The IASB has been working on determining whether or not an entity’s credit risk should be incorporated into the measurement of the liability. The Staff Paper that accompanies the Discussion Paper on Credit Risk in Liability Measurement, dated June 2009, outlines three reasons to support this treatment and three arguments cited against this treatment. (This paper is available at The examples below clarify the issues being addressed. The example given in the paper discusses a regular bond payable that will be settled in cash and will be valued using an effective rate of interest based on the market’s assessment of credit risk and the entity’s ability to pay. For example, this might be 7%: in other words, the company would have to pay 7% interest on these bonds and this is used as the effective interest rate to value these bonds at the time the bonds are issued. In addition, suppose that the company also has an asset retirement obligation that will be settled in the provision of services in the future. This will also require some outlay of cash in future and the value of the liability is determined by discounting these future cash flows using a discount rate that incorporates the time value of money and the risks specific to the liability. In many cases, this could be different from the 7% used for the bonds. Should the same discount rate, which incorporates credit risk, be used to determine this liability? Or should the asset retirement obligation be discounted using a default risk-free rate of interest? Furthermore, as market rates change, should the value of the liabilities also be changing to reflect this? Let’s say that the current market rate one year later required for the bond is 8% and this increase is due to a lower credit rating for the entity. Under current accounting standards, the bonds payable does not get revalued since it is reported at amortized cost. Should the bonds payable now be revalued and the effective interest rate changed? The asset retirement obligation would get revalued using the most current discount rates at each reporting period.
(a) Explain the meaning of “non-performance risk.”
(b) Using the example of a bond payable and an asset retirement obligation, discuss the arguments for and against incorporating credit risk into the measurement of liabilities.
(c) What are the alternatives for measuring liabilities?

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