Contrary Views on Liability Measurement

GAAP introduced in FAS 157 and elsewhere supports a view that an entity’s own credit risk is a determinant in measuring fair value of a a liability.

Some financial statement preparers don’t like the idea that a reduction in an entity’s credit rating would create a gain. How does this work? If a company’s credit rating dropped, the likelihood that it would repay its liabilities decreases, resulting in an entry such as:

Dr Liability
Cr Gain

If later the company’s credit rating was raised, then a loss would result:

Dr Loss
Cr Liability

If an entity’s credit rating increased above the rating when the liability was set up, the liability would be carried at an amount in excess of the amount that was required to be repaid, resulting in a gain if early repayment occurred.

In June, the FASB sought comments proposed FSP Measuring Liabilities under FASB Statement
No. 157 (FSP 157-f).

The Government Relations Committee (GRC) of the Association of financial Professionals sent a comment letter to FASB to voice its concerns with the guidance.

The GRC generally supports the FASB in its efforts to issue timely guidance on fair value measurement. However the GRC takes the position that the FASB’s current model for measuring liabilities is significantly flawed for the following reasons:

1. The inability to actually realize the fair value at the reporting date should be considered.


2. The fair value calculation of a liability should not exceed the contractual value of the debt a company actually owes.


3. Gains arising from a company’s own credit impairments should not be allowed.


4. Any restrictions on a debt should be taken into consideration in subsequent measurement.

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