Historical Cost/Accrual Accounting vrs “Fair Value” Accounting and how it facilitates Pirating the Time Value of Money

(Posted by Andrea Psoras on September 26, 2010 at 3:09am originally on Bankinnovation.net on 26 Sept 2010 at original link http://www.bankinnovation.net/forum/topics/accrual-accounting-and-using?xg_source=activity (broken link)

Historical Cost Basis Accrual accounting versus Fair Value Basis Accounting and using the ‘harmonized’ but in reality, eroded financial reporting model to pirate the time value of money

This past week while reading through Woelfel’s 1993, “Handbook of Bank Accounting” to improve my understanding of Statement of Cash flows for financial institutions, I stumbled on his comments about accrual accounting’s need for operating “Cash flows”…which “are important indicators of a bank’s profitability and viability. To be profitable and viable, a bank must have sufficient operating cash flows to make loans and investments, meet withdrawals, satisfy loan commitments, and meet other cash requirements. Cash basis information provides critical support to accrual basis accounting (but does not replace the need for accrual basis accounting)”.

What would he say in a new edition about current erosion of Financial Reporting that has some ISDA (International Swaps and Derivatives Association) cartel members funding using 1980’s brain-dead thrifts’ 2.0 version using Asset-backed securities, Repos and whatever commercial paper and Fed sponsored liquidity mechanisms the Fed has surfaced from its bowels which Woelfel also lists on pg 32 and 33 as “Specific and detailed supervisory powers of the Fed through its Board include prescribing rules and regulations governing:” which includes a number of mechanisms that Chairman Bernanke this past week at Princeton attempted to characterize as new, playing on our ignorance about what the Fed has done or what it has among its supervisory powers.

Although this doesn’t directly relate to my concerns about the continued erosion from accrual accounting we’re experiencing with the abuse of fair value accounting corrupting the income statement, what the Fed does and its credibility or lack thereof is key. Perhaps the frequency of these Fed ‘irregularities’ is extremely limited that the Fed has engaged in buying anything other than Treasuries, and having the Treasury Department serve as the effectuator of Open Bank Assistance also is rare, rather than have the Fed engage in discretionary efforts however the financial sector crafted their own enron-esque collapse with the Fed as its faciliator – as was the Fed’s design to be that creature that came to life in 1913 by Warburg, Morgan and Rockefeller with their lackey Senator Nelson Aldridge.

Back to the reporting abuses, US GAAP’s Conceptual Framework is not missing in action nor esoteric in this who-done-it. GAAP’s Concept 6 definition of revenue recognition violates accrual accounting’s need to report the recognition of the financial effects of transactions, events and circumstances having cash consequences to the period in which they occur rather than when cash receipt or payment occurs (Woelfel p,20).  Keep in mind that given all the Fair value which, in effect is Concept 6 Definition of revenue recognition, management can take the gain in the (or loss if the financial markets are correcting downward) value of an asset – a Balance Sheet item – at the end of a period and run the unrealized non cash gains through the Income Statement (or Other Comprehensive Income “OCI”) as if it were a real revenue that realizes to cash when it doesn’t. This Concept statement also existed even before harmonization with US GAAP and IFRS (International Financial Reporting Standards under promulgation for the EU by the International Accounting Standards Board “IASB”), or even before the push for the US to adopt IFRS, although it seems it was a more European way to claim a gain, or ‘revenue’ to run through the Income Statement.

It occurred to me that this Concept Statement and FV basis dominating the financial reporting model allows management to pirate the time value of money without the need for either a transaction or a contract such as one that generates a rent on real property, an interest on a loan or bond, or dividend which is income on an equity. These all at the very least in their contractual form have their associated incomes and/or in the case of a transaction of these Balance Sheet items also have associated consequences such as a capital gain or loss or the true sale with the transfer of rights and/or responsibilities, privileges of ownership.

But the most craven, subtle, self dealing here absolutely has been Agency’s pirating the time value of money using the financial reporting model now dominated by Fair Value while it’s ‘harmonizing’ with IFRS. And I’d thought I’d said it here, but now I have to add this – the impact in the Income Statement of the FV of the items on the Balance Sheet, that in the FVing of those items, now when run through the Income Statement – if of the $600 Trillion to $700 Trillion or more notional amount  – if of this amount even 1 basis point of that, ie .0001 of this amount is run through the Income Statements, this still is a HUGE gravy train for bank management and they nor their ripple effect of all the others of every part of our society feeding from THAT  that bank management has enjoyed and thus don’t want that OX gored.

Back to what I also was saying about the FVing of what’s on the Balance Sheet which in turn is run through the Income Statement, we all can only have access to the unlocked time value of money and associated impact on a balance sheet item when we transact – buy or sell it. Agency at the bigFinancials and their ‘servants’ at the regulators, in Congress and other institutional participants, however have now how to cripple the financial system, and abuse these crafted flaws facilitated by flaws in financial reporting to the degree where they can print money through their Income Statements merely by even inflating their Balance Sheets using derivatives and OTC contracts.

Recall that these items which have to be fair valued, meanwhile with the appearance of management having done their jobs, and worse too with their ability to write the OTC contracts and derivatives, as I’d observed they can use their Income Statements to ‘print’ money with their derivatives which are fungible via their traders books through their Income Statements. Thus this serves as their currency while every one else has to meet accountability tests that agency at the bigFinancials and the Global corporates seem to have been permitted to avoid.

Traded derivatives contracts/contractual OTC obligations by ISDA banks’ of their respective resources plumed after Phil Gramm added the loophole for these in the Commodity Futures Modernization Act 2000. This plume related and contributed to the collapsing of the US economy for it to comply with the G20 agreements’ constraints for the US economy (see my Basel III Opposition post here in wordpress, Note 6 p29).  These contracts also contributed to inflating the ISDA banks’ Balance Sheets which also occurred after and also is related to, and legitimized with Gramm Leach Bliley in 1999 (with the ability to write and trade Credit Default Swaps (“CDS”) ‘recognize’ them as if these were insurance) and the SEC program (aka “Net Capital Rule” obtained in 2004 by Goldman’s Henry Paulson from SEC Chairman Bill Donaldson) for the largest US investment banks to suspend keeping their leverage ratio constraints.

The nos/vos ‘netted’ position of the OTC derivatives, however still gives us a $25T moving target hole. One fixed income analyst at one of the world’s largest banks, said we have to look at a little tiny window of that and address this in small increments rather than deal with a hole that could swallow 2 years of US GDP.

Regardless, given the $25T OTC contracts and derivatives hole, agency at the ISDA players have vastly over obligated the resources of their enterprises. Altogether this gives serious agency self-dealing and abuse with their OTC derivatives contract-writing and ‘hedging’, all of which has enabled bank management to run the Fair Value unrealized non cash gains through their income statements, while producing insufficient cash flow other than from repo, Commercial Paper, and other short-term funding that would vanish except for the Fed if the markets got nervous. Again feudalism of a contemporary sort in this ‘free’ rider ability to pirate the time value of money.

In addition banks’ Interest Income is fouled with the hedging which perhaps may have associated cash-flows but perhaps not, with non cash items both packed into the interest revenues as well as the loan accounts on the Balance Sheet and are subject to fair value accounting, which again has the unrealized non cash gains recognized in the Income Statement as if these were real revenue that would realize to cash.

Moreover, insufficient quality lending without hedging on the loans and asset items has diminished cash in the operating section of the Cash-Flow statement. Consider too, the impact of backing out Interest Revenues when management has to put loans on Non-Accrual, while having to make provision for deteriorating asset quality – although provisions goose operating cash flows rather than penalizing management for poor asset quality.

Meanwhile all of this contract writing which agency can fair value and enjoy bogus revenues for those, has obscured poor management decisions and in general poor managing at our BigFinancials. It also is agency engaging in their inside and self-dealing with virtually no push-back or punishment by the regulators which now will ‘supervise’ via some committee of oversight (aka Financial Services Oversight Committee established by the Dodd Frank Act, “FSOC”) that is stacked with regulators and insiders that wallstreet and bigFinancials will be able to choose those at the table and via campaign contributions pay for legislation about how that oversight body will be structured, with little to no sunshine or accountability.

But again worst of all is that it’s taken between $10T to $16T of voter money to flush the markets so that the bigFinancials can have stable and upward moving markets to re-value their Balance Sheets so that on the Fair Value mark-to-market, it appears as if the values are greater one period over the next. Then when the unrealized non cash gains from the mark-to-market are ‘recognized’ as Revenues or in OCI, the abuses of this reporting appear to be profitable and managements are then enjoying some smoke and mirrors to legitimize paying themselves higher comp.

Between our Congress’s problems and our domestic economic problems, as well as the self- interest of the Europeans financials and their governments, our regulators haven’t punished nor cease and desisted this sort of agency plunder now seriously into the public weal. That bigFinancial fief will devour all of our society, except we who understand the problem and in turn condemn it, all of it, every conflicted participant in all of this.

Agency, Congress and our regulators are to draw back in horror at the systematic looting by agency of the bigfinancials aided and abetted by the Fed and Treasury’s regulators with the FDIC also at that table as a the good cop in the good cop/bad cop routine.

We’re also having enronesque/dotcom-esque problems with bigfinancials’ barter with their trading; we thought we’d shed that inferior economic model with slavery, or in having left Europe behind, also had enjoyed liberty from their feudalism, but we’re there with this kleptocracy and their hijacking of the reporting model devolving from accrual accounting, while lining managements’ pockets with the regulators and congress looking to likewise feed from that trough.

Perhaps soon this will cease; God’s hand is not too short for there to be a swing in the pendulum in this world against people who think they can cripple the system and shave value outside the rules or hijack the rules while the balance of society again has to survive accountability tests. There also are scriptures in the Torah about unjust weights; I characterize US GAAP harmonized with Fair Value as unjust weights further corrupting US GAAP (Comment
Letter (#81):  FASB –
Project: Fair Value Measurements and Disclosures
(Topic 820) Reference Number: 1830 100 Amendments for Common Fair Value
Measurement and Disclosure Requirements in U.S. GAAP and IFRS http://www.fasb.org/jsp/FASB/CommentLetter_C/CommentLetterPage&cid=1218220137090&project_id=1830-100 ).  10/09

Aside from repealing US signatory status to G7/8/20 Agreements, shedding Basel Accords, and restoring the former US GAAP financial reporting model of Accrual Basis accounting where the Revenues have to realize to cash in the reporting cycle, are there enough smart people in the appropriate positions to rectify this purloining? Time will tell….

(Posted by Andrea Psoras on September 26, 2010 at 3:09am originally on Bankinnovation.net on 26 Sept 2010 at original link http://www.bankinnovation.net/forum/topics/accrual-accounting-and-using?xg_source=activity (broken link)

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