Authors: Nikolaos Kalantzopoulos, Nikolaos Nanos, Athanasios Mandilas, Dimitrios Kourtidis

Title: Fair Value Accounting and Financial Covenants: Evidence from adoption of ISA 540.

Abstract

During last decades, and especially in 2010’s, a long debate took place in literature regarding the fair value aspect of financial statements. In Greece the adoption of ISA 540 activated through the adjustment of article 24 of Greek Accounting Standards (Law 4308/2014). We examine the effects of the adoption of fair value accounting in designing debt contracts in European economies, as well as the use of financial covenants in private loan contracts. The existing theory, supported by literature, suggests (Demerjian, 2016) that using the fair value in accounting create a significant differentiation between assets and liabilities. A significant proportion of loans, modify covenant definitions to exclude the effects of ISA 540 and fair value accounting. The difference is located in assets and liabilities, and more specifically these modifications exclude in a very minor percent the asset elected at fair value while, they exclude all   liabilities elected at fair value. We examine the correlation between fair value accounting and debt contracting. Results from European economy which is in depression from 2010 will vary positive or negative to the adjustment of borrowers and their attribute to the modification of covenant definition. Empirical research in European economies will explain how the adoption of ISA 540 effect debt contracting in real economy. Evidence seems to be related with the hypothesis that loan contracts modify covenant selection to exclude the effects of fair value. Two distinct competing schools of thought have been formulated in the matter for and against the use and usefulness of fair values in contracting. One that deems fair value as an infringement of reliable accounting measurements and as such, an element that detracts from the usefulness of accounting for contracts, traditionally represented by the works of Watts and Ziemerman (1986) Holthousen and Watts (2001), Watts (2003) and Kothari et al. (2010). The other, supported by the work of Barth et al. (2001) and Barth (2004, 2006), argues fair values as elements that provide timely and value relevant information to the end users of financial information. This work has identified the need for considering fair value for its own merits for its continuing adoption.