Lack of confidence in financial reports among the vulnerabilities of Europe

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06 Sep 2013

The Joint Committee of the European Supervisory Authorities (ESAs) has published its second bi-annual 'Report on Risks and Vulnerabilities in the European Union's (EU) Financial System'. A lack of confidence in the representation of the underlying economic financial position and financial performance in financial reports fueled by the belief that the existing accounting framework is frequently misapplied and that there are shortcomings and room for interpretation in the accounting framework is cited as one of the risks and vulnerabilities.

Some of the main relevant topics in connection with financial reporting made include:

  • valuation of complex financial instruments, notably in illiquid markets,
  • timely and sufficient recognition of impairment losses of financial assets measured at amortised cost,
  • valuation of goodwill and deferred tax assets in light of profitability prospects, and
  • overall transparency of financial information provided to the market.

As regards the valuation of complex financial instruments, some hope is put on IFRS 13 Fair Value Measurement, however, the report stresses that "[r]igorous application of the new requirements is necessary in order to accurately represent the fair value of complex financial products in financial reports".

The ESAs also believe that the new expected losses model regarding the impairment of financial assets will contribute to restoring confidence in financial reports as the "too little too late" problem regarding the recognition of impairment losses will be alleviated.

Lastly, the ESAs are convinced that increased transparency leading to more confidence will be achieved within a comparatively short time frame: "New accounting standards, currently under discussion, regarding classification and measurement of financial assets, impairment and hedge accounting should help to increase the level of transparency of financial reports by decreasing the number of classification categories and impairment models and aligning risk management practices more closely with financial reporting."

The full report is available on the ESMA website. Chapter 5 of the report is dedicated to Risks to confidence in balance sheet valuations and risk disclosures. The EBA has published a press release on the publication of the report on its website.

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