How Fair Value Rewards Deadbeats

Panelists of a Securities and Exchange Commission roundtable on fair-value financial reporting on Wednesday clashed over an accounting provision under which a company can boost its reported earnings by becoming less creditworthy.

In the provision, paragraph 15 of standard number 157, the Financial Accounting Standards Board’s controversial new stricture on fair-value accounting, FASB states that the fair value of a company’s liability must reflect the risk that the company won’t pay it back. Thus, as the risk that companies won’t pay back their debts rises, their reported liabilities actually decrease--and may even provide an earnings boost.

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Illogical as the provision sounds—and it sounds illogical to many—quite a few companies are already making hay by using it ... For the 25 companies with the biggest amounts of liabilities on their balance sheets measured at fair value, widening credit spreads—an indication of a lack of creditworthiness—spawned first-quarter earnings gains ranging from $11 million to $3.6 billion, according to the study.

Not all companies are so hot on the paper gains. One speaker, Joe Price, the CFO of Bank of America, found the provision too divorced from economic reality. “The inability to monetize this type of gain is very troubling,” he said. “We personally have not availed our self of it for generally that reason.”

CFO