11

Valuing Liabilities

If only people who worry about their liabilities would think about the riches they do possess, they would stop worrying.

—Dale Carnegie (1888–1955), American author

SO FAR, WE HAVE DEALT MAINLY with valuing assets because most investors relate to those items. However, fair value also applies to liabilities, especially in purchase price allocations (PPAs—see Chapter 13). In effect, liabilities are valued as assets to their counterparties (owners/lenders), often generating counterintuitive results. As an entity's credit rating declines, the fair value of its liabilities decreases, giving rise to imaginary gains that are reported through other comprehensive income (OCI). Credit ratings are important indicators of the major risks relating to liabilities—that the entity will default or otherwise fail to perform its obligations as they come due. Another significant factor affecting the value of a liability is the existence of embedded derivatives, such as rights to convert into equity.

LIABILITIES TRANSFERRED RATHER THAN SETTLED

Since the Financial Accounting Standards Board (FASB) issued the Statement of Financial Accounting Standards (SFAS) 157 in 2006, Generally Accepted Accounting Principles (GAAP) has valued liabilities on a transfer basis; however, the International Accounting Standards Board (IASB) did not always agree. As recently as a 2010 exposure draft of a new International Financial Reporting Standard (IFRS) to replace International Accounting Standard ...

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