Promised Value or Expected Value

by Cenen Reyes Herrera

Writing from Martinez, San Francisco Bay Area

Which would you prefer: a promised value or an expected value?
There seems to be a contradicting premise on the values that both paradigms would suggest. When I read the proceedings on the review of FAS no. 7 on the use of present value accounting, two of the members of the Board issued dissenting views on the use of present value as a measure for estimating fair value.

What could be the main distinction between a promised value and an expected value?
A promised value refers to the nominal cash flows that are indicated in the contractual agreement. The main difficulty of this paradigm is that under the promised value concept, a $100 received today is the same as the $100 received at a future date after considering the implicit interest of the contract. On the other hand, the expected value concept presents the realistic view that future cash flows could vary in terms of amount and timing. The word "expected" connotes a probabilistic view that is aligned with the concept of risk. Risk represents an exposure to an adverse consequence. That adverse consequence, however, could happen anytime depending on a number of variables. The timing of payment and the actual amount of payment could be estimated using a number of porbabilistic models that are available in financial markets.

The main problem in the shift towards the present value accounting is on the impact on liabilities. FAS 7 indicates that diseenting views focused on the fact that it would appear that changes in the effective interest rates of liabilities could impact on equity and that in an environment of rising interest cost of borrowings, there would be a tendency to increase equity. This is something that could create some difficulties in financial reporting. My long years of experience in accounting also point to a need to clarify how the changes in present values of both assets and liabilities could be handled or treated in a transparent manner, i.e., should they be treated as an activity account or a resource account?