Falling Interest Rates Destroy Capital | Keith Weiner | Safehaven.com

The guiding principle of accounting is that it must paint an accurate and conservative picture of the current state of one’s finances. It is not the consideration of the accountant that things may improve. If things improve, then in the future the financial statement will look better! In the meantime, the standard in accounting (notwithstanding the outrageous FASB decision in 2009 to suspend “mark to market”) is to mark assets at the lower of: (A) the original acquisition price, or (B) the current market price.

There ought to be a corresponding rule for liabilities: mark liabilities at the higher of (A) original sale price, or (B) current market price. Unfortunately, the field of accounting developed its principles in an era where a fall in the rate of interest from 16% to 1.6% [1981 to 2012] would have been inconceivable. And so today, liabilities are not marked up as the rate of interest falls down.

via Falling Interest Rates Destroy Capital | Keith Weiner | Safehaven.com.
Comment:~ Keith Weiner makes an interesting point. Consider two companies. Both have liabilities of $500, but one pays interest at 5% and the other at 10% a year. The balance sheet of the company paying 10% would reflect a greater liability if valued at current interest rates. The counter-argument is that balance sheets often reflect historic costs and companies are more often valued using earnings/cash flow that would recognize the difference in interest charges.