Custom «Impairment of Assets and Subsequent Events Reporting» Essay Paper

The accounting reporting and practice in the US is governed and regulated by the International Accounting Standards Board and the Financial Accounting Standards Board both of which operate in collaboration with American Institute of Certified Public Accountants. The contemporary accounting environment is becoming complex and advanced, thuds making the two bodies to be always aggressive in instituting changes that are tailored around the modern changes in business environment. In the AICPA, the International Accounting Standards Board has announced changes in reporting of loan value and other financial instruments by banks and other financial institutions (AICPA, 2009). This is also reported in the FASB corporate website. Financial institutions are required by the IASB and FASB to publish audited financial reports at the end of every financial year in addition to unaudited interim statements after every quarter of financial year. In FASB, there is a new requirement that tends to address the accounting and reporting of subsequent events. This will be an amendment of the FASB No. 165 which handles the issue of accounting and reporting of subsequent events in financial statements.

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AICPA is a regulatory body for the certified accountants whose mission I to ensure that accountants provide valuable services to all stakeholders through provision of relevant resources, information and leadership (AICPA, 2009). Before this announcement for amendment, financial instruments have been impaired through the use of incurred loss model whereby loan repayment was being done until a trigger event was identified that necessitated the lowering of loan value. This has been a challenge since the expected losses were only recognized when the trigger event was identified, affecting even the realization/recognition of interest income by the financial institutions. Generally, impairment of assets refers to the loss of the value of the asset relative to the book value of the same asset. In other words, the cash flow from the assets tends to be less than the carrying value of the asset in question. Financial assets normally get impaired due to the changes in economic conditions that affect the market interest rate, thus making the price of the financial asset differ from the fair market price. Under the new model, financial institutions will make a provision for credit losses that will run throughout the life of the loan.

This new proposal is aimed at replacing the old standard in ‘IAS 39 – Financial Instruments: Recognition and Measurement’ and incorporating a new standards under IFRS 9 Financial Instruments, following the limitation of the former standard in addressing the treatment of impairment of financial assets. It will eliminate the complexity of recognizing the loss component of the impairment. For instance, where a loan issued at 5% interest rate can fetch 10% interest rate in the market, and then there will obviously a loss that has to be disclosed separately as a loss on impairment of the financial asset. The impairment loss is normally recognized in the profit and loss account as an expense although it can be reversed in the subsequent financial period where it reduces due to events occurring after its recognition. This recognition will have an effect on the rate of interest which has to be discounted to take care of the impairment loss. Therefore, the proposed amendment will ensure that the banks and financial institutions report the amount of loan having factored the impairment loss. This amendment has been necessitated by the current financial crisis that has been affected the financial market to an extent of making some financial institutions to collapse.

The proposed amendment tends to be a move in the right direction as it will allow the recognition of financial instruments at their fair value when preparing financial statements. This will provide the right valuation that can be relied upon by the users of financial statements. The financial market is always volatile, causing frequent fluctuations of the value of financial instruments and therefore it would be prudent to report the value of the instruments at their current carrying value. To the users of the financial statements, the new mode of reporting will give a clear picture of the firm’s financial position and the effect of the market conditions on the firm’s financial assets, thus making it possible for the users to make reasonable decisions. However, not all conditions will necessitate the recognition of impairment especially where the conditions are temporary and are not likely to adversely affect the prices of the financial assets for quite a long time.

The valuation of financial assets to determine the impairment loss should also put into consideration the price in arms length asset measurement and the prevailing fair value of similar financial instrument in the market.

One of the most affected financial instrument/asset is the loan where impairment will come in the form of the lender being unable to recover the whole amount as per the terms of the loan agreement. In this case, making a provision of loss on part of the loan will be more realistic in order to portray the right or fair position of the firm’s financial position.

Financial Accounting Standards Board is a regulatory body responsible for establishing and enforcing accounting standards that should be adhered to while preparing and reporting accounting financial statements. The body was established in 1973 and is operates in collaboration with the AICPA and the Securities and Exchange Commission (SEC) to ensure quality and reliability of the financial statements produced by business organizations. The FASB has produced a proposal on how to treat the subsequent events. The subsequent events are reported under FASB 165, subsequent events and AU 560. The body as proposed that the subsequent events should be disclosed and should indicate the date through which they have been evaluated in both the initially issued and reissued financial statements unless otherwise regulated by SEC.

The rule will apply to those entities that do not issue statements through SEC, although those reporting through SEC will have to disclose the date of issue as the date of evaluation, and will cover among others, the correction of errors in the financial statements (FASB, 2009). Usually, the subsequent events are those events that happen after the last date of financial period but before the issuance of the financial statements, and normally have a material effect on the financial statements thus the need for disclosure in the financial statements. In most cases, the events that have a material effect on the financial statements may include the availing of fresh evidence that is likely to affect the estimates as at the last date of the balance sheet, requiring adjustments to the financial estimates before they are issued. For instance, the litigation costs that are incurred on conditions that fall before the balance sheet date but are actually settled in the subsequent period after the balance sheet date are material and need to be adjusted in the financial statements thus reducing the reported profit. In other words, the costs have to be recognized as costs that were incurred in the just concluded financial year.

Subsequent events are important in ensuring the reliability of the financial statements to the various users and the organization itself. Disclosure of the subsequent events removes the complexities that could arise in the subsequent financial period, where it may involve reporting events that affect estimates of a different financial period, thus leading to non-clarity of the statements. Other subsequent events that may be disclosed include those events that happened after the balance sheet date but do not directly affect the estimates of the financial statements thus require no adjustments of the financial statements but will have to be disclosed in the statements as notes as they may influencer the decision of the users of the financial statements. These events may include loss of property or inventory from a disaster after the balance sheet date, unwarranted losses on receivables after the balance sheet date, sale of bond or issue of stock, legal settlement for an event that happened subsequent to balance sheet date and purchase of business after the balance sheet date but before issuance of the financial statements.

The disclosure of the date of the subsequent events is a good idea as it will help the organization to align its financial statements and make sound decisions from the statements that are reliable and accurate. According to the Financial Accounting Series (2008), disclosure of the subsequent events should be a management duty as they affect it directly in making corporate decisions. The omission of date especially where the subsequent events are material may lead to misleading financial statements that don’t reflect the true position of the state of affairs of the firm as at the balance sheet date. The auditor should be concerned with the subsequent events in order to ascertain whether they have a material effect on the financial estimates as the balance sheet date or whether the subsequent events are relevant for disclosure in the financial statements (Financial Accounting Series, 2008).

The users of the financial statements will rely on the statements as a true reflection of the financial position of the firm and will make decisions based on them. Where the disclosures, whether requiring adjustments of the financial estimates or not arte missing, the users may make improper decisions that may end up affecting their expectations. For instance, the disclosure on the losses of inventories or receivables will help the user (investor) to gauge the financial strength of the business based on the information contained in the financial statements and the magnitude of the loss that is not reflected in the financial estimates. In addition, the disclosure will give alert to the users of the financial statements that the firm has not evaluated the subsequent events in the financial information contained in the statements.

To ensure the financial statements offer benefit to the users, there is need to examine whether the data provided reflect the occurrence of a subsequent event before the date of issue of the financial statements or the date the financial statements were available for issue. This will ensure that the decisions ma de will only reflect the information in the financial statements including the disclosures thus creating confidence in the stakeholders (mostly the investors, suppliers and trade partners) that the financial statements are correct, accurate and reliable.