The Accounting Standards Board has announced:
amendments to Sections 3855, Financial Instruments — Recognition and Measurement, and 3862, Financial Instruments — Disclosures. The amendments permit reclassification of financial assets in specified circumstances. They are being made to ensure consistency of Canadian standards with International Financial Reporting Standards (IFRS) and US standards. They are effective for reclassifications made on or after July 1, 2008, but only for periods for which annual or interim financial statements have not been issued previously.
“The amendments allow entities to move financial assets out of categories that require fair value changes to be recognized immediately in net income,” said Paul Cherry, Chair, AcSB. “However, it must be stressed that assets will remain subject to impairment testing and the amendments involve extensive disclosure requirements. Transparency will remain for investors.”
Predictably, this is being treated as big news by the Financial Post:
Canada’s top financial institutions will get relief from the corrosive effects of the toxic assets sitting on their books today thanks to a controversial decision that turns back the clock on modern accounting methods, according to people familiar with the process.
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The timing of the announcement will be welcomed by the Conservatives and puts Ottawa onside with Paris on a divisive issue that has split Europe because of fears that loosening of so-called mark-to-market rules will mask losses and encourage riskier behaviour.
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The decision will be welcomed on Bay Street and give insurers such as Manulife Financial Corp. extra breathing room when they report on their performance next month after seeing their share prices punished.The new ruling will also provide some relief to Canada’s banks as they prepare end-of-year results expected to show a broad decline in profitability.
Chief executives on Bay Street have said they were counting on the measures to help them deal with problematic portfolios of mostly foreign loans.
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Associations representing accountants and financial analysts have objected to the rule changes, charging that they mask the problem of toxic assets on the books of financial services companies.
The Globe and Mail story is similar but not as detailed.
Why is this important? There’s one small reason why it matter, but to your basic investor it doesn’t mean a thing.
I’ve got some news for the “associations representing accountants and financial analysts” mentioned in the report … nothing is being masked. The assets will still be on the books and will be worth whatever it is they’re worth, regardless of which of the “historical cost”, “mark-to-market” or “discounted cash flows” methods is used to value them for bookkeeping purposes. Each of these three methods has its strengths and weaknesses – big deal.
Virtually the only people affected by this will be brain-dead pseudo-quants, who pick a few numbers of the balance sheet and income statements, throw away all those boring old notes to the financial statements – geez, who reads all that muck anyway? – and makes a big kerfuffle about how scientific they’re being.
The only real-life implications I can see to this change is that it may affect the enforcement of regulatory capital ratios, because the regulators pick a few numbers off the balance sheets and cherish them deeply. The regulators are the guys who figured the credit rating agencies spoke with the voice of God, remember, and turned a blind eye to potential problems. But now they’re frantically trying to patch up the divinity with MORE RULES, so perhaps everything will be OK. If not, expect MORE RULES!
Each of the various methods of valuing an asset has its strengths and weaknesses. Sometimes one form will be appropriate, sometimes another. All in all, the Accounting Standards Board has got it right, telling the industry: use your best efforts and justify yourself in the notes. Investors may then make any adjustments they please to the published figures. It is desirable, of course, that they read the notes to the financial statements and make a genuine effort to understand what’s going on.