A Summary of How Revenue is recognized within the Construction Industry under IAS 11
Title: Revenue Recognition: Construction contracts are designed to meet specifications for the negotiations on how assets are constructed or combined to meet their ultimate objectives (Buschhüter, Michael & Andreas 2011). Contract constructions may involve fixed prices where some are subjected to the cost escalation costs. On the hand, a cost plus contract involves reimbursements or allowable and percentages of costs or the fixed rates present. The changes were made to meet the standards of Financial Accounting (IFRS 15 2014). Revenue is considered to be income earned from everyday activities as it goes by different names such as royalties, dividends, interest, fee or sales.
Revenues that are to be recognized would be from the selling goods, providing services royalties and interest. However, in this case, revenue is to be recognized from the construction of contracts. Construction contracts may be either fixed or cost plus contracts or a combination of the two (IAS 11 2011).
In this regard, a contractor needs to identify and determine what contract to use to know when to recognize revenue and costs as well. When the outcome can be properly estimated, the contract revenues and costs would be recognized as revenues and expenses respectively at the end of the contract period. A loss is also recognized as an expense by the accounting standards.
In fixed price contracts, construction contracts are estimated reliably once total contract revenues are reliable. The revenues are considered as benefits since the effects will be felt positively by any business. Stages of contract completion, as well as, the contract costs have been reliable to meet the standards. All contract costs are to be measured reliably to account for the actual contract costs that would be incurred when compared.
Similarly, for cost plus contract to be enforceable, the economic benefits of the contract have to be passed to the entity. The costs have to be also clearly and easily identified for measurements to be done reliably (IFRS 15 2014). The recognized revenue at the end of a contract is considered to be the percentage of completion. This whereby the contract revenues are matched with the contract costs and then reported in the books of account.
Afterward, the contract revenues and costs are recognized as revenues costs in the profit and loss account. The expected excess of costs over revenues is treated as expenses. If the outcomes are not measured reliably, the revenues will not be recognized and perhaps not even recoverable in the business. An entity will then disclose the revenues recognized during the accounting period as techniques of arriving at the revenues will be recognized as well.
A Description of the Process of Developing New Standards IFRS 15
The International Financial Reporting Standard had to be formed by the Internal Accounting Standards Board; IASB to provide rules and procedures on how to account for revenues that are from customers. There were significant differences between IASB and the IFRS when it came to the definitions of revenue.
Even though they were almost similar, the different understanding of revenue resulted in different ways of treating revenue in financial accounting. The IASB thought they had not given enough revenue standards, policies and procedures on how revenue was treated (IAS 18 1993).
The IASB began working on the issues to try and formulate ways it could solve the issue from 2002.Their first review paper was released in 2008 as they further discussed it and gathered information from relevant sources. Afterward, a release on the exposure draft was done proposing the new accounting standards in 2010 and 2011. After a long process of deliberations and reviews that took several years, the IASB issued the final standard on 28th May 2014.
Changes made about the IAS 18 included recognizing and measuring financial tools revised in 2003 and the 2004 revision of insurance contracts. In 2007, the presentation of financial statements was reviewed through amendments in the different terms used. Their first issued review in 2008, involved investment costs in jointly controlled entities and subsidiaries as well as improvements on the IFRS. The same year also saw IFRIC agreements on issues relating to the constructions of the real estate.
The IFRIC 15 also dealt with issues of the non-monetary contributions by investors in entities that are jointly controlled as they evaluated all legalities in leasing or substance transactions. Barter trade and service concession agreements were also made as they issued customer loyalty programs in 2007 (IAS 18 1993). The IFRS 15 model follows procedures that begin with the; identification of the contracts as well as all individual parties involved.
Transaction prices are also determined as the prices are allocated to the different obligations in accounting. Revenues are finally recognized as the performance obligations are fulfilled. The amount of revenue to recognize and when acquiring costs are capitalized as assets are under the guidelines of the IFRS 15. Any of the expenses not capitalized as assets are considered to be expenses incurred. After all proper recognitions are reporting is done, financials are to be properly disclosed by the company.
Why the Process of Developing New Standards has proven to be difficult and Time-consuming
The new revenue recognition standards had left out key areas that bring in revenue and had not been recognized. New standards on how to recognize revenue had to be set for businesses to follow by the relevant bodies. The objective of the new set of rules and procedures is to explain how the different revenues would be treated.
Revenue recognition is recognized when it estimated to bring economic benefits that are measurable to the business in the future. Therefore, practical guidance is given on how the criteria will be met. The International Accounting Standards Board adopted previously issued the construction contracts and the new standards of recognizing revenue.
IAS 18 was put in place to replace the former methods of recognizing revenue while the IAS 11 replaced some accounting rules on the construction of contacts (Buschhüter, Michael & Andreas 2011). This is to help in knowing how to treat costs and revenues that are associated with the nature of activities undertaken.
Also, due to the then existing rules, changing to new standards had to take long processes of deliberations that were time-consuming. Steps had to be followed as described above as company’s found it hard to easily and quickly adapt to the new set of rules. The new set rules had to be then applied first to see if they would meet the specifications with no interference of other accounts that would result in imbalances in the financial statement and misappropriation and misallocation of resources.
Changing one side would have to result in changing of the other side to cancel out the effects. For instance, in ledger accounts, a debit entry has to be followed a credit entry and vice versa is also true.
What people do not know is that different firms have different accounting rules they follow. A majority however, follow the international standards while others follow the U.S. GAAP principles (Kieso, Jerry & Terry 2010). Unlike the U.S. GAAP, the International Financial Reporting Standards does not always give extensive regulation prompting the need of having some exercises in judgments in some instances. The U.S. GAAP accounting is based on standards while the IFRS focuses more on principles.
The accounting differences have made the financial comparison between different organizations difficult. For instance, actuarial gains and losses are treated differently. They are treated as off-balance sheet items by the IFRS standards unlike under the U.S GAAP. The off-balances in the balance sheets would cause volatilities and fluctuations. Therefore, the IASB is trying as much as it can to harmonize the differences in the standards. This would also take time as the harmonization would require changes in almost every aspect of accounting (IASB 2006). Adaptation by firms would take time as well making it a difficult and a long, tedious process.
A Summary of how the New Standard IFRS 15 would Deal with a Construction Contract where Construction Happened Over One Accounting Period
The important principle of IFRS is that a company would have to recognize revenue for it to be related to the transfer of the commodities and services that were promised and what the company is expected to get. Services rendered depend on the agreement of the specific time it should cover. The period might exceed one accounting period as would be expected.
An accounting period is often considered to take one year. This, therefore, means that more than one accounting period takes more than one year. The work done at construction contracts usually take more than one accounting period. Therefore, rules have to be set that best suit the situation. One of the methods is to recognized revenues or profit at the end of the contract. This would be through following the IAS 18 – Revenue (IAS 18 1993).
Recognizing profit at the end of the period does not show that profit was accrued. Under the IAS 11 all revenues and costs will be matched to the accounting period and documented at the end of each financial period (IAS 11 2011). Recognition of profit at the end of the contract would see the company reporting spikes or rises in profits that may not often be matched with the accruals. This is because the revenues would have accumulated to amounts exceeding what would have been recognized in one accounting period (Ursachi, Antonela, & Geanina 2014).
In this regard, revenues and costs are only recognized once estimations of the outcome are reliable. As stated earlier, properly estimated outcomes from contracts should be reliable for use and interpretation. An expected contract loss should be recognized immediately. The completion stage would be calculated on the basis of sales, costs, and physical proportions.
Revenue recognition done at the end of the construction contracts is known as the percentage of completion method. The reported revenue and costs would later be credited to the proportion of work that was completed (IAS 11 2011). The contract revenue is recognized as revenues while the contract costs as expenses in the profit and loss accounts. Similar to when accounting was done in one accounting period, expected amount that exceeds when contract costs are more than contract revenues are treated as expenses.
Buschhüter, M & Andreas S 2011, ‘IAS 11–Revenue Recognition & Construction Contracts’, Kommentar Internationale Rechnungslegung IFRS. Gabler, 374-391.
International Accounting Standards Board Revenue Recognition: (IASB) 2006, ‘International Financial Reporting Standards (IFRS’s): Including International Accounting Standards (IAS’s) and Interpretations’, International Accounting Standards Board.
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Corporate Accounting – Significance, Application and Standards
Corporate Accounting is one of the major parts in financial management procedures of an organization. Accounting practices are necessary for a company in order to show how an organization has been successfully operating over the course of the year and making future plans for budgets and expenditures (Das, 2011). However, it is studied that accounting is a broadest term which have several branches and areas for different business and for different purposes. In which some of them are financial accounting, cost accounting and corporate accounting (Malwitz, 2008). However, this paper is merely focusing on defining the corporate accounting by incorporating corporate accounting theories, significance, concepts, legislation, applications and standards.
Corporate accounting is a special branch of accounting which can be defined as the quantity, recording and interpretation of financial information and data of a limited company which can be either a public limited company or a joint stock company (Fyler, 2013; Ijiri, 1980). Moreover, it is found that corporate accounting is an accounting which is particularly for larger companies since smaller-scale companies, sole traders or partnerships business cannot implement corporate accounting to maintain their financial record or information.
It is because smaller-scale companies, sole traders or partnerships businesses have not much requirements and demands in order to fulfil the accounting standards and to meet with accounting principles (Ijiri, 1980). On the other hand, large scale organizations or limited companies have sufficient financial information and data that they have to show to the general public and regulatory bodies therefore they have to maintain proper financial records with the help of corporate accounting (Fyler, 2013; Ijiri, 1980; Das, 2011).
Furthermore, it is studied that corporate accounting also deals helps the limited companies or large scale organizations in term of preparing final accounts, maintaining cash flow statements, analysing and interpreting financial results of the respective company particular for any specific events such as amalgamation, absorption, and helps company in preparation of consolidated balance sheets (Paton & Littleton, 1986).
By reviewing several studies, it is identified that the corporate accounting has some basic principles and foundations on which the overall accounting practices are based. The key foundations of corporate accounting include Accounting Cycle, Double Entry Accounting, and financial statements (Bennett, 2013). In which Accounting Cycle involves the regular recording and reporting of financial data or information. The accounting cycle completed within a specific period of time as per the policies of companies. Usually, it completed in a month or year.
Corporate Accounting Cycle
The accounting cycle begins by recording all financial transactions such as cash exchanges or debits and credits by using a general ledger approach. General Ledger is a precise and clear summary of all accounts including payable and receivable (Bennett, 2013; Ijiri, 1980). The next stage of accounting cycle is the adjustment of general ledger which can be done by taking items or entries which are not the direct transactions, such as bad debt, taxes and accrued interest. Thus, it is a key area therefore accountants must ensure that revenues and expenditures are match up as per each accounting period. In case, of accountant failed to do this properly, it can lead to confusion over financial irregularities and at the end of the period it can create confusion in overall revenue and total profit for the period (Bennett, 2013; Ijiri, 1980).
The second key element of the corporate accounting is double entry accounting, which can be defined as the standard accounting concept used by limited companies or large scale organizations. The basic of double entry accounting is based on the notion that for all actions there is an equal and opposite reaction (Bennett, 2013; Ijiri, 1980). It means that when a financial gain takes place in any part of financial statement, it should be escorted by a loss somewhere else on the balance sheet.
Suppose that of if a limited purchases a product to sell, so it will show the decrease in cash in financial statement and in the same way it will show the increase in inventory of certain organization (Bennett, 2013; Ijiri, 1980). Finally, the financial statement is another key aspect of corporate accounting, which is refers to the financial reports prepared at the end of the company’s financial year.
This financial report basically includes the cash flow statements, balance sheets and income statements for the previous 12 months. The financial reports of an organization show the summary and of all financial activity including overall profits or losses incurred by respective company (Bennett, 2013; Ijiri, 1980). Furthermore, it has been examined that the financial report helps accountant of a limited company in terms of preparing tax returns, while stockbrokers and investors use the same financial reports for the comparison between respective company and international business performance.
In addition to this, it is found that the financial reports also help the managers of certain company in terms of a assessing the performance of the company as well as in making proper plan and budget for company to successfully execute its operation in upcoming year. Following is the table that represents the different accounting terms used in UK and USA (Joos & Lang, 1994):
Table 1 – Accounting Terms as Per UK and USA Standards
United States of America
Balance sheet/Statement of financial position
Accounting for loss contingencies
Profit and loss Reserves
Paid in surplus
Shares premium account
Management’s premium of operations
Management’s discussion of financial resources and liquidity
Income statement/Statement of earning
Profit and loss account
Earnings per share
Net income per share
Balance sheet/Statement of financial position
Tangible fixed assets
Property, plant and equipments
In addition to the above, it is identified that in most of the limited companies particularly in UK (United Kingdom) and USA (United States of America), for the preparation of financial reports or execute corporate accounting practices specific accounting standards are used which are only set in common law (Joos & Lang, 1994). However, in different countries, it has been studied that the corporate accounting are different from each other therefore different countries uses different accounting regulations in order to maintain financial records and for the preparation of yearly financial reports.
Furthermore, it has been examined that throughout the world there are two types of accounting standards are used which includes the International Financial Reporting Standards (IFRS) and the Generally Accepted Accounting Principles (GAAP) (Young & Wiley, 2011; Everingham, et al., 2007).In which International Financial Reporting Standards (IFRS) provides rules for business affairs from the global perspective in which the accounts and financials of a company can be understood and compared across international boundaries (Young & Wiley, 2011; Everingham, et al., 2007). On the other hand, General Accepted Accounting Principles (GAAP) provides rules to collect and interpret financial data for multinational competitors with the help of financial statement (Young & Wiley, 2011; Everingham, et al., 2007).
International Financial Reporting Standards
It is further examined that the International Financial Reporting Standards (IFRS) are mostly adopted by the companies operating throughout the European Union. Beside it, the organization in several countries like Australia, South Africa and Russia are also now widely followed IFRS accounting standards for the recording of financial information and analysing and interpreting financial data. In contrast, specifically in the United States limited companies are bound to utilize the GAAP accounting standards for all kinds of accounting practices (Young & Wiley, 2011; Everingham, et al., 2007).
Thus, it has been concluded that, the corporate accounting system allow companies to successfully maintain financial data as per their company policies, regulated accounting standards and accounting principles or laws determined by common law.
Bennett, R. (2013) Corporate Accounting Basics. Free Press.
Das, B. (2011) Is Corporate Accounting a science or an art? Accounting, pp. 1-1.
Everingham, G. K., Everingham, G., Kleynhans, K., Posthumus, L., Kleynhans, J. E., & Posthumus, L. C. (2007) Principles of Generally Accepted Accounting Practice. Juta and Company Ltd.
Fyler, T. (2013) What Is A Definition Of Corporate Accounting
Ijiri, Y. (1980) An Introduction to Corporate Accounting Standards: A Review. The Accounting Review, 620-628.
Joos, P., & Lang, M. (1994) The Effects of Accounting Diversity: Evidence from the European Union. Journal of Accounting Research, 32, 141-168.
Malwitz, M. (2008) Financial Consolidation and Reporting Solutions: Adding Value to Enterprise Resource Planning Systems. Oracle Paper, pp. 1-21.
Paton, W. A., & Littleton, A. C. (1986) An Introduction to Corporate Accounting Standards. Amer Accounting Assn.
Young, E. &., & Wiley, J. (2011) International GAAP 2012 – Generally Accepted Accounting Practice Under International Financial Reporting Standards. John Wiley & Sons.
Critically Evaluate the Use Budgets in the Modern Business World
Research Title: Budget Plans. The Proprietors are always obliged to carefully plan and audit their find if they are to maintain their businesses regularly. For recognizing, measuring and calculating and reporting finance data, organisations rely upon accounting software. Moreover, there are others tools which incorporate planning, monetary proclamation, estimation and different apparatuses for the overseeing of finance data. Out of all the accounting tools used by organisations, businesses budgeting ones are the ones that are seen as the exceptional ones. What “Budget” entails is an incisive analysis of the organisation’s future spending strategy and plans.
Most organisations try to create their yearly budget plans on a yearly basis so that take into account every spending need in that office. A yearly budget plan entails that capitals assets that the organisation would try to acquire would not be easily done so because of the confines on the time. Small organisation differs from the big organisations in the sense that they are able to complete their budgets plans without having to consult experts in the field.
Knowing a budget means that you will not hastily spend money on operations that are relatively unimportant or of least priority, similarly having a budget ensures that the precious capital is properly used on only those economic resources that are worth your time and money. This naturally entails that the business organisations and owners may have to check for alternate sources of supply or vendors, and cutting down miscellaneous costs. Having a budget properly mapped out gives the company a sense of direction of how they are going. It will also mean that you are able to bring about a comparison with the budgeting that happened the previous year and where and how the discrepancies occurred and if there is a way to resolve them. In the case of a budget fluctuation that had occurred due to an unexpected incident, such as an increment in the sales income, then it is not necessarily a negative business circumstance, instead, it is an opportunity, for the organisation to create to recollect and build a monetary allowance sum for future deals and increments.
This is where the flexibility of the budgets comes into the limelight, as it is capable of being edited into a plan which prepares the organisation for any imminent development or extension. The money saved due to budgeting spending can be utilized in the way of injecting it into a store account which is used to finance the selection of new business opportunities. This type of planning ensures that when the scenario arises when you have to close a deal to ascertain a possible expansion in business operations, it can be done without having to scramble for finances. These extra capital saved can be utilized during times when there is a moderate progress for financing operational expenses. With the aid of an accounting or business program, organisation will be able to, more efficiently, create budget plans that allow them to plan their finances and monitor costs. Similarly, it is possible for them to create a better accounting plan or procedure that makes it possible for creating and overseeing spending plans, by virtue of data gathering. Therefore, software such as these is imperative for budgeting and data collection in a consistent and constant arrangement.
Critically Analyses the Figures Shown in the Cash Budget
After careful examination of the monetary proclamation of Ground Ltd, it is inferred that the records receivables are consistent at Euro 464,480; therefore, there is no visible variance or occasional ones in deals. There at least 6 turns of the record receivables during a year, or during regular intervals, they turn at least once. The Stock during this time is constant at about Euro 484, 480 and only turns over at regular intervals. On the other hand, the records payable have a tendency to turn over at least eight times a year, like clockwork. The time for records receivables is about 60 days and the equalization remarkable stays at Euro 484, 480, which gives the impression that Euro 464, 000 is the sum that is ought to be gathered on the receivables after 90 days. From such a point of view, a stock of Euro 1,000,000 at retail that turns on regular intervals and Euro 750,000 traverses the records receivable, and then it is imperative that about Euro 250,000 ought to be the amount that is sold on money premises alone.
It is estimated that the costs for money installments is 150,000 Euros for the coming 90 days. One can easily check this figure if they were to allude to the pay articulation costs. If there happens to be a measure of the money costs that is relatively unpleasant, so to speak, then it can be acquired by a deft utilization of working costs minus non-money costs, i.e., devaluation. In a scenario where there is no regular variable at work, then it is often the case, that he aggregate sum is divided by four, which will in turn keep an eye on the sum planned for the subsequent 90 days. Cash budget, will have an estimation of the anticipated sources as well as the purpose and use of the future cash costs. This purpose of the budget is to give a measurement of the cash needed to meet anticipated money necessities. If it is not possible, then it is up to the administration to find new sources of income and cash, and the inputs are only gathered from a small collection of different budgets. When the trade spending plans is spent upon, all that remains will be used for the financing the future budget, that in turn organizes ventures, debt, interest salary and expenses.
There are two areas of the cash budget – the sources of cash and the uses of cash. The former consists of the starting money equalization, cash money receipts, debt claim collections, and offer of advantages. The former consists of arranged money uses, start spawn from material budget, direct work budget, overhead budgets and expense budgets that is part of the selling. It will also contain a multitude of details for settled resource purchase and profits to shareholders.
In the unlikely possibility that there exist certain bizarre and extensive trade equalization, they are adequately maintained in the financing budget plan that shows the any possible ventures for them to consider. Similarly, if there exists any negative parity inside the cash budget, then it is inside the financing budget, a clause that details how to manage these equalization by means of stipulating a certain time and measure for this obligation.
In the illustration given, we found that an expert spending plan of organization proceeds here with the planning of calendar of expected money accumulations. The business figures are acquired from the business budget of the organization. 70% of offers are relied upon to be gathered in the quarter in which deals are made and the rest are required to be gathered in the following period. Bad debts are insignificant. Also, an exorbitantly substantial profit installment in the second week of the budget plan, combined with a vast resource buy in the next week, puts the organization in a negative money position. Paying out such an extensive profit can be an issue for banks, who don’t prefer to issue credits with the goal that organizations can utilize the assets to pay their shareholders and along these lines debilitate their capacity to pay back the advances. In this manner, it might be more astute for the organization to consider a little profit installment and maintain a strategic distance from a negative money position.
Ways in Which Cash Budget Can Be Improved
Balancing cash will occur quite impressively inside a solitary accounting period that will entail the concealment of cash which is often quite fatal for many organisations. In order check the arising of such situations, then it is necessary for maintain a cash conjecture on a weekly basis. These transient plans are sensible for only a month, but then the ability to anticipate any occurrence of delays quickly vanish, and then the organisation is coerced to plan on a month to month basis. What happens during this tumultuous time is that the plan created is lost in significance after a month and to a great extent absolutely erroneous after two months.
In its least complex structure, income is the development of cash all through your business. It is regularly portrayed as the procedure in which your business utilizes money to create merchandise or administrations for deals to your clients, gathers the money from the deals, and after that finishes this cycle once more.
There are few ways to improve cash budget like making ordering your product for customer easy and by improving commitment and handling well the shipping process. Accelerating the trade change period out this region requires that you utilize the fastest method for conveying your items or administrations to your clients. Superfluous deferrals in the transportation and treatment of your items or administrations can include countless to your money transformation period, also the negative effect this can have on your client connections.
Another important way to improve cash budget is the completion of the invoice properly. Your absence of consideration in this stride can accidentally protract the money transformation period. Your receipt really starts the money gathering process for your finished deals. You’ve presumably made sense of at this point most clients don’t pay without first getting some type of receipt for the products or administrations you sold them. Receipts serve as a suggestion to your clients that your products or administrations have been conveyed. Receipts additionally serve as a suggestion to your clients that they have a commitment to pay you. Apart from this, you can give some credit considerations to your client. With existing clients or customers, it is best to envision bring up in their credit limit at whatever point conceivable. This can be done by taking a gander at the client’s present credit point of confinement and contrasting it and your normal levels of business with them. You can maintain a strategic distance from postponements in satisfying their request on the off chance that you can settle on your credit choice well in front of the client’s solicitation for an adjustment in their credit limit. Foreseeing existing clients’ credit needs can fundamentally diminish your money transformation period, and awe the clients in the meantime with your eagerness to expand their credit limit.
Steven, M 2003, ‘ Budget Economics: Principles in action’. p. 502. ISBN 0-13-063085-3.
Panagariya, A 2008 ,’The Emerging Giant’ p. 514. ISBN 978-0-19-531503-5
The financial crisis commenced in August 2007 after the preceding inflation. The crisis became more defined throughout 2007 and gained momentum in 2008. This took place even after the financial regulators and the central banks’ tireless attempts to tame the situation. It is alleged that the main factors that influenced its manifestation include corruption, fraud, speculation, greed, bankers and bankers’ bonuses. However, the academic discourse, politics or media has been unable to solve the mystery surrounding the main causes of the crisis. The mystery is academically relevant to the world of research just like the Great Depression, whose causes are still being discussed. Other sources believe that the crisis might have been as a cause of human failures especially following the refusal to bail out the Investment Bank Lehman Brothers. The housing bubble was the immediate trigger of the 2008 financial crisis. The following were the triggers under the housing bubble.
A subprime mortgage is the mortgage that is readily acceptable without imposing strict measures of standard on it. Before the 2008 financial crisis, there existed a fierce competition between mortgage lenders. The competition between the mortgage lenders ensued from the struggle for market share and revenue. It also took place in tandem with limited supply of creditworthy borrowers which put unconditional stress on the financial institutions. The relaxing mood by the mortgage was apparent and hence less creditworthy borrowers were granted mortgages. This was a financial err due to failure to adhere to high standards of lending and hence riskier mortgages were granted to the borrowers. This was also evident in early 2003 where the Government Sponsored Enterprises (GSE), due to their conservative nature, sustained relatively high underwriting standards. The Government Sponsored Enterprises also policed mortgage originators prior to 2003 while maintaining high underwriting standards at the same time. Consequently, the market power shifted originators straight from the securitizers and hence led to tight competition between Government Sponsored Enterprises and the private securitizers. This competition undermined the power of Government Sponsored Enterprises and therefore compromised the mortgage standards. The situation also led to proliferation of risky loans.
During the years preceding the 2008 financial crisis, there was a competitive pressure that ultimately accelerated the subprime lending by the investment banks in the United States and Government Sponsored Enterprises such as Fannie Mae. The Fannie Mae became the biggest lender while the GSE relaxed their quest for the purpose of catching up with the private banks in the United States. Summarizing the subprime lending, there were low bank interest rates, existence of abundant credit and hiking prices of houses. Due to these, there was relaxation of the lending standards and hence the increase in the number of loan borrowers. Through the scheme, the borrowers were able to borrow loans to buy very expensive houses that they could not afford initially. Later on, the house prices started to decline, the loans went sour and hence the cause of shock to the financial system and the global economy. This happened prior to 2008 and hence it can be declared as the major instigator of the 2008 financial crisis
Growth of the Housing Bubble
Identification of a bubble is complicated before it bursts. It is counter intuitive to state that early detection of the housing bubble and its immediate eradication is the best mitigation practice. However, mitigation of housing bubble is the worst thing to do because it can damage the economy. It is advisable to wait for the housing bubble to burst and then respond to its effects.
The housing bubble, as far as the 2008 financial crisis is concerned, led to 124 per cent increase in the price of typical American houses. The bubble took place between 1997 and 2006-approximately one decade. The bubble had drastic consequences on the economy and especially to the home owners in the United States of America prior to the 2008 crisis. The homeowners started to finance their mortgages at very low interest rates and hence denying the financial banks room for development. Other homeowners picked on securing secondary mortgage loans due to appreciation of prices.
The housing bubble started to collapse in early 2006. Several factors led to the bursting of the housing bubble. There was decline or stagnation of the hourly wages in the United States of America between 2002 and 2009 and hence house prices could not continue rising. This is because the houses had become completely unaffordable. The second cause of bubble bursting was as a result of increased supply of houses due to the high market demand. Consequently, the supply of houses superseded the demand in the market. This case reduced monopoly by the housing providers and later increased the desired healthy competition in the housing industry. As a result, the house prices began to decline due to the high supply and less demand. The above causes were also related to the subprime lending-another cause of the 2008 financial crisis.
Increased Debt Burden or Over-Leveraging
Before the 2008 financial crisis, there was an increased leveraging of financial institutions. The institutions were very optimistic and hence they did not mind engaging in risky investments. They also set up smart measures that would cushion them from the unexpected consequences. The leverage entailed the use of complicated financial tools such as derivatives and off balance sheet securitization. This was risky because it denied the financial monitors and crediting institutions the capability to curb the impending risks. It became harder to reduce the risk levels due to the vulnerability exposure by the financial institutions and their subsequent moderations. Consequently, the measures could not curb the stress on the financial institutions and hence exacerbating bankruptcy of several commercial banks and other lending institutions.
There was evidence of over-leveraging by the financial institutions in the United States during this prime period. The financial institutions became highly indebted just before the 2008 financial crisis set in. The institutions were hence vulnerable to the failure of the housing bubble. The economic tantrums became worse in precedence to the crisis. At this time, the U.S household debt hit 127 percent in 2007, up from 77 percent in 1990. Allegedly, the debt led to economic recession that in turn led to the fall in employment rates and increased credit losses by the involved financial institutions. Other effects were also felt prior to the crisis as far as the household and the financial institutions finances are concerned. After the spread of the balance sheet leveraging across the economy, consumers started to save on the purchase of durable goods, businesses started to lay off workers, planned investments were cancelled and the financial institutions started to freeze their assets to improve their financial stability while bolstering capital.
Following the collapse of housing bubble in early 2007, prices of essential commodities increased. The increase in commodity prices was one of the very many consequences of the housing bubble burst. The housing bubble, according to economists, was very stressful to the household economy and the banking institutions at large. Consumption of certain commodities was either regulated or cut off to increase on savings and carter for the other basic needs. To prove this, it is on record that the price of oil was approximately three times the initial price. The price tripled to US $147 from a mere US $50 between 2007 and 2008. There was speculation that money was flowing from the household finances into commodities. The financial institutions were also blamed for the increased commodity prices. There existed an acute shortage of raw materials and hence increasing the cost of production. This scenario subsequently raised the prices of essential commodities. The raw material crisis was somehow contributed by the Chinese dominance in Africa and the other potential states in the world.
The soaring prices of oil directly affect the arithmetic involved in consumer spending. Most often, production cost is transferred to the consumers who are required to spend more on gasoline and gas than on the other essential commodities. During the 2008 financial crisis, house bubble was part and parcel of all these occurrences and hence its exacerbation as a result. The pending issues were not solved in accordance with the economic situation due to the surging oil prices. The oil producing countries were the main beneficiaries of this scheme as they ended up accumulating most of the wealth. Apparently, the oil importing countries had to spend more in purchasing the oil and hence the cost of commodity production in the respective states increased. The consumers were the main sufferers because they had to redirect finances from other avenues to settle the commodity bills. Copper and Nickel prices also went high prior to the crisis. Without any doubt, it is evident that the effects of the price instabilities and price variations contributed to the financial crisis.
Role of Economic Forecasting
Economists are the principle advisors whenever economic issues such as depression, recession and stability are concerned. They are required to analyze the past financial crisis and should be responsible for forecasting any impending economic crisis. They are also required to advice the ordinary people, stakeholders and financial institutions on economic trends, future crises and the mitigation measures of mitigating them. An unfortunate occurrence took place prior to the eruption of the 2008 financial crisis. The crisis was not predicted by the mainstream economists in the United States. However, it is rife that several heterodox economics had a feeling of the occurrence of the crisis but there was an argument of misunderstanding between them. They had varying arguments on the estimating of the appropriate time of the crisis. Only 12 of the economists managed to predict the crisis. They included Eric Janszen of the US, Dean Baker of the US, Fred Harrison of the UK, Wynne Godley of the UK, Kurt Richebacher of the US, Peter Schiff of the US, Nouriesl Roubini of the US, Steven Keen of Australia and Denmark’s Jens Kjaer Sorensen.
Schools and other economic institutions also predicted the crisis. The schools based their predictions on observing the effects of artificial and laxity in the supply of money. It was also stated that the economists were unable to predict the crisis since the 1930’s global Great Depression. There were several articles including the New York Times and other university journals that had a revelation of the occurrence of the 2008 global financial crisis. However, from the economic school of thoughts’ perspective point of view, it is stated that predicting financial crises is a nearly impossible task.
Impacts on Financial Markets
The 2008 financial crisis impacted negatively on financial markets. Since the financial markets greatly affect the economy, various stakes were upheld and hence the stress on the economy. The impact was evident on the U.S stock market and the other financial institutions.
U.S Stock Market
In October 2007, the stock market in the United States peaked after exceeding the Dow Jones Industrial Average Index with 14, 000 points. In early 2008, the stock market started experiencing a steady decline until it reached approximately 6, 000 points by March 2009. The statistics started to flourish again between March 2009 and early 2011 when it exceeded 12, 000 points. The points were recorded above 13, 000 points by 2012. This was a positive improvement based on the comparison between the performances of the stock market during 2007, 2008, 2009, 2010, 2011 and 2012. The steady increase was quite beneficial to the economy of the United States at a time when it was experiencing the most drastic effects of an economic downtown.
Partially, the quantitative easing technique that was applied by the Federal Reserve’s economic policy of aggression was behind the success of recovery of the United States stock market. The recovery of the United States stock market back to its functional status was a welcome effect that was essential to curb the effects of the financial crisis and mitigate the future occurrences of the same caliber. The positive performance in the stock market was also attributed to various factors concerning the efforts steered by the financial community to save the economy from succumbing to the financial crisis. The poor performance by the United States’ stock market was also experienced during the Great Depression.
Financial institutions are a conglomerate of bankers and providers of banking services. Lending firms and institutions are also part and parcel of the financial institutions. There was an estimated amount of money by the International Monetary fund alleged to have been lost by the U.S banks and European banks. The estimated amount of the lost money was $ 1 trillion. The money was lost through poor techniques of loan allocations between the time period of 2007 and September 2009. Approximately 60 percent of American banks were affected while 40 percent of the banks in Europe were affected.
Northern Rock bank of Britain was one of the worst-hit banks in the European region. The bank engaged in over leveraging matters of business that later forced it to seek security and protection from the Bank of England. This led to bank-run and instilled panic among the investors in September 2007. The bank’s management was then put under the receivership of the public by the British government after failing to secure the interests of willing private investors to take control of the bank. The Northern Rock’s scenario was just an indication of the very many problems that the other financial institutions were facing. The mortgage lending firms were the most affected since most of them became bankrupt. They were unable to secure their loans and financial benefits from credit markets. Almost all financial institutions predicted danger in terms of downfall and bankruptcy. The consequences included complete failure of the institutions to survive, subjection to takeover by the government or fire-sale in terms of duress acquisition by the willing investors. Most of the U.S and European banks were completely eliminated from the financial map.
Effects on the Global Economy
Global economy is supposed to be sustained at all costs. It is responsible for diversification of the resources and economic empowerment of the countries that operate under one umbrella. When one country is hit by an economic crisis, the other countries that engage in economic activities with the affected country are likely to experience an economic shakeup. Financial crisis is just like any other crisis but its effects are the most tragic because they impair economic growth. Economic stability is beneficial to a country while its instability has negative impacts on both the country and the citizens within its borders. Matters of economic interest are given the first priority when it comes to security and protecting citizens from economic depressions and its aftermaths such as high production costs, high interests on the borrowed funds and the subsequent increase in commodity prices. Apparently, the 2008 financial crisis affected several states both directly and indirectly.
Analysis of the commentators’ suggestion is welcome for argumentation. The commentators, with too much experience in the world economic trends commented on the impending effects of liquidity on the global economy. However, if the liquidity crisis persists, recession is likely to continue manifesting. With no mitigation measures urgently put in place to curb the liquidity crisis, it is likely that even more drastic effects of the recession will be experienced. Continued persistence of the financial crisis is predicted to affect the global economy which in turn can cause a collapse of the economy if not mitigated as soon as possible. This is an argument from a group of certain forecasters. Contrary to this argument, there also exists another group of optimistic forecasters who believe that financial crisis is not likely to affect the global economy.
School of thoughts has it that the financial crisis is likely to cause a major shakeup in the banking industry due to the melt-down of loans and savings. In mid-October 2008, the Investments Banks in the United States and the United Kingdom declared that continued financial crisis was a clear-cut indication of an impending global recession. They even had the audacity to estimate the time it would take for the global recession to start manifesting itself. They estimated the minimum period before the global recession could start shaking the economy as two years or less. Later on, the economists predicted that the crisis would end soon and that it was now the beginning of its end. This was evidenced by the efforts made by financial stakeholders in the world. This action was supposed to mitigate the financial situation immediately. Subsequently, the government injected reasonable capital into the economy that facilitated the cut-down of interest rates. This was one of the initial steps meant to enhance the well-being of the interested borrowers or the borrowers who were still repaying their loans. This meant that mortgages were now more affordable or better off. Their repayment was made cheaper as compared to the previous times when they were very high.
The United Kingdom was clever enough to mitigate the effects of the financial crisis by injecting the mentioned capital into its economy. The central banks across the globe were forced to cut-down the bank interests imposed on borrowers. This sufficiently helped to revive the deteriorating economy by attracting large numbers of borrowers. The United States was also required to systematically inject capital into its economy. This was not meant to completely mitigate the crisis because the worst was expected. It was only meant to deal with the financial crisis at that time but not the main solution to the crisis and the presumably impending economic crisis such as the global economic recession.
The UBS had already estimated the presumed duration of the expected recession in various economic power houses in the world. Recession in the Euro zone was to last for an approximated period of six months, the United States was to experience it for three quarters while the United Kingdom was to face a recession that would last for four quarters. Iceland is an example of some of the commonest countries on earth to be directly affected by the financial crisis. There was a major banking collapse in Iceland. It is still rated as the world’s major banking collapse in the history of economy.
The other countries in the world were also affected by the crisis because the Unites States was by then, the biggest shareholder in the world economy. Its spending habits were very beneficial to the world and hence it is intuitive to state that the rest of the world depended greatly on its success. The negative effects on the global economy were first observed in 2009 when Japan experienced a 15% decline in its GDP, 14% in Germany, 21% in Mexico, and 7% in the UK. The other developing countries also suffered significant slowdowns in their economic trends. However, the Arab World was least affected by the financial crisis because there were different sources of finances.
The government of the United States was supposed to establish the most appropriate mitigation measures and thereafter implement them for the purpose of streamlining the economy and its subsequent cushioning from any future crisis. There were various measures that were lined up by the government to gain both temporary and permanent stability of the economy. The two main responses included the short-term and emergency responses and long-term responses and regulatory proposals.
The Short-Term and Emergency Responses
The central banks across the world and the US government under the jurisdiction of the Federal Reserve have put the most appropriate measures in place to facilitate money supply and prevent occurrence of deflationary spiral. Deflationary spiral is the situation where high employment rates and lower wages cause low global consumption trends. The governments are also spending and borrowing funds from outside sources to increase demand by the private sector. The Federal Reserve in the United States dealt with the emergency by expanding liquidity facilities to enable the central bank to carry on with its duty of lending money. In mid-2008, the Central Banks and the Federal Reserves responded promptly to the crisis by settling government debts and buying private assets from the hard-hit banks. The European governments and the United States raised their national banking systems’ capital by approximately U.S$ 1.5 trillion. They purchased stocks from the major banks to set-off the liquidity saga. To curb further liquidity, the U.S government decided to create currency valued at approximately 600 Billion dollars and injected them into its banks. Brave enough, the banks invested the money in foreign investments and currencies.
Long-Term Responses and Regulatory Proposals
There was a series of regulatory proposals introduced in 2009 by President Barack Obama of the U.S. The contents of the proposal included consumer protection, cushioning of bank finances, and regulation of the systems involved with shadow banking. Another proposal was to limit involvement of banks in proprietary banking. In Europe, the regulators drafted regulations for their banks. The proposals required the banks to amend their liquidity requirements, increase capital ratios and limit leverage. The regulations have since increased lending to the government by the banks and hence increasing the risk of a possible financial crisis. More lending to the government has been encouraged.
Without the long-term, short term responses and regulatory proposals, the crisis could have worsened and even led to a global economic recession. The government of the United States through its Federal Reserves, the government of the United Kingdom and the economic regulators in both countries were pivotal in mitigating the crisis and preventing a repeat of the same in the future. The short term measures were meant to deal with the situation immediately before the most appropriate long-term measures could be approved and implemented. The proposals were also implemented by various central banks across the affected nations in the world. The United States led the other nations such as the United Kingdom in the fight against the financial crisis through the most appropriate short-term and long-term responses. A positive improvement was observed as the economy started to be more stable and sustainable. The proposals were also very significant because they managed to streamline the banking systems which are still effective at the moment. There is optimism that the measures and proposals will continue to be effective for the purpose of decreasing the probability of occurrence of another financial crisis in the future. These measures and proposals are still in place up to now though with subjectivity to legislated amendments.
Response by the Congress of the United States
The United States-being the worst affected by the financial crisis-sort assistance from the law makers and the Congress. Under the leadership of President Barack Obama, the congress and the senate were required to pass the most important financial Bills into law. The Bills were meant to cushion the U.S economy from any impending financial crisis. Stability of the economy was achieved after the implementation of the Bills. At the end of 2009, the House approved a Bill titled Wall Street Reform and Consumer Protection Act 2009. The Act was enacted to protect the consumers against exorbitant prices of consumer goods and services. The interest rates were also shelved for the benefit of borrowers. Another response involved the enactment of Restoring American Financial Stability Act 2010 in mid 2010 by the U.S Senate. Several other Acts were enacted in response to the financial crisis. Meanwhile, in April 2012, a court in Iceland prosecuted a former Prime Minister for instigating the Icelandic Financial Crisis between 2008 and 2012.
Economic stability was the main remedy for the persisting financial crisis which impacted greatly on the global economy. Stabilization was to be achieved through the well-researched mitigation measures. The affected economies were supposed to get back on their feet after nullifying the threat from interfering with their finances. The United States and the United Kingdom were the front runners in ensuring economic stability.
The U.S recession lasted between December 2007 and June 2009. Similarly, the financial recession also ended at the same time. By the beginning of 2010, President Barack Obama declared that the markets were stable and that he had managed to retrieve the money spent on the banks during the crisis. The stability can also be evidenced by the observed growth of most stock markets. However, fundamental changes are yet to be made on financial markets and banking.
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Budgetary control is always followed by budget preparation. Budget needs not only top management assistance but also the control is supported by “participation of budgets holders into the investigation of solution to the problems which arise”
Budgeting acts as a service function because these did not put back management. Organizations draw budgets to achieve excellence and meet strategic business plans to avoid from any failure in future. These strategic business plans are divided into midterm and short term plans for cost minimization and profit maximization. This is a benchmark to measure the results of planned budgets. Reynolds told that budget planning is a source for the endurance of organizations in these highly competitive and challenging organizations.
A case study “Budgeting and budgeting control in business organization” written by Chika Agu (2006) defined that Budgetary control is the deployment of budget as a tool which regulates and guides the business activities and operations. The case study showed that budget is a measuring tool to administratively control operations and to determine whether planned goals are achieved on desired time or not?
Budgeting control system controls cost through budgets. It compares actual results with budgeted one by keeping in view whether obtained outcome matches with planned results. If any divergence from budgeted results is obtained, corrective measures proposal is established to achieve actual performance that matches with planned budget. Core objectives of budgetary control system are comprised of planning, synchronization and control. All these functions are interconnected (Arora, 1995).
Budget meets two fundamental prerequisites in the entire control procedure:
It provides fundamental control which can better help in decision making process in initial phase. These budgetary controls should be made whether the desired goals are rationale or not? Amendments should be made if budget is found irrational.
Feedback provides foundations to measure the effectiveness and efficiency once point of action has been taken into account. This helps to improve previously committed mistakes and unmanageable impediments.
Budgetary control system has following functions:
Planning being an important part of budgetary control system encompasses long term, strategic and short term planning as well. Further, he stressed upon short term budgeting that must admit current environment, tangible, human and financial resources which is available in the organization. (Sizer, 1989). Planning is made by selecting goal and ways to attain them. It has a strong association with budgeting due to similarity in nature. Top management primarily focus upon the importance of planning and they plan where to invest, how to finance and how to increase market share keeping customers loyalty towards their brand. It is also certain that only planning and budgeting are the key survival for an organization.
Research publications by various authors have substantial concern for participative budgeting despite of contradictory findings. Cherrington & Cherington (1973) found that negative relationship exists between budget participation and performance. Merchant (1987) and Brownell (1982) found positive relationship. Participative budgeting is utilized mostly when lower management has immense knowledge than middle management.
Budgetary monitoring and control approach is systematic and unremitting which is simplified by different steps: Establish departmental target performance of each organization by establishing goals to be attained so as to improve overall monitoring and performance of each organization. Communicate detailed budgetary strategy to entire stakeholders to greet and admire established goals and objectives. It boosts ownership of the consequences obtained at the end. Monitoring of real revenues data is evaluated by comparison of actual performance with the budgeted performance; thereby, reporting differences to the concerned officers on continual basis. The reason for variation in achieved data can be sort out and recommendation can be made (Drury, 2006).
Control is set by comparing actual performances with planned and differences are addressed to management for intriguing corrective acts. Control is impossible without planning and it facilitates to maintain expenditures within planned perimeters. (Alesina and Perotti, 1996).
Achievement and accomplishment of the anticipated output data and results, their monitoring and assessments is compulsory. Both monitoring and evolution sustains steadily environment irrespective of various challenging forces; therefore, it is significant to local government effectiveness as well. It is also found that monitoring and evaluation need just raw data for test purpose and consumes a lot of time to scrutinize performance. Therefore, a valuable control system is needed for organizational development and continuous improvement with significant growth.
Horvath & Seither (2009) stated that performance measurement is a continuous process which quantifies the effectiveness and efficiency of each action, being a versatile concept; it also tells use of technology can better improve business functions. It is comprises of entire management planning, controlling and leading concept. Performance measurement could vary from business to business i.e. service sector and manufacturing sector but overall concept remains the same. In case of financial sector, budget performance can be quantified which helps to learn from mistake and perform better in the future.
Performance indicators include input, output, efficiency, effectiveness, cause and effects and outcomes as well. Input can be defines as all the necessary efforts required to keep on a project i.e. land labor, capital, raw material and money to meet necessary expenses. While, output is the outcome of input efforts and these are end results. Example may include budgeted overhead in production department which are calculated by costing department.
Outcomes and organization’s mission are closely related with each other. Outcome measures and evaluation of effectiveness defines the degree, the firm is attains its missions and objectives.
Budget is totally based upon estimations and there is always uncertainty and ambiguity as future is uncertain.
Budget assumptions may or may not actually happen in real life. Many organizations face bankruptcy and insolvency problem due to poor liquidity.
We cannot blindly focus on it and it may affect long term planning and organizations nay face profitability issues.
Arora, M.M (1995). Cost Accounting, Principles and Practice (4th ed.) Vikas Publishing.
Sizer, J. (1989). An insight into Management accounting (3rd ed). Penguin Books Limited.
D.J. & Cherington, J.O. (1973). Appropriate reinforcement contingencies in the budgeting process. Journal of Accounting Research.17 (2), 225-253
Brownell, P., Dunk, A.S. (1991). Task Uncertainty and Its Interaction with Budgetary Participation and Budget Emphasis: Some Methodological Issues and Empirical Investigation. Accounting, Organization & Society.16 (8), 693-703
Drury, C. (2006), Cost and Management Accounting (6th ed). Boston Irwin. McGraw-Hill, 422-471
Alesina, A. & Perotti, R. (1996). Reducing Budget Deficits. Swedish Economic Policy Review, 3(1)
Horvath, P. & Seiter M. (2009). Performance Measurement. Die Betriebswirtschaft, 69 (3), 393-413
Agu Chika E., (2006) Budgeting and Budgetary Control in Business organization. (A case study of Emenite Nigeria Limited Emene Enugu Branch)