When 'fair value' isn't so fair

Fair value is one of the more complicated and controversial areas of accounting. Some assets and liabilities are initially recognized at their fair values, and some of those are subsequently adjusted to account for changes in fair value. Other assets are initially accounted for at cost, and fair value only enters into the equation if the value of the asset dips below its cost (or amortized cost).

Many of the rules involving fair value require the application of a great deal of judgment, and that's where the risk of fraud comes into play. As I've written before, the greater the required use of judgment, the greater the risk of fraud.

In this column I'll use three recent cases to illustrate the risk of improper applications of fair value. These cases also share another characteristic — each involves fraud charges based on violations of the U.S. Securities Act of 1933. (See the sidebar, "Fraud and securities laws" for details.)

Miller Energy Resources

A January 2016 enforcement release from the U.S. Securities and Exchange Commission (SEC) describes how Miller Energy Resources Inc. committed a financial accounting and reporting fraud scheme in connection with particular Alaskan oil and gas assets it acquired in December 2009. (See Accounting and Auditing Enforcement Release [AAER] 3731.) Miller acquired the assets in a court-approved auction for $2.25 million in cash plus the assumption of $2 million of liabilities from an entity that was going through bankruptcy.

When Miller filed its financial statements for the quarter ended Jan. 31, 2010, it reported the acquired assets at a value of $480 million ($368 million for the oil and gas properties and $110 million for fixed assets). The increase in book value resulted in an after-tax "bargain purchase gain" of $277 million, which incidentally resulted in net income of $272 million for the quarter. This had a dramatic effect on the price of Miller's stock, which soared from 61 cents per share on Dec. 10, 2009, the date of the asset acquisition, to $6.60 on March 31, 2010.