Debt Valuation Adjustment

 
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Debt Valuation Adjustment

A Debt Valuation Adjustment (DVA) is an accounting valuation technique related to how a company handles changes in its issued fixed income securities. According to FASB 159 (adopted in 2007), firms can recognize market value declines in some debt instruments as earnings (income).[1]

Use of this valuation method is optional for reporting companies, and can be adopted on a security by security basis (vs. applying to all outstanding bonds, for example). An interesting aspect of the rule is that once reporting companies adopt this rule for certain securities, switching to a different valuation technique is prohibited.

This valuation technique was used by financial firms in 2008 as a way to minimize accounting losses: as the market value of issued debt declined, companies would recognize the decline as income. [2]

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Considering that declines in market value of debt could signal future problems for a company (namely a higher cost of debt and interest burden), investors should evaluate the full implications of DVA on the long term condition of a firm and the quality of earnings affected by DVA. For example, if a $100 par bond has a DVA to $50, the company will still need to pay the bondholder $100 at maturity (either from cash or financed with more debt, which would likely be at a higher interest rate).

References

  1. FASB 159 Summary
  2. Bloomberg.com "Bank Profits Depend on Debt-Writedown ‘Abomination’ in Forecast"
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