The paper goes on to describe similar thorny issues linked to accounting for the transfer of wealth between creditors and shareholders when a company's credit rating changes. Since assets equal liabilities plus equity, the value of a company's assets is always tied to the value of the liabilities. But there's also a debate about whether a shift in value of a liability - connected with a credit downgrade, for instance - should be dropped into shareholder's equity. The underlying problem, says the paper, is whether the company's creditors or owners should absorb the value change.

The IASB staff also shows that excluding credit risk changes can result in an accounting mismatch between asset and liability measurements. If a company's assets are measured at fair value, then changes in credit spreads on those assets will affect their fair value, according to the paper, as well as the company's profit, loss, or other comprehensive income, depending on the transaction. So if the measurement of liabilities doesn't also incorporate credit-spread changes, the accounting mismatch will distort the recorded profit, loss, and OCI, goes the argument.

Observers who want the rules changed point to their other accounting mismatches. One occurs when there's a change in the value of a company's liability accompanied by a change in the value of recognized assets that is not reported in the financials. Such unreported assets can include unrecognized intangible assets (patents, trademarks, goodwill) or confidence in a company's management.

"There are tradeoffs in any debate around accounting standards," says PwC's Everett, noting that his firm is currently working on comments to the IASB discussion paper, which are due by Sept. 1. Last fall, the Big Four accounting firm issued its own white paper advocating a limited application of fair-value accounting for liabilities.

One situation that may warrant a fair-value approach is when a liability offsets an asset reported at fair value. In that way, the accounting symmetry will reflect the underlying economics of the transaction. "Unfortunately, this approach decreases comparability across companies, but the financial reporting is more informative than it would otherwise be - an acceptable tradeoff," adds the PwC paper. "

Between now and the time IASB and FASB issue a standard or guidance that addresses the credit-risk issue, many other fair-value rules will be discussed and put in place, and the boards will have to consider the added effect of those predecessor mandates, according to Everett. Further, "by the time [standard setters] finish debating a new standard, the economic landscape may have changed," he says.

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