FASB May Do Away with Adjustments for Changes in Debt Value: Report

Accounting adjustments for credit changes that can appear to distort some banks' earnings may be about to end.

The Financial Accounting Standards Board stands ready to repeal a directive that allows banks to record a gain in income when the value of their own fixed-income securities decreases, and losses when the liabilities' worth rises, the Wall Street Journal reported late Sunday.

The provision, known as debt value adjustment, stems from a standard the board adopted in 2007 that allows companies to appraise some of their obligations at current market value instead of original cost. 

FASB voted preliminarily in June to do away with the provision, which reflects the theory that companies pay less to retire their debt when its price falls.

The standard, known as FASB Accounting Standard 159, requires companies to supply information in the notes of financial statements to help investors understand the effect of a company's election to measure certain assets and liabilities at market value and to display the information on their balance sheets.  Though the provision aims to reduce complexity in accounting for financial instruments and volatility in earnings that can result from measuring related assets and liabilities differently, it has not worked out that way.

"Financial statement users have told the FASB they find this result confusing and counter-intuitive," a FASB spokesperson told American Banker on Monday.

The board expects to approve final changes in the standard before the end of this year.  Any change is unlikely to take effect until 2014, following a public comment period.

The possible repeal comes as some of the nation's biggest banks have flagged the adjustments recently.

On Friday, Bank of America (BCA) said it expects to book a debt value adjustment loss of $1.9 billion in the third quarter to reflect improvements in its credit quality.

In July, JPMorgan Chase (JPM) recorded a gain of $755 million as a result of a weakening in the value of its debt.  The gain "reflected adjustments for the widening of the Firm's credit spreads which, as we have consistently said, do not reflect the underlying operations of the Firm," the bank wrote in a news release that announced its results for the quarter.

Debt value adjustments in the second quarter caused Citigroup (C) to add roughly $270 million to its earnings, though the company displayed the adjustment separately from net income.

The adjustments reflect investors' perceptions of banks' creditworthiness, although the accounting has little to do with banks' financial performance. 

"We believe it is critical to distinguish between core bank earnings and noncash valuation adjustments that have little to do with the fundamental financial performance of the bank," Fitch Ratings wrote in July.  "As a result, we back out DVA gains and losses from reported pretax earnings in our analysis of quarterly results, and in the computation of relevant credit metrics."

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