Credit standing and the fair value of liabilities: A critique

The author reviews the positions of major accounting and actuarial bodies on the issue of whether the holder’s own credit standing should be reflected in the fair value of its liabilities, identifying certain anomalies, both in the current GAAP treatment of debt and in the FASB approach to the fair valuation of liabilities. He also examines the treatment in financial theory of risk capital in the case of unsecured debt. An alternative approach is proposed, stressing the need for an objective valuation standard based solely on contractual terms and ambient economic conditions, and yielding readily interpretable public information. Finally, he reviews the probable consequences if, as seems likely, the FASB approach prevails, or, as seems unlikely, the views advocated here prevail.