Fair value of own liabilities

Accounting has once again been confirmed as an art not a science by a quick glance at the 2008 Interim results for Barclays Bank. I confess that prior to learning about accounting I had naively assumed that accounts recorded undisputed facts.

Then I started on my ACA studies and was introduced to the mysteries of double entry bookkeeping and strange concepts like goodwill and I discovered that accounting numbers were just as imaginary as “i” () in mathematics.

Barclays Capital has reported losses on credit market exposures of £2,831m but has then set against this gains on its own debt securities of £852m. In other words changes in market yields of its own securities have caused the mark to market valuation of its own liabilities to fall creating a windfall gain.

On the scale that Barclays operates the change in this valuation of liabilities is modest but for a failing company facing a dramatic deterioration (increase) in its credit spreads you would end up with the perverse appearance that the worse the business and the worse the credit risk becomes, the bigger the reported gain. At present International Accounting Standards do not require a corporate to fair value its own liabilities but the clear objective of the IASB is to head down the route of fair valuing all financial assets and liabilities.

Having said that showing a gain on account of a deterioration in own credit was perverse this may be true for small changes but when a company has reached the stage of needing a complete reconstruction of its debt and equity, this apparent gain can actually be crystalised. Lenders may well accept a repayment at less then par as part of an overall package to salvage something and to give the company a chance to recover and to maximise the eventual payback to the banks and lenders.

So where does the real true and fair view lie? For many the test of what accounting rules or principles should be applied is “Are the accounts providing useful information for the users”. If a debt obligation is realistically going to exist until maturity and be repaid at par then the point in time market value is largely irrelevant and does not give a realistic view of the outflow of cash that will be required to repay it. Indeed this attitude is taken by Standard & Poor’s in their Criteria Methodology: Calculating Adjusted Debt And Interest For Corporate Issuers of 2 June 2008, where in essence they say they will normally adjust any market values back to amortised cost for their analyses.

To maximise the collective happiness of users perhaps the solution is to account at amortised cost, but disclose the market values by way of a note?