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Fair value accounting for liabilities: The role of disclosures in unraveling the counterintuitive income statement effect from credit risk changes

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  • Gaynor, Lisa Milici
  • McDaniel, Linda
  • Yohn, Teri Lombardi

Abstract

When liabilities are accounted for at fair value, a deterioration of a company's credit risk results in the reporting of an income statement gain; an improvement in a company's credit risk results in a loss. Many argue that these income statement effects are counterintuitive and that financial statement-users are likely to misinterpret fair value gains as positive signals and fair value losses as negative signals. Utilizing an experiment with CPAs as participants, we find that these arguments are indeed valid. Specifically, we find that over 70% of the participants incorrectly assess a company's credit risk as improving (deteriorating) when a fair value gain (loss) is recognized. We also find that disclosures that explicitly specify the relation between the direction of the credit risk change and the income statement effect significantly reduce participants' misinterpretations, and are more beneficial when fair value gains versus losses are recognized. These findings provide empirical evidence in the debate over the recognition of company-specific credit risk changes and offer direction for improving disclosures in the area of fair value accounting.

Suggested Citation

  • Gaynor, Lisa Milici & McDaniel, Linda & Yohn, Teri Lombardi, 2011. "Fair value accounting for liabilities: The role of disclosures in unraveling the counterintuitive income statement effect from credit risk changes," Accounting, Organizations and Society, Elsevier, vol. 36(3), pages 125-134, April.
    • Handle: RePEc:eee:aosoci:v:36:y:2011:i:3:p:125-134
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    1. Sebastian Kaumanns, 2019. "“Some fuzzy math”: relational information on debt value adjustments by managers and the financial press," Business Research, Springer;German Academic Association for Business Research, vol. 12(2), pages 755-794, December.
    2. Jannis Bischof & Holger Daske & Christoph Sextroh, 2014. "Fair Value-related Information in Analysts’ Decision Processes: Evidence from the Financial Crisis," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 41(3-4), pages 363-400, April.
    3. Martin Schmidt, 2018. "A Note on the Proprietary and Entity Perspectives in Financial Statements: The Implications for two Current Controversial Issues," Accounting in Europe, Taylor & Francis Journals, vol. 15(1), pages 134-147, January.
    4. Lachmann, Maik & Stefani, Ulrike & Wöhrmann, Arnt, 2015. "Fair value accounting for liabilities: Presentation format of credit risk changes and individual information processing," Accounting, Organizations and Society, Elsevier, vol. 41(C), pages 21-38.
    5. Kelton, Andrea Seaton & Montague, Norma R., 2018. "The unintended consequences of uncertainty disclosures made by auditors and managers on nonprofessional investor judgments," Accounting, Organizations and Society, Elsevier, vol. 65(C), pages 44-55.
    6. Ryan McDonough & Argyro Panaretou & Catherine Shakespeare, 2020. "Fair value accounting: Current practice and perspectives for future research," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 47(3-4), pages 303-332, March.
    7. Couch, Robert & Wu, Wei, 2016. "The fair value option for liabilities and stock returns during the financial crisis," The Quarterly Review of Economics and Finance, Elsevier, vol. 59(C), pages 83-98.
    8. Barker, Richard & Schulte, Sebastian, 2017. "Representing the market perspective: Fair value measurement for non-financial assets," Accounting, Organizations and Society, Elsevier, vol. 56(C), pages 55-67.
    9. Hua-Wei Huang & Mai Dao & Wen-Chi Sun, 2017. "The Timeliness of Financial Reporting and Fair Values: Evidence from U.S. Banks," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 20(01), pages 1-30, March.
    10. Martin, Rachel, 2019. "Examination and implications of experimental research on investor perceptions," Journal of Accounting Literature, Elsevier, vol. 43(C), pages 145-169.
    11. Francesco Bellandi, 2023. "Own Credit Risk Accounting, Modigliani-Miller Theorem, and the Fallacy of Counter-Intuitive Results," International Journal of Business and Management, Canadian Center of Science and Education, vol. 16(9), pages 129-129, February.
    12. Lambert Jerman, 2015. "Les Enjeux De L'Application Des Normes Ias-Ifrs : L'Etude Des Preparateurs Des Comptes, Une Perspective De Recherche Encore Inexploree," Post-Print hal-01188736, HAL.

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