Summary
Financial reporting works best, and maybe only, when it is complete and unbiased. If it is biased to manage the message, it becomes a method of distributing propaganda and all credibility is lost.The economics of gain occurrence is unarguable. If management can retire a debt for a smaller amount than the carrying value, then there are fewer liabilities and more equity. More equity means income has occurred. There is no rationality behind efforts to suppress truthful news just because you don't like it. Let's all hope the standard setters are not swayed by "visceral" impulses into the direction of keeping useful information out of financial statements. The inevitable consequence is greater risk and discounted share and bond prices, simply because users don't have access to the truth. That does no one any good.
Analysis
The objective of financial reporting is to provide users with information that's useful for their decisions. As soon as someone starts to argue for leaving out some information because they don't like the message, we've moved away from reporting to propagandizing.
The fact is that a decline in the value of a liability has to produce an increase in equity (the article's author missed that point and tied liability values to assets). Whether that outcome is welcome news or not, it remains the truth. Trying to snuff it out will not boost confidence in financial reports.
The undiscussed point is that this sort of gain is seldom going to make a lot of difference in projecting the future. The credit rating has probably fallen because the assets have also declined in value and/or because earnings are disappearing. As long as the gain is clearly identified, users will know what to do with it. in most cases, they can safely ignore it, but at least be thankful the financial statements are complete and otherwise reliable.
The same cannot be said when accounting principles are designed to send only certain messages instead of revealing everything. Of course, that is the case with asset impairments and other forms of so-called conservative practices that accelerate losses and stifle gains.
The fact is that efforts to manage the message, no matter how well-intentioned, will produce biased reports. Biased reports increase uncertainty, uncertainty boosts users' risk, risk makes them demand a higher rate of return, and a higher rate of return is a higher cost of capital for the security issuer.
The truth is the truth, and it should be honored, even when it is not welcome news. Wayne Upton is right by referring to visceral reactions because the response of stifling news is certainly not rational.
Analyses are solely the work of the authors and have not been edited or endorsed by GLG.
