw a nationwide ban from the 1930's until the 1970's. Even after the 2008 financial crisis, fair value accounting was blamed again, believed to have been used to determine executive bonuses. However, fair value accounting has seen extensive use globally. It has seen extensive use in goodwill impairment testing, employee stock options, derivatives and hedges, and financial assets. This is because finance theory the 1980's and 90's made it appear that financial markets are effective and reliable measures of value were believed to be in their prevailing prices.

Essentially asset managers and investment banks grew used to using fair value accounting every day for preparation of in-house balance sheets. Fair value accounting may have even influenced financial reporting standards and defined GAAP profits that are used to determine managerial bonuses. If it is so widely used, then it should continue as the standard means of accounting.

The premise of value under the desire for each party to receive the optimal outcome, would ascertain the fair market value of any business asset potentially competing in the market. However, fair market value lacks incorporation of discounts for lack marketability/control. This is something that can see improvement in terms of market value. By providing a more detailed picture of market value, it can help expand transparency and create sizeable flow within the markets.

4.

Derivatives instrument equations exist to understand concepts, convey ideas while ignoring the grammar. They also permit the redistribution/sharing of risk. Derivatives are useful in protecting against distinct exposure of a company like movements in interest/exchange rate, asset price, and default of creditor. Derivatives can also be used through market participants in taking on risk and speculation on movement in market value. However, there are inherent risks.