The Securities and Exchange Commission will make sure that companies are properly using fair value accounting and not deceiving investors, warned an SEC official.

"We will drill down into the fair value valuations you are making," said Stephanie Hunsaker, associate chief accountant in the SEC's Division of Corporate Finance, at a conference sponsored by the New York State Society of CPAs' Foundation for Accounting Education. "It has to make sense," she added. "If it doesn't, we'll drill down."

She noted that the SEC had recently completed its congressionally mandated study of mark-to-market and fair value accounting. The study concluded that fair value accounting should not be suspended, but it could be improved (see SEC Study Defends Fair Value Accounting). She advised accountants to keep a close watch on the Financial Accounting Standards Board's Web site, which is issuing more FASB staff positions clarifying fair value guidance.

Hunsaker urged accountants to make ample disclosures of impairments and other problems they foresee in a company's or institution's financials, and to be aware of the warning signs, such as a company's market capitalization falling below its book value. "If you're trading below book, that's probably going to be a trigger for an impairment [on goodwill]," warned Hunsaker. "Perform an impairment test if your book value is trading below your market cap."

The SEC has hired a valuation expert from Ernst & Young to help the commission assess whether companies have properly figured the value of assets. Hunsaker noted that many companies are now turning to outside experts to help with these decisions.

The SEC is casting a more skeptical eye these days on the justifications that companies and financial institutions are giving for why an asset shouldn't be impaired. Some companies are citing studies of "comparable companies," but Hunsaker noted that the business unit within the company might not really be comparable.

She also pointed out that an impairment assessment is required when a security is in an unrealized loss position. "There is no bright line," she said. "We recognize that certain types of securities are more liquid than others. But if you don't have the ability to hold a security until maturity, then it's an impairment."

Some companies are capitalizing costs where they shouldn't, she noted. "We asked one [energy] company about why they were capitalizing all these costs like drilling and exploratory costs," she said. "They pointed to something in IFRS and we told them, 'No, you have to find something in U.S. GAAP.'"

Another thorny area is revenue recognition. "Don't say, 'We generally recognize revenue this way," warned Hunsaker. "Get rid of 'generally.' How did you do it?"

Another red flag is the use of shell entities, which was especially concerning with one bank that was using them for items such as janitorial services. "I got really scared," said Hunsaker. "I asked, 'Is this all fake?' I said, 'Let's issue a hundred comments.'"

Comments are often used to bring companies in line. "This [past] year, the staff issued a ton of comments," said Hunsaker. Another red flag is when a company claims that fair value equals par value. "No, that's not the case," said Hunsaker.

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