Auction Rate Securities / Variable Rate Demand Notes

STATUS
- AFP is calling for updating and additional clarification of cash and cash equivalents as defined in FAS 95 to make the standard more responsive to today’s markets. Further, AFP is urging FASB to set policy to prevent instability and inconsistency through immediate interpretations by accounting firms. The Financial Accounting Standards Board (FASB) is currently reviewing AFP’s recommendations and has not yet determined whether to begin a formal project regarding this important issue.

BACKGROUND – The problem with auction rates securities (ARS) and Variable Rate Demand Notes (VRDN) began in February 2005 when PricewaterhouseCoopers (PwC) issued an advisory indicating that auction rate securities which had been commonly accounted for as a cash equivalent by both corporations and external auditors no longer qualified for this treatment and should now be considered a short-term investment. The PwC advisory concluded that "Most auction rate securities have maturities that span many years, and such securities will not qualify as cash equivalents." In addition, the advisory suggested that the risk of auction failure contributed to their conclusion. A similar scenario has played with regard to VRDNs. The Big-4 CPA firms have collectively determined that VRDNs no longer fit the definition of a cash equivalent even though FASB has rendered no official opinion on the matter.

Without prior notification, companies were required to modify current financial statements (balance sheet and cash flow statement) and to restate prior financial statements under threat by the external auditor. Most often, notice was not received by the company until February or later, after the auditor had begun the year-end work for calendar year 2004. As a result, plans for managing cash had to be hastily modified. Debt covenants with cash and cash equivalent compliance requirements had to be reviewed to assure that there were no loan covenant violations. If there were covenant violations triggered by this change, they needed to be remedied by amendments to loan agreements or risk a technical default and the possible withdrawal of financing.

AFP ACTION – AFP convened a special task force composed of AFP members to respond to the PwC advisory. In July 2005, AFP submitted a letter to the Financial Accounting Standards Board (FASB).

Members of the AFP ad hoc task force on Auction Rate Securities held a conference call with staff members of the Financial Accounting Standards Board (FASB).