American Capital Avoids Loss With Fishy Math

American Capital Strategies(ACAS Quote) appears to be using aggressive accounting to delay a large writedown in its portfolio of investments.

The most surprising piece of the company's earnings release this week was the firm's valuation of its investment in European Capital, a publicly traded London-based stock that fell 18% in the quarter.

This stock drop should have resulted in at least a $140 million loss for American Capital. Instead, it somehow translated into a $2 million gain.

Investors and analysts have been puzzled ever since.

TheStreet.com reported in August that certain investors and analysts have criticized the methods used by American Capital to value its many investments, which range from publicly traded stock and debt securities to private investments.

The valuation of European Capital, however, might be the most perplexing move to date.

The latest issue centers around FAS No. 157, a new accounting standard issued by the Financial Accounting Standards Board last year. The rule governs how companies should determine the fair value of assets and financial instruments.

The FAS 157 accounting standard gives companies a hierarchy of "fair value" inputs to determine the way assets should be valued on balance sheets. Level I inputs are quoted prices of identical securities in active markets. Level II inputs are essentially comparable investments that may or may not be publicly traded. Level III inputs are unobservable inputs; essentially this is a valuation based on a financial model.