Accounting for Financial Instruments

1 Introduction.

1.1 Introduction.

1.2 Scope of the book.

1.3 Background.

1.4 Concerns over the misuse of financial instruments.

1.5 Complexity.

1.6 Revenue recognition.

1.7 Inappropriate reward incentives.

1.8 Protection for shareholders.

1.9 Measuring the ‘traders’ dilemma’.

2 Accounting Foundations.

2.1 Introduction.

2.2 IASB improvements.

2.3 The framework.

2.4 Fair value or cost.

2.5 Artificial volatility.

2.6 Cost model.

2.7 Cherry-picking.

2.8 Subjective valuations.

2.9 Proactive vs. reactive.

2.10 Goodwill.

2.11 Market value accounting.

2.12 IFRS and its contribution to banking crises.

2.13 IFRS post-Enron.

2.14 Conclusion.

3 Corporate Governance.

3.1 Introduction.

3.2 Corporate governance.

3.3 Small vs. large shareholdings.

3.4 Traders’ dilemma.

3.5 Moral hazard.

3.6 Credit rating agencies I.

3.7 Shareholder democracy.

3.8 Structured products.

3.9 Revenue recognitio.

3.10 Non-consolidation.

3.11 Credit rating agencies II.

3.12 Accounting standards and lobbying.

3.13 Investment entities.

3.14 Conclusion.

Appendix: Constant proportion debt obligations.

4 Hedge Accounting.

4.1 Introduction.

4.2 Accounting for forward contracts.

4.3 Accounting pre-IAS 39.

4.4 Artificial volatility.

4.5 Hedge accounting rules.

4.6 Example: Forward rate agreement.

4.7 Conclusion.

5 Illustrative Examples: Hedge Accounting.

5.1 Introduction.

5.2 Illustration: Fair value hedge.

5.3 Credit spreads.

5.4 Cash flow interest rate swaps.

5.5 Time value vs. change in interest rates.

5.6 Long method fair value hedge.

5.7 Foreign exchange hedge.

Appendix: Documentation.

6 Accounting for Structured Products (Market Risk).

6.1 Introduction.

6.2 Risk adjusted return on capital.

6.3 Bifurcation rules.

6.4 The reward for risk.

6.5 Protection for shareholders.

6.6 Illustration: The structured products problem.

6.7 The accounting treatment under embedded derivative rules.

6.8 Past mistakes.

6.9 Conclusion.

Appendix 6.1: Overview of embedded derivative rules in international accounting reporting standards.

Appendix 6.2: Introduction to derivatives.

7 Accounting for Credit Risk.

7.1 Introduction.

7.2 Loan approvals.

7.3 Credit spreads.

7.4 Accounting standards.

7.5 Credit rating agencies.

7.6 Credit derivatives.

7.7 Accounting for loans.

7.8 Changes in the accounting standards.

7.9 Accounting rules on credit derivatives and financial guarantees.

7.10 Structured credit products: an extra layer of complexity.

8 Accounting for Structured Products (Credit Risk).

8.1 Introduction.

8.2 Securitisation overview.

8.3 Regulatory arbitrage.

8.4 Prepayment risk synthetic securitisations.

8.5 Accounting for credit risk.

8.6 Accountants, regulators and credit agencies.

8.7 Complexity.

8.8 Disclosure.

8.9 Credit Suisse fiasco.

8.10 Monoline insurance companies.

8.11 Accounting implications.

8.12 First to default.

8.13 SFAS 157 valuations.

8.14 Conclusion.

9 Off-Balance Sheet Accounting.

9.1 Introduction.

9.2 Off-balance sheet manipulation.

9.3 Case studies: off-balance sheet.

9.4 Accounting implications.

10 Reconciliation.

10.1 Introduction.

10.2 Middle office.

10.3 Initial and variation margin.

10.4 Example: Illustration of reconciliation.

10.5 Conclusion.

11 Moving Towards Mark-to-Market Accounting.

11.1 Introduction.

11.2 Liquidity and fair value.

11.3 Banking vs. trading book.

11.4 VaR.

11.5 Basel 2.

11.6 Accounting for VaR and IFRS 7.

11.7 Conclusion.

12 Accounting for Insurance.

12.1 Introduction.

12.2 Significance of insurance risk.

12.3 IFRS vs. embedded value reporting.

12.4 Finite insurance and unbundling.

12.5 Other aspects of IFRS 4.

12.6 Phase two embedded value.

Appendix: The collapse of AIG.

13 Conclusion.

Glossary.

Index.