The market for auction rate securities has been seized up for months, but ARS holders continue to paint very different pictures about the value and long-term prospects for their securities, according to an analysis of 600 public company filings.
Joseph Floyd, head of financial consulting for the Huron Group, recently pored over the auction-rate disclosures looking for patterns. It’s not as if the valuations and disclosures are non-compliant, he says—the rules allow for acceptable inconsistency in reporting. Instead, says Floyd, “The burden of understanding that inconsistency is placed on the user of the financial statements.”
The market for auction rate securities sputtered to a halt in February when auction failures left holders unable to sell what they intended to be short-term investments. Auction rate securities are debt instruments with long-term maturities, though investors traded them as short-term liquid investments via the auction process until a wave of mortgage failures led to widespread problems in credit markets.
In many cases the underlying debt instruments were sound. The auction seizure and resulting loss of short-term liquidity, however, created a host of financial reporting quandaries. Floyd says the dynamics create an interesting opportunity to study how companies interpret and comply with financial reporting rules and how meaningful the resulting disclosures are for investors.
Of the 600 filings Huron studied, 90 percent disclosed some measure of auction rate holdings in the first quarter. Of that number, 53 percent reported the securities were temporarily “impaired” (or the fair value was less than the amortized cost basis) with no effect on earnings, while 32 percent reported no impairment of any kind. Only 10 percent reported the impairment as something other than temporary, meaning it could linger or be permanent, with a charge to earnings.
For securities backed by collateralized debt obligations, Huron found the average impairment, or write-down in fair value, was 20 percent. For municipal bonds, the average impairment was only 5 percent. Of companies reporting balance sheet classifications for their auction rate securities, 41 percent changed the classification from short-term to long term in the first quarter of 2008.
Floyd
The diversity in valuations and disclosures isn’t entirely surprising, Floyd says, given the latitude provided in the accounting rules for management to reach widely varying conclusions about their holdings. He’s referring to Financial Accounting Standard No. 115, Accounting for Certain Investments in Debt and Equity Securities. “Accountants don’t like when we say this, but we have acceptable inconsistency because of the way the rules are written,” he says. “Companies can have the same investment but can have different treatment of it.”
Huron’s report picks apart some of the disclosures to highlight those that are helpful to investors and those that are more obscure, Floyd says. “We found some disclosures you just couldn’t interpret,” he says. “We couldn’t figure them out—either because they were lacking in details or they were nonsensical—making it difficult to really understand what was going on.”
FASB Adds Business Mergers Guidance to Codification
The Financial Accounting Standards Board has added guidance on business combinations to its online codification research tool, which is intended to simplify research of and compliance with U.S. Generally Accepted Accounting Principles.
The codification is intended to serve as a single source for all authoritative GAAP. FASB developed the tool over a period of several years and is giving it a one-year test run to work out glitches. It is available free of charge during the test run, or verification period, via the FASB Website, until the Board completes it in April 2009.
Literature on business combinations initially was omitted from the codification because Financial Accounting Standard No. 141R, Business Combinations, was still in development at the time. The addition of business combinations to the codification integrates a number of standards in addition to FAS 141R, including FAS 109, Accounting for Income Taxes; Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes; and various literature from FASB’s Emerging Issues Task Force and Securities and Exchange Commission Staff Accounting Bulletins.
Tom Hoey, codification project director at FASB, says the Board is still looking for feedback on whether the business combinations and other content in the codification provide an accurate and adequate roadmap for U.S. GAAP. The free, one-year verification phase is open until Jan. 15.
Surveys Suggest Big Concern, Slow Progress on ERM
Risk management is a top priority for chief financial officers and audit committee members, according to three separate surveys at accounting firm Crowe Chizek.
More than 65 percent of CFOs and more than 70 percent of audit committee members say managing enterprise risk is the biggest challenge their organizations face in the coming 12 months, according to the aggregated results. The results suggest ERM is a challenge even greater than financial reporting and improving internal controls, Crowe says.
Rick Julien, an executive at Crowe Chizek says several factors make risk management such a challenge, including the increasingly global economy, turbulent market conditions, changing technology, changing demographics, and everyday operating challenges. “All of those are adding risks to all aspects of the business,” he says.
Julien
There’s plenty of room for improvement in understanding and managing risk, as less than 25 percent of respondents viewed their company’s performance as “excellent” on any specific risk management tasks, the firm says. Julien says companies are coming to grips with the notion that ERM is bigger than a business unit or a corporate silo. “It isn’t a light switch that you can turn on and off,” he says. “It’s a journey and you need a practical approach to get started.”
A separate study by consulting firm LRN, the “2008 Ethics and Compliance Risk Management Practices Report,” found that companies are making progress in their ethics and compliance education programs, but they need to become more strategic in addressing risk management and compliance. LRN says the number of companies using a formal cultural assessment increased 10 percent from 2007 to 2008.
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