Debt Purchasing and FASB Rule 159

For those businesses who buy debt from lenders, usually to pursue or to assume the income stream for such activities on favourable terms (i.e. $1 for a cost of 50 cents up front), the world may have just become a bit of a brighter place.

The Financial Accounting Standards Board (FASB) along with many other edits and tweaks, have made a change to the debt purchase arena that will result in significant ripple effects across the industry. The change is particularly helpful for those involved in consolidating financing and investment to support the purchase of inventory.

Beginning in 2008 (fiscal year), the accounting standard "FASB 159" retools how assets specified are to be listed. In short, the change converts the representation to being fair market value versus the old standard of reporting them valued at cost to obtain. For debt purchasers the difference is huge. The value obviously of a debt could be 100 percent or more as an asset than what was paid to obtain the ownership of the debt.

The objective, according to FASB, is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The change is expected to expand the use of fair value measurement, which is consistent with the Board's long-term measurement objectives for accounting for financial instruments.

The 159 change applies to all entities, including not-for-profit organizations. Most of the provisions apply only to entities that elect the fair value option. However, an additional amendment to FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, also applies to all entities with available-for-sale and trading securities. Some requirements apply differently to entities that do not report net income.

The change allows a portfolio shift to market value rather than operational value. And, of course, when you have a 100 percent more difference between market and cost, your company is easily going to see an increase in business' equity side of the balance sheet as well (remember, assets = liabilities plus equity on the balance sheet). For presentation the change clearly increases the equity balance under the company's own, direct management.

From an examination perspective, the change provides a more accurate view of the company's worth as well. Your balance sheet reflects market value, and provides investors or partners a better gauge of what your business equates to as venture worth supporting.

A third benefit comes of course in seeking additional financing. By having a larger direct control of the equity side of the business, your management can leverage greater credit lines (under normal circumstances of course, and not in the current credit crisis which has nothing to do with your everyday business). Finally, having a fair market value of your debt assets allows an easier calculation of worth when your business gets involved in dispute resolution or if you decide to sell your business.

The 159 change became effective as of the beginning of an entity's first fiscal year that began after November 15, 2007. Early adoption was permitted as of the beginning of a fiscal year that began on or before November 15, 2007, provided the entity also elected to apply the provisions of FASB Statement No. 157, Fair Value Measurements. No entity is permitted to apply this Statement retrospectively to fiscal years preceding the effective date unless the entity chooses early adoption.

For a number of reasons, aside for objectivity and avoiding conflicts of interest, we strongly advise against trying to make these adjustments yourself for your own business.

Anyone running a debt purchase operation should work with their accounting and review this new FASB option with a professional and certified valuation advisor.

Neil Lemons is an independent writer who enjoys writing articles to be used as business valuation resources. He has years of knowledge, and has written many articles about business valuation, with a particular focus in the business litigation services arena.

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