Premium
Failing Faithful Representations of Financial Statements: Issues in Reporting Financial Instruments
Author(s) -
Abdelkhalik A. Rashad
Publication year - 2019
Publication title -
abacus
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.632
H-Index - 45
eISSN - 1467-6281
pISSN - 0001-3072
DOI - 10.1111/abac.12176
Subject(s) - valuation (finance) , fair value , accounting , volatility (finance) , financial accounting , cash flow , business , substance over form , economics , accounting standard , mark to market accounting , actuarial science , international financial reporting standards , financial instrument , finance , accounting information system
Both the International Financial Reporting Standards (IFRS) and the codified accounting standards (ASC) for the US GAAP categorize hedging relationships as falling into several buckets. The two buckets of relevance in this paper are (i) hedging the volatility of fair values, and (ii) hedging the volatility of future cash flow. In this paper, I argue that at least three accounting treatments of derivatives and hedging lead to creating serious distortion of reporting actual transactions, to combining hard and plastic valuations, and to violating adherence to the principle of ‘faithful representation’. The three accounting treatments are as follows: (1) creating the fictional Hypothetical Derivatives Method ; (2) allowing for the establishment of purely discretionary valuation adjustments for all over‐the‐counter derivative assets (Credit Valuation Adjustment) and liabilities (Debt Valuation Adjustment) without any guides or constraints; (3) requiring subjective metaphysical separation of embedded derivatives with the main guide being the management's own perception of the instrument's embodiment of unrelated value and risk generators. To remedy the resulting distortion in financial reporting, significant revisions of certain accounting standards are sorely needed.