The Day The Standards Died

We have spent a lot of time discussing the Gold standard and what it means to have the world reserve currency here at the Capital Research Institute. But today we want to look at something a little different, but just as crucial: the importance of accounting standards. OK, OK, I am hearing the yawns already, just bear with me! When the Financial Crisis hit in late 2008 not only did Capitalism die, when the Government decided bankrupt firms (of their choosing) should no longer be exposed to the risk of failure! The history books are going to be speechless on that one, and will simple relate: “It seemed like a good idea at the time!?!?” But what may have slipped under a lot of (non-accounting) people’s noses was that accounting standards were also effectively removed at that time. The most important of which were mark-to-market accounting rules.

For all those that don’t have an accounting background, it can be summarized like this. All public companies have to record and release in their financial statements how many assets they have, and how much money they owe. Assets are things like machinery, factories or land. Assets are used to generate income. So the inventory in a store is its most important asset. But what happens when the inventory can no longer be sold, either because its condition has deteriorated or demand has disappeared? Well, we have to be honest, and mark down those assets, to what we actually believe they are now worth. Maybe the inventory is only worth $2 today, when before it was worth $50 when recorded on the company’s books.

Now for a second imagine why a company would not want to do the above. Well, first of all, it is almost like admitting failure. You are admitting that your assets were not as valuable as previously thought. But secondly, the company will record a loss due to the write down of the asset, so if there are a lot of assets to mark down that could result in MASSIVE losses! So what companies want to do in this case is somehow just pretend nothing happened, “We are going to tell investors that damned inventory is still worth $50″. Now, it only takes a child to see how dishonest this is, we have inventory we are looking to sell, but that inventory is now only worth $2 on the open market. Instead of selling it, and taking the $2, we are holding on to the inventory, and pretending that it is still worth $50, or hoping against hope it will be worth $50 again one day.

Any corruption of this type goes through three stages: Stage 1: Its only a one-off, a temporary adjustment, and we will fix it in the future.

Stage 2: OK, we have to make the adjustment again. But its not dishonest, its just our ‘preferred reporting option’!

Stage 3: “Oh god, its worse than we thought, isn’t it? You are telling me we are actually insolvent??? What if other companies were up to the same tricks? OH GOD!” *throws up*

Stage 3 is clearly the Crisis phase. For historical examples see either the Asian Financial Crisis in 1998, or the one we continue to experience, the Financial Crisis of 2008. When companies finally admit to themselves how dishonest they have been and start to figure out that others have been using the same loopholes and work-arounds they themselves have confidence collapses.

The beauty of it all is this, because IFRS (the international accounting standard setters)got rid of ‘Mark-to-Market’ accounting rules everything described above may be dishonest, but it is completely legal! Thats right, IFRS has given financial companies the right to pick and choose whether they want to record their assets at cost or market value! Well, thats going to depend on which gives the higher end result, isn’t it! “WHAT?!?! Market value has fallen off a cliff? Well, lets not go shouting that off the rooftops or anything… Aggregate the accounts, and hide it in the notes.”

So not only have accounting standards been compromised, with the end result being almost useless financial reporting, but it also means there are dozens of billion dollar companies (!!!), and the only thing keeping them afloat is extremely questionable accounting practice! Its not just corporations that take shortcuts when it comes to financial reporting, so do governments! But that is an issue for another day… Thanks for joining us, and come back soon, as we continue to unravel The Web of International Finance!

Original article here.
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