Accounting Treatment of Bonds

Abstract

On Friday, March 10th 2023, U.S. financial authorities took over Silicon Valley Bank after a large group of customers began withdrawing their deposits, creating liquidity challenges for the bank. To raise liquidity, Silicon Valley Bank was forced to sell a large holding of government bonds at fair value, which they had accounted for at amortized cost. This led to a change in their accounting practices and a significant accounting loss, contributing to the bank's collapse. In light of this, there were several articles published in Danish newspapers about Danske Bank, which had an unrecognized loss of 12 billion DKK in its 2022 annual report related to the fair value of its bond holdings accounted at amortized cost. Media drew parallels to the 2008 financial crisis and questioned whether a new economic crisis was looming. A Danish economic analyst commented that it only took one bank failure in the U.S. to shake the entire international financial world. Despite banks in Europe and the U.S. being significantly strengthened with financial buffers since the 2008 crisis, the system still appears highly sensitive and vulnerable. The discourse in the articles was quite negative, even though it is not against regulations to account for bonds at amortized cost, which sparked the interest that led to this project. The project aims to investigate the factors influencing Danish banks' choices in accounting for and presenting bonds (as financial assets), beyond whether they are part of a trading portfolio or not. Although accounting rules are quite strict, there is still some leeway in choosing accounting practices for individual items, and for bonds, the focus of this project, there can be a significant value difference between accounting methods. The complexity, strategy, risk management, and other factors can influence the preparer of the accounts, making it a considerable consideration when choosing an accounting method. The choice between the two accounting methods for bonds has also been an area of increased focus for the Danish Financial Supervisory Authority in the 2023 accounting period. They clearly communicate that preparers of financial statements must have solid arguments for accounting bonds at amortized cost rather than fair value. This project will investigate what these arguments might be, how Danish SIFI banks actually account for the bonds held, and whether they are influenced by the Financial Supervisory Authority's statements on the topic.