For close to three years the Big Four accounting firms have been advising their corporate clients to change the way they account for auction-rate securities. Many companies changed the way they account for auction-rate securities on their balance sheets, sometimes classifying them as current assets and short-term investments. But some, like Continental, continued to included at least some portion of their auction-rate securities in the “cash equivalent” line.

Early last year the Financial Standards and Accounting Board decided that the “cash equivalent” designation was too open to confusion and abuse and recommended it be eliminated from cash flow statements. Many corporate treasurers and investment banking professionals who spoke to DealBreaker believe that this helped trigger the sell-off of auction-rate securities at the end of last year and the beginning of this year.

Others point to an even more recent accounting phenomenon—an advisory issued in January by Deloitte that warned auditors that “many issuances of auction rate securities have been adversely affected by the turmoil in the credit markets; thus, their current fair value is at a discount, sometimes substantial, from par value.” As auditors began to inform client corporations that they were going to have to record impairments of their auction-rate securities, corporate treasurers decided to unload this new source of credit market damage to balance sheets. Even corporations that had changed the accounting treatment of the auction-rated securities much earlier had not really paid much mind to them.

Deloitte told auditors that “because many entities assumed that these securities were economically equivalent to cash (even if they are not the accounting equivalent of cash), investments may not be on the “radar screen” as companies consider their loss exposures in the current environment.”

Once companies began to appreciate the potential for significant declines in value, they began to jettison their auction-rate securities. Suddenly, demand for these securities vanished from the marketplace, however, and companies seeking to unload them found themselves burdened with suddenly illiquid investments they once considered cash.

Auction Rate Securities Warrant Scrutiny for Impairment [Deliotte]