A few accounting standards arguably have an unfortunate tendency to exaggerate the economic cycle. During a time of economic downturn, the chances of a company having impaired assets is increased. This has the unfortunate effect of taking poor trading results and augmenting them with impairment losses. In other words, accounting conventions take a bad situation and make it worse.
Or so some people would say.
Some financial instruments are also shown at fair value. Fair value is primarily decided by reference to market values. During a slump, this also makes reported results worse.
The argument advanced by many is that we ought to amend accounting standards to introduce some sort of dampening effect – requiring companies to impair assets or make provisions during times of boom and release these provisions during a slump. This, it is argued, is only the equivalent of making hay while the sun shines.
There’s only one problem with this idea of “dynamic provisioning”. Mostly, it flies in the face of the definition of a liability in the Framework. Also, it’s precisely the opposite of what IAS 37 and IFRS 4 (insurance contracts) aimed to do. Fiddling with the accounts to save people from unjustifiable optimism and excessive, groundless pessimism might be politically popular in the current market turbulence, but arguably it would only reduce the reliability of financial reporting in the long term. Investors ought to be smart enough to use other information provided to them, such as the statement of cash flows, before reaching judgement on the desirability of a company’s shares.
We hope that the IASB stick to their guns and resist the pressure to codify creative accounting and massaging figures by bogus provisions. We’re confident that they will.