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The financial crisis of the late 2000s resulted in the collapse of many large financial institutions, the bailout of banks by national governments...

The financial crisis of the late 2000s resulted in the collapse of many large financial institutions, the bailout of banks by national governments and downturns in world stock markets. Among the scapegoats blamed for the crisis was fair value accounting rules. The argument was that companies were forced by fair value accounting to write down their assets to what they hoped was temporarily irrational prices. These write-downs supposedly exacerbated market downturns.

Possibly in response to these arguments and to threats by the European Union to override international accounting standards, the International Accounting Standards Board changed its rules in IAS 39 on balance sheet classifications so that companies could shift many of their financial assets out of categories where fair value accounting was required. This meant a company holding 'dodgy' bonds could delay recognition of future losses on those bonds by simply changing their category on the balance sheet. Such an action is possible because the changes to IAS 39 meant that financial assets could be classified four ways: as fair value through profit or loss, as available for sale, as held to maturity, and as loans and receivables. The first two classifications require financial assets to be marked to market, with those classified as the first category requiring changes in value to go through the income statement, while changes in value for those classified as available for sale would not impact on the income statement. The other classifications allow companies to avoid using fair values on the balance sheet.

In 2009, the Financial Accounting Standards Board also changed its comparable standard to allow companies to keep losses on impaired financial instruments out of net income.

Questions:

Suppose you are a company holding large quantities of financial instruments the market value of which had declined markedly since purchase. How would you classify those instruments and why?

Will companies with large holdings of dodgy financial instruments be motivated to disclose information about those instruments? Give reasons for your answer.

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