Financial Accounting Standards Research Initiative

< ![CDATA[Agreed, that is one crazy name for an income statement account! When I first saw this printed in the WSJ online, I thought the "i" was mistakenly included in the word "debt". But no, looking at the actual media release, JPMorgan actually calls it a "debit valuation adjustment."

What's even more interesting is the media reaction. The incident is being help up as an example as to why the FASB was wrong in allowing companies the option to report liabilities at fair value. The criticisms reflect a strong income statement bias, without thought as to the fair value effects on the balance sheet.

Further, according to JPMorgan, the gain is due to a "widening of the Firm's credit spread." That's a little vague to me. Does this mean that JPMorgan's credit quality has significant deteriorated, in which case the resulting gain is a little perverse (but still represents a decline in the fair value of the debt). Or, does the widening of the credit spread simply mean that interest rates increased during the period on fixed rate debt with no deterioration in the credit risk of JPM? In this case, the gains would unambiguously be a good sign for the bank.

Another good example as to why it might be a good idea to require firms to partition gains/losses into two components: gains/losses due to firm credit risk, and gains/losses due to market-wide interest rate changes.]]>

< ![CDATA[Citibank reported their earnings this morning and I was waiting with bated breath (not really) to see what they would call their "debit valuation adjustment". They call it - "credit valuation adjustment" - you cannot make this stuff up. The ultimate irony - both Citi and JP Morgan reported exactly $1.9 billion - one called it Credit Valuation Adjustment - the other called it Debit Valuation Adjustment - take your pick. Can't blame MBA students too much if they get their debits and credits mixed up, can we now?

JP Morgan's earnings release:

"Third-quarter results included the following significant items: $1.9 billion pretax ($0.29 per share after-tax) benefit from debit valuation adjustment (“DVA”) gains in the Investment Bank, resulting from widening of the Firm’s credit spreads."

Citibank's earnings release:

"Third quarter revenues included $1.9 billion of credit valuation adjustment (CVA) reflecting the widening of Citi's credit spreads during the third quarter."

Both firms take great care to use the neutral "widening of credit spreads" blather instead of the more accurate "deteriorating credit spreads"

Imagine a third company which is in pretty much the same situation; but issues a press release that says: Investors should treat the $1.9 billion with caution - this is not a "gain" in any real sense of the term. This "gain" arose because our credit rating deteriorated, which is not a good thing. We are doing our best to ensure that such "gains" do not become a permanent part of our financial statements.

We know something from accounting research about what happens when companies disavow mandatory disclosures (such as being forced to expense stock based compensation based on some wild assumptions)- here is a case where companies disavow a mandated disclosure - but in an incentive-inconsistent fashion - do we think that investors will applaud such disavowal or simply shrug their shoulders?]]>

Well, accountants are as bad, so we shouldn’t point our fingers too much at firms. Deferred income taxes. Errr, well it’s not always deferred… sometimes you pay the tax up front on the deferred income tax accounting….

< ![CDATA[Lynn,
Widening credit spreads could refer to investors charging a larger premium for a given level of credit risk, which would reflect changes in the interest rate market. But I think it more likely the widening spread is specific to the entity. In that case, I would guess the entity would have difficulty settling the debt to realize the gain. While a variety of commentaries on own-credit-quality are out there, mine can be found in the June 2002 Accounting Horizons.]]>