Fair value accounting for liabilities : Presentation format of credit risk changes and individual information processing

Abstract

International Accounting Standard 39 (IAS 39) and the Statement of Financial Accounting Standard 159 (SFAS 159) both require a firm to include adjustments to the fair values of its liabilities resulting from changes in its own credit risk in net income. Previous research confirms that including these gains and losses in net income can confuse financial statement users. The International Accounting Standards Board (IASB) therefore issued a revised standard for financial instruments, International Financial Reporting Standard (IFRS) 9. It requires that credit risk effects be presented in other comprehensive income (OCI) instead of net income. We use an experiment to investigate whether this difference in presentation affects knowledgeable nonprofessional investors and whether the presentation format effect depends on firm profitability. We find that participants are more likely to acquire the information on changes in credit risk if that information is included in OCI. The perceived importance of credit risk information for the evaluation of firm performance is only slightly lower under the OCI presentation format, and the risk of misinterpreting a credit risk gain is unaffected by the presentation format. However, the evaluation of overall firm performance is less biased if fair value gains are included in OCI. Moreover, information acquisition and the interaction of weighting and credit risk evaluation mediate the effect of presentation format on firm performance evaluation. Furthermore, we identify firm profitability as an important factor that influences the processing of information on credit risk changes.