Global Debt Situation - Fair Value - Financial Statements - Paradigms

The global economy is in a tailspin. Politicians and economists like us to believe otherwise amid  worsening job losses and a weakening US dollar. The graph of the USD vs. gold price shows the fall in value of the USD. This situation throws up questions for the auditor/CFO/accountant and others involved with financial statements. Analysts would  also need to evaluate the fair value of assets on financial statements in this evolving situation. In this analysis I look at some of  these questions.

1. The value of debt instruments is subject to many variables but at the core is dependent upon the capability of the ultimate borrower to repay his contractual obligations.

 

2. A worsening global debt situation and a increase in job losses only shows that  the ability of  borrowers to repay their loans and other fixed obligations will deteriorate.

 

3. This would naturally lead to a fall in the value of  the  derivative based upon these obligations.

 

4. CDO's and other instruments which are based on the value of these instruments will obviously face a decline in their value.

 

5. Analysts will then need to question what were the documented variables based on which the value of the CDO's were quantified.

 

6. The dichotomy in fair values as presented in financial statements and as reflected with changes in the economy can lead to surprises for analysts in terms of the real value of the assets of the enterprize.

 

7. Some of the questions which analysts will need to ask when evaluating financial statements with large exposures to derivatives and CDO's are:

8.The fact that the recession is far from over is indeed a challenge to preparers, auditors and users of financial statements.

 

 

 

Nitish Grover consults with leading institutions through GLG