Fair Value Debated; Pensions; More

Proponents of fair-value accounting rushed to defend new fair-value accounting rules last week as corporations blamed the rules at least in part for earnings tailspins.

Georgene Palacky, a director at the Chartered Financial Analyst Institute, says fair value is being used as a scapegoat for companies when problems are more likely tied to market conditions than accounting rules. “Fair-value accounting doesn't create losses,” she says. “It reflects a company's present condition.”

Palacky

Palacky was responding to reports that Martin Sullivan, CEO of American International Group, blamed a large part of the company's recent $11 billion write-down of debt securities on Financial Accounting Standard No. 157, Fair Value Measurements. Sullivan told media at an insurance industry conference that the write-down under pre-FAS 157 accounting might have been closer to $900 million.

And in AIG's fourth-quarter conference call, Sullivan noted that market conditions are extraordinary, leaving complex financial instruments difficult to value. “These valuations are not mechanical,” he said, according to a transcript of the call. “They involve difficult estimates and judgments. I can tell you that we have at all times brought our best judgment to bear in making these valuations.”

UBS strategist David Blanco also came to the aid of fair-value accounting rules with a brief report last week. He said investors want full disclosure of value and risk, and they will reward good information with confidence and premium valuations. Acknowledging that such valuations aren't easy, he said investors want “disclosures that clearly identify the nature of the assets and address key valuation uncertainties, including the questionability of any observable market input or other assumptions used.”

Palacky said corporate resistance to fair-value measurements only exacerbates problems with investor confidence. “When companies start deflecting scrutiny from their own business practices, those are most likely causes for the situation we're in now,” she said, where investors are expressing doubt about security values.

FAS 157 doesn't require any new use of fair value, but establishes a three-tier hierarchy for measuring fair value using market prices as the most reliable yardstick to determine the value of a financial asset or liability. “The whole thing works as long as the liquidity is there,” Palacky says. “But it's almost like a domino. When one starts to fall, it's so closely related to another, there's a chain reaction in the marketplace.”

Palacky says fair value is getting unfair blame for declining security values. “I don't know why fair value is viewed as the culprit,” she says. “The notion of fair value isn't a newly introduced measurement attribute. It's simply provided consistent guidance and principles for anything that is currently required to be measured at fair value.”

FASB Seeks Views on More Pension Disclosure

The Financial Accounting Standards Board has published a proposed staff position that would require new disclosures regarding corporate pension plans.

The guidance would revise FAS 132, Employers' Disclosures about Pensions and Other Postretirement Benefits (already revised in 2003), to establish a new principle for disclosing the fair value of categories of plan assets based on the types of assets held in the plan.

It also would require more categorical breakdown of plan assets, and more disclosure about the nature and concentration of risk arising from various asset categories. Finally, the amendments would require more disclosure about fair-value measurements used in valuing pension assets, much like the disclosures now required in FAS 157.

Waite

Jon Waite, chief actuary at consulting firm SEI, says the proposed guidance will not affect the earning calculation. “This is purely a disclosure item,” he says. “They're looking at adding more detail on the disclosures in the footnotes about assets and asset allocation.” If the guidance becomes final in its current form, the new disclosures will require CFOs to get more familiar with their pension plan investment policies, Waite says.

FASB is open to comment on the proposed guidance through May 2. Meanwhile, the Board continues work on a longer-range project to overhaul pension accounting rules with a goal for more mark-to-market accounting for pension plan assets and liabilities.

Separately, FASB determined recently to issue proposed amendments to FAS 5, Accounting for Contingencies, to address concerns that the recognition criteria can result in delayed recognition of liabilities. Contingencies are potential liabilities, such as lawsuits, that create some uncertainty in financial reporting because the ultimate outcome of the event is not known at the time of reporting.

FASB planned to require a fair-value approach around contingencies in the context of a merger or acquisition when it was writing FAS 141R, Business Combinations, but dropped the approach when commenters pointed out it conflicts with FAS 5. Instead, FASB promised to revisit the guidance in FAS 5 to determine how it would modify first the disclosure requirements. Depending on the outcome of this guidance and the future direction of the International Accounting Standards Board in its review of contingency rules, FASB may choose a broader look at contingencies later.

The board expects to publish a proposed approach in April and hold it open for a 60-day comment period. Because it expects some controversy, the Board also is planning to hold a public roundtable on the guidance. Board members hope to complete the guidance by fall.

Survey: Payment Fraud Increases in 2007

Almost one-third of respondents to a new Association for Financial Professionals survey say incidents of fraud increased in 2007 compared to 2006.

The 2008 AFP Payments Fraud and Control Survey found large organizations (those with more than $1 billion in revenues) were more frequent targets than smaller entities. Eighty percent of larger organizations were victims of payment fraud compared with 58 percent of smaller organizations, according to the survey.

The AFP says paper checks remain the most vulnerable payment instrument for companies. Almost all organizations in the survey—94 percent—reported they were victims of an actual or an attempted check fraud in 2007. Electronic payments seem less vulnerable to fraud attempts, AFP says, with 26 percent reporting an attempt to hack into ACH debits, 13 percent reporting assault on corporate credit or payment cards, 4 percent on ACH credits, and only 3 percent on wire transfers.

Thankfully, the losses associated with fraudulent payments are relatively small, according to AFP. The median financial loss reported in the survey was $13,900. The AFP says companies need to use more sophisticated tools to combat attempts or actual incidents of fraudulent payments.

Chapman

Arlene Chapman, a senior consultant in technical services for AFP, says companies tightening controls around checks is resulting in a greater spread between companies' reports of actual incidents of frauds compared with attempts at fraud. Still, check fraud remains the easiest type of payment fraud to commit, she says.

As such, the survey results are yet another reminder for companies of all sizes to improve controls around payment systems, especially paper checks. “Fraud control needs both tight internal controls and antifraud services,” she says. “We're trying to make companies aware of the need to put controls in place.”