RISK MANAGEMENT ACTIVITIESUnderstanding and addressing the inherent risks in various business environments are critical components of strategic leadership. This chapter provides an overview of enterprisewide risk management, its importance to E&P organizations, and the consequences for petroleum accounting.Successful risk management includes an appropriate assessment of the accounting and information needs of a company and its stakeholders. Yet, risk management involves much more than a simple focus on internal controls. Chapter 3 can be referenced for a discussion of internal control and audit frameworks with E&P companies.

RISKThe Merriam Webster Dictionary defines risk as exposure to possible loss or injury. In reality, the term risk is used in different ways depending on the activity under discussion.Every organization faces some level of uncertainty. Uncertainty creates both risks and opportunities, which can either erode the value of a company or enhance it. This is especially true for E&P companies that seek to manage a plethora of risks: exploration, competitive, market, financial, operating, technology, environmental, regulatory, litigation, and political.

WHAT IS RISK MANAGEMENT?The ability to develop processes and controls that minimize the negative impact of risks is commonly referred to as risk management. An organization can focus on individual elements of risk, such as financial risk management or political risk management, or it can take a more holistic approach. Enterprise Risk Management (ERM) is a comprehensive,systematic approach for helping organizations identify, measure, and prioritize their risks, and respond to the risks that could challenge critical objectives and operations.ERM helps a company decide how much risk it can manage, or wants to manage, given the needs of its stakeholders. It provides enhanced capabilities to align risk appetite with the organizations strategy. By successfully managing risks, an organization can improve its performance and better protect itself from pitfalls. Thus, ERM is an integral and essentialcomponent of a risk and value-based management framework.

RISK FRAMEWORKS FOR PETROLEUM ACCOUNTANTSIn 2004, the accounting industry was presented with an official framework for applying ERM by The Committee of Sponsoring Organizations of the Treadway Commission (COSO).COSOs Integrated Framework describes the essential components, principles and concepts of ERM. A holistic approach, it applies to the activities at all levels within the organization.ERM utilizes a portfolio view of the organization and its risks. The three-dimensional framework begins by identifying the organizations objectives in terms of Strategic, Operational, Reporting and Compliance goals. Figure 33-1 illustrates these objectives along with the eight interrelated components of the framework. Descriptions of the frameworks eight components are summarized in Figure 33-2.

Components of COSO Framework

ComponentPurpose

InternalEnvironmentA successful ERM program sets a tone from the top of the organization; it establishes and communicates a risk management philosophy that becomes the entitys risk culture.

ObjectiveSettingManagement must first specify the objectives of the risk management program before it can identify risks and take the necessary actions to manage them. Objectives should align with the entitys mission and strategy, and be consistent with its risk appetite and risk tolerance level. Measurable objectives are set at the strategic level, establishing a basis for operations, reporting, and compliance objectives.

EventIdentificationWhile identified events can range from the obvious to the obscure, they are equally important. Internal or external incidences that could affect strategy and achievement of objectives are identified. The distinction between risk and opportunity is made during event identification.

RiskAssessmentRisk assessment is perhaps the most critical aspect of the framework. Risks are assessed from two perspectiveslikelihood and impact (or significance).Likelihood represents the possibility a given event will occur, while impact represents its effects. The likelihood of an event can be expressed in: (1)qualitative terms such as high, medium and low or other judgmental scales; or (2) as a quantitative measure such as a percentage, frequency of occurrence, or other numerical metric. The impact of an event can be described in terms such as expected or worst-case value, or a range or distribution. Units of measure for assessing risks should be the same units used for measuring related objectives.

RiskResponseThe next step involves identifying and evaluating possible responses to risk.Typical responses include risk avoidance, reduction, sharing, and acceptance.The evaluation of risk responses are based on: (1) assessment of the cost versus the benefit of potential risk responses, and (2) the effect of potential risk responses on risk likelihood and their impacts.

ControlActivitiesControl activities involve the policies and procedures that help ensure the risk responses are carried out. All levels of the organization should participate in developing and implementing these policies and procedures.

Information andCommunicationAll relevant information should be identified, captured, and communicated.The form and timeframe used should enable people to carry out their responsibilities. Information can originate from internal and external sources, and include both financial and non-financial aspects. It should be appropriate,timely, current, accurate, and accessible.

MonitoringA monitoring program to observe and measure the effectiveness of the ERM components allows management to evaluate and improve upon itsrisk management activities. The monitoring program should be an ongoing process.

RISK IN AN EXPLORATION & PRODUCTION COMPANYMany business decisions are driven by an assessment of risks. For an E&P company, risk-taking is an asset, and like all assets, it should be managed.An E&P company buys many leases expecting to drill successful wells and some dry holes. It strives to discover enough oil and gas to be sold at an adequate profit for the overall exploration and production effort. Leases (and the associated risks) are purchased on the assumption that opportunities will outweigh hazards. Buying several leases and enteringinto joint venture agreements reduce the risk of little or no success. However, exposure to unexpected events is always present, such as the occurrence of a well blowout or local citizens who rally to keep a companys new offshore discovery from being produced.Risk is inherent in virtually every business action and inaction. It cannot be eliminated entirely and is a natural part of business success. In fact, a risk-averse organization frequently does not survive as new markets, products, and responses quickly pass it by.

AREAS OF RISKBroad areas of risk exist for every company and its stakeholders. Risks must be recognized in order to be managed, and recognition requires an awareness of stakeholders who may be affected.A stakeholder is defined as any group or individual that affects or is affected by achievement of a companys objectives. Stakeholders include shareholders, creditors, employees, governments, communities in which a company operates, and even the world when a companys activities have an impact on general prosperity. The long-term viability of a company partly depends on intelligent, balanced service to its stakeholders.Risks can be categorized in a variety of ways. The most common risks found in petroleum companies include:Strategic risks arising from corporate decisions on mergers, acquisitions,geographic focus, and other strategic actions.Financial risks concerning capital costs, information systems, and employee fraud.Operational risks occurring in property acquisition, exploration, development, and production.Compliance risks which exist in attempting to conduct business according to myriad government laws, regulations, and contracts dealing with exploration, production, employees, customers, taxation, and environmental safety.The petroleum industry continues to experience significant changes, and each one brings new risks to be identified and addressed. Trends such as globalization have led U.S. companies to seek business in areas of the world where opportunities exist for major discoveries. Yet, kidnappings and guerilla warfare can be among the hazards of doing business in these areas.

IMPORTANCE OF RISK MANAGEMENT TO THE E&P INDUSTRYThe foundation of the E&P industry is the management of risks. As wells deplete and dry holes occur, new reserves must be found. A typical E&P company must focus on adding reserves value in order to be successful. There are many strategies for managing risks to add reserves value including:Acquisition of lease rights in promising areas to improve opportunities forexploratory success Use of the most suitable exploration technologySpreading risk and gaining expertise via joint venture arrangementsHedging oil and gas prices in line with management directivesSophisticated approaches to valuing reserves Strong engineering oversight of production Geological, engineering, and management personnel with technical, financial, and risk management perspectivesCreative and assorted financing arrangements to provide capital at the lowest cost for the degree of retained risks of property ownershipGiven the: (a) core nature of the industry to explore, (b) volatility of petroleum prices and exploratory success, (c) industry issues of globalization and global warming, and (d) rapid and substantial technology changes, a strong risk management process throughout anE&P company should be of significant benefit and importance.

IMPACT OF RISK MANAGEMENT ON PETROLEUM ACCOUNTINGRisk management drives many of the events and transactions petroleum accountants must address, including:Use of joint venture arrangements to manage risk at the expense ofcomplicating petroleum accounting Globalization to enhance corporate opportunities at the expense of requiring additional or specialized accounting systems and policies for new foreign locationsCreative financing arrangements such as conveyances of volumetricproduction payments, which can necessitate special petroleum accountingDevelopment and use of standardized forms, contracts, and joint ventureprotocols, such as COPAS accounting exhibits, gas balancing agreements,EDI (Electronic Data Interchange) standards, joint venture audits, and material transfer accounting procedures Enhanced, secure internet communications of accounting transactions Hedge accountingInternal and external financial and tax reporting Internal auditingPetroleum accounting is a key element of risk management for an E&P company. As a companys risk management program increases in importance and sophistication, so should the companys accounting department.

DERIVATIVES IN A RISK MANAGEMENT PROGRAMExploration and production, marketing, pipeline, refining, and utility companies, as well as large industrial consumers, use derivatives in their operations. Energy derivatives are widely used to hedge risks associated with oil and gas pricing. Investors and companies that speculate on the movement of commodity prices also utilize them.Derivatives are financial instruments whose values are derived from the value of an underlying asset, reference rate, or index. Oil and gas companies typically use futures, forwards, options, and swaps. Derivatives designed specifically for the energy industry have existed for several years. The New York Mercantile Exchange (NYMEX) crude oil and natural gas futures contracts have been in existence since 1983 and 1990, respectively.

COMMON TYPES OF COMMODITY-BASED DERIVATIVE INSTRUMENTS FUTURESA futures contract can be defined as an exchange-traded legal contract to buy or sell a standard quantity and quality of a commodity at a specified future date and price. Both crude oil and natural gas futures contracts are traded on NYMEX, with other exchanges developing similar contracts. A standard NYMEX crude oil futures contract is for 1,000 bbls for delivery in Cushing, Oklahoma, while a standard NYMEX natural gas futurescontract is for 10,000 MMBtu for delivery at the Henry Hub in southern Louisiana.Futures contracts protect against adverse price changes or losses on existing assets.They may be used to speculate on upward and downward price movements of underlying commodities. Futures contracts are subject to regulation by the Commodities Futures Trading Commission (CFTC).The purchaser of a futures contract has a long position, and the seller of a futures contract has a short position. Buyers/sellers of futures contracts can easily liquidate their positions by selling/buying an offsetting contract for the same delivery month. Most crude oil and gas futures contracts are settled in this manner, as opposed to delivering or receiving oil or gas at the exchange delivery points. Buyers/sellers may also settle their futures positions by exchanging for physicals.Transactions are typically executed through a commodity futures brokerage firm. Initial margin deposits of cash or cash equivalents are required for futures contracts. If the value of the futures contract decreases by a significant amount, the customer must deposit additional funds to restore the original margin account amount. The exchange acts as a clearinghouse between buyers and sellers of futures contracts, guarantees contractperformance, and assumes all counterparty credit risk.

FORWARD CONTRACTSLike a futures contract, a forward contract is a legal contract between two parties to purchase and sell a specific quantity and quality of a commodity at a specified price, with delivery and settlement at a specified future date.1 Oil and gas forward contracts, however, are not traded on regulated commodity exchanges. The contracts are privately negotiated agreements referred to as over-the-counter (OTC) contracts. Consequently, they lack the liquidity and minimal credit risk exposure offered by exchange-traded futures contracts. However, forward contracts are more flexible than futures contracts because they can be tailored to specific quantities, settlement dates, and delivery points. Like futures contracts, forward contracts can be used for both hedging and speculating.

OPTIONSOption contracts give the holder a right, but not an obligation, to buy (call) or sell (put) a specified item at a fixed price (exercise or strike price) during a specified period (exercise period). The buyer (holder) pays a nonrefundable fee (premium) to the seller (writer). Options are either exchange-traded (such as NYMEX options on the NYMEX crude oil futures contract) or OTC contracts. OTC options expose the holder to counterpartydefault. Options can be used for both hedge and speculative purposes.

SWAPSSwaps are contracts between two parties to exchange variable and fixed-rate payment streams based on a specified contract principal or notional amount. For instance, two companies may enter into a natural gas price swap which requires one company (the fixed-price payor) to pay a fixed price and another company (the variable-price payor) to pay based upon a published gas index or futures contract settlement price. The volumeof gas (e.g., 1,000 MMBtu per month for six months) used to calculate the variable and fixed-rate payment is the contract principal or notional amount. The settlement amount of these contracts is typically calculated as the difference between the fixed and variable prices multiplied by the notional volume. A net payment is made to one of the parties.Swap contracts are more flexible than futures contracts because they can be tailored for specific quantities, settlement dates, and locations. Swap agreements are OTC contracts and therefore expose the parties to counterparty credit risk (i.e., the other party may be unable to pay or honor the contract). Consequently, parties to swap agreements may require margin deposits. Swaps are used primarily for hedging purposes or to alter the terms of an existing agreement.

RISKS ASSOCIATED WITH DERIVATIVESAlthough derivatives can be effectively used to protect companies from adverse commodity price movements, significant risks are associated with them.PRICE RISKBecause of the volatility of oil and gas prices, producers are exposed to the risk that prices will decline. If derivatives are used to hedge this exposure, risk management activities should be performed by knowledgeable personnel with good understanding of a companys price risks and the terms of the derivatives/financial instruments used to reduce this risk. Poor risk management strategy can result in increased exposure to volatile oil and gas prices.CREDIT RISKSimilar to other financial instruments, derivatives expose a company to credit risk. Credit risk is the risk a loss may occur from the failure of another party (counterparty) to perform according to contract terms. It includes not only the net payable or receivable outstanding, but also the cost of replacing a derivative contract if the counterparty defaults. Counterpartycredit risk is further concentrated when companies enter into multiple derivative contracts with the same counterparty or counterparties in the same geographic location or industry.Credit risk is generally lower if the derivative is an exchange-traded contract. Exposure to credit risk can be further minimized by requiring collateral or margin deposits.LIQUIDITY RISKLiquidity risk results from the inability to easily purchase or sell derivative contracts in required quantities at a fair price. Fair prices may not be available when there are large discrepancies between the bid price (buyers price) and the asking price (sellers price).Exchange-traded derivatives are generally more liquid than over-the-counter derivatives.CORRELATION RISKCorrelation risk is a risk the commodity price in the derivative contract will not move in tandem with the commodity price being hedged. Consequently, an increase in the value of a derivative transaction might not fully offset the decrease in the value of the hedged item, or vice versa. When deciding whether to hedge a risk, a key factor is whether there is an expected high correlation between anticipated changes in the market value of thehedging instrument and market value of the hedged item, and whether that correlation is likely to continue throughout the hedging period.BASISBasis is the difference between the spot price of a hedged item and the price of the hedging instrument. Basis is sometimes referred to as the spread. Because the prices received for oil and gas vary by location, quality, local supply/demand conditions, and other factors, the commodity price of a hedge contract frequently does not equal the spot price received for the production.

ACCOUNTING GUIDANCEIn June 1998, the FASB issued Statement of Financial Accounting Standards No. 133 (FAS 133), Accounting for Derivative Instruments and Hedging Activities. It represents a comprehensive framework of accounting rules that standardizes and creates uniform accounting for derivatives. All entities and all types of derivatives are subject to the rules of FAS 133.Under FAS 133, all derivatives must be recognized on the balance sheet at fair value with an offsetting entry related to unrealized gains and (or) losses reflected either: (1) as part of current earnings, or (2) in other comprehensive income, which is a component of stockholders equity. These modifications eliminate the practice of synthetic-instrumentand off-balance sheet accounting.The ultimate goal of the FASB was to increase the visibility of derivatives and require hedge ineffectiveness to be recorded in earnings. The adoption of FAS 133 resulted in an increase in earnings and equity volatility as well as an increase in the number of derivative contracts included in the balance sheet accounts for many E&P entities.As a result of the complexity of FAS 133, FASB created the Derivatives Implementation Group (DIG). DIG was a task force to assist the FASB in answering questions as companies implemented and interpreted FAS 133. The objective in forming the group was to establish a mechanism to identify and resolve significant implementation questions in advance of adoption of the standard by many companies.In June 2000, the FASB issued FAS 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, an Amendment to FASB Statement No. 133. For E&P companies, a notable provision of FAS 138 is to allow certain contracts to avoid being considered derivatives. Contracts that contain net settlement provisions qualify for the normal purchases and sales exception if it is probable at inception, and throughout the term of the individual contract, the contract will not settle net and will result in physicaldelivery. In April 2003, FASB issued FAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, which amends and clarifies FAS 133 for certain decisions made by the FASB as part of the DIG process.

DEFINITION OF A DERIVATIVEA derivative is defined as a financial instrument or other contract that possess all three of the following characteristics:1. Value changes by direct reference to: (1) one or more underlyings, and (2) one or more notional amounts or payment provisions or both2. No initial net investment (or a small investment for time value)3. Settled net or by delivery of an asset readily convertible to cashThe three concepts of underlying, notional amount, and payment provision are key to defining a derivative. An underlying in a derivative is a specified commodity price, interest rate or security price, or some other variable. It may be a price or rate of interest, but not the asset or liability itself. Thus, the underlying generally is the referenced index that determines whether or not the derivative has a positive or negative value.The notional amount is a number representing the barrels of crude oil, natural gas MMBtu, pounds, bushels, currency units, shares, or other units specified in a contract.Settlement of a derivative is determined by the interaction of the notional amount with the value of the underlying. This interaction may consist of simple multiplication or it may involve a more complex formula.A payment provision specifies a fixed or determinable settlement that is to be made if the underlying behaves in a certain manner. For the energy industry, the payment provision is the most problematic component as the commodity (such as crude oil and natural gas) is produced and sold in liquid markets.The net settlement requirement can be accomplished in three ways:Net settlement explicitly required or permitted by the contract (i.e.,symmetrical liquidating damage clause)Net settlement by a market mechanism outside the contract (i.e., futuresexchange)Delivery of a derivative or an asset that is readily convertible to cashBased on these concepts, the definition of a derivative has been expanded to include not only the typical financial instruments that have been viewed in the past as derivatives, but may also include traditional physical commodity contracts which do not meet thenormal purchase and sale exclusion provided for in FAS 133. FAS 149 allows contractsthat contain net settlement provisions to qualify for the normal purchases and salesexception if it is probable at inception and throughout the term of the individual contractthat the contract will not settle net and will result in physical delivery. The FASB and DIGhave provided additional interpretive guidance pertaining to the new settlement criteria.EXCLUSIONSExamples of types of exclusions include: normal purchases and sales, contingent consideration resulting from a business combination, certain insurance contracts, and employee compensation arrangements that are indexed to an entitys own stock and classified as part of stockholders equity. Contracts, which meet the definition of a derivative and qualify for one of the exclusions, are not subject to the guidance for accounting for derivatives.EMBEDDED DERIVATIVESAn embedded derivative is a provision in a contract through its implicit or explicit terms that contains the characteristics of a free-standing derivative which ultimately affect the cash flows or value of other exchanges required by a contract. Thus, the combination of a host contract and an embedded derivative is referred to as a hybrid instrument. Examples of an embedded derivative include a purchase or sale contract subject to a cap, floor orcollar. An embedded derivative should be separated from the host contract and accounted for separately in the financial statements if all of the following criteria are met: The embedded characteristic in the contract meets the definition of a derivative. Characteristics and risks of the embedded derivative are not clearly and closely related to the host contract. The host contract is not measured at fair value.

Judgment is required to interpret the phrase clearly and closely related. It implies the economic features of an embedded derivative and host contract are somewhat interdependent, and the fair value of the embedded derivative and the host contract are impacted by the same variables, and vice versa.

TYPES OF HEDGESIncome statement recognition of changes in the fair value of derivatives depends on the intended use of the derivatives. If a derivative does not qualify as a hedging instrument or is not designated as such, gain or loss on the derivative must be recognized currently in earnings. To qualify for hedge accounting, the derivative must qualify either as a fair valuehedge, cash flow hedge, or foreign currency hedge.A fair value hedge represents the hedge of an exposure to changes in the fair value of an asset, liability, or an unrecognized firm commitment that is attributable to a particular risk.An example of a fair value hedge is a forward contract pertaining to an unrecognized firm commitment (fixed price sales and purchase contracts), or an interest rate swap contract associated with fixed rate debt. A fair value hedge is reflected in the financial statements at market value each reporting period, and the associated unrealized gain or loss incurredwith respect to such instrument is included in earnings.Changes in the fair value of the corresponding unrecognized firm commitment or asset/ liability being hedged are also recognized in the financial statements each reporting period.As a result, both the income statement and balance sheet of an organization are increased for these transactions. The only component that affects net income, in any given reporting period, is any ineffectiveness identified as part of the effectiveness assessment made by the organization.A cash flow hedge is a hedge of an exposure to variability in cash flows that is attributable to a particular risk associated with an existing recognized asset or liability (floating rate debt) or a forecasted transaction (future production of crude oil or natural gas). Some common examples include the use of futures, swaps, or costless collar arrangements associated with future crude oil and natural gas productions, or an interest rate swapassociated with variable rate debt. A cash flow hedge is reflected in the financial statements at market value each reporting period, and the associated unrealized gain or loss incurred with respect to such instrument is included in other comprehensive income. The amount that is deferred in other comprehensive income is always the lesser of (in absolute valueterms): (1) estimated changes in the expected future cash flows of the hedged item that are attributable to the hedged risk, or (2) cumulative gain or loss on the derivative instrument.The corresponding forecasted transaction or recognized asset/liability is not reflected in the financial statements. In a given reporting period, the only component that affects net income is any ineffectiveness identified as part of the effectiveness assessment made by the organization.FAS 133 generally retained the FAS 52 hedge accounting provisions. In this regard, it includes a narrow scope of transactions for which hedge accounting may be applied to foreign currency/operations activities. A foreign currency hedge is the hedge of a foreign currency exposure to an unrecognized firm commitment, available-for-sale security, forecasted transaction, or net investment in a foreign operation. Foreign currency hedges can have the dynamics of a fair value transaction, cash flow transaction, or foreign currency hedge of a net investment in a foreign operationdepending on the nature of the underlying physical transaction(s). They are accounted for in a manner consistent withthe general provisions of a fair value hedge or cash flow hedge as previously described.

EFFECTIVENESSCertain criteria must be met for a derivative financial instrument to fall within one of the hedging categories described above. Some criteria are similar to the determination of hedge accounting at present, while others formalize a process which may already be in place. First, an entity indicates what it is doing with the derivative financial instrument through formal documentation of the hedge relationship and risk management objectiveand strategy at the beginning of the contract term. This documentation encompasses a specific designation of the hedge instrument and related items, nature of the risk being hedged, and the method of assessing effectiveness. A hedging item should be consistent with the respective risk management policy, and is expected to be highly effective at inception and on an ongoing basis throughout the term of the contract.The FASB declined to quantify the term highly effective; however, DIG provided interpretive guidance on this matter. An assessment of effectiveness is required to be performed at least every three months and whenever financial statements or earnings are reported to the public. The method for assessing effectiveness should be included as part of the initial documentation requirements. Hedge effectiveness must be achieved initially and on an ongoing basis. Measurement of hedge effectiveness is prospective, as well as retrospective. Ordinarily, it is expected an entity will assess effectiveness for similar hedges in a similar manner; use of different methods for similar hedges must be justified. Effectiveness allows an entity to utilize hedge accounting; however, ineffectiveness must still be measured and recorded in the financial statements. If a derivative has beendetermined to be highly effective, some ineffectiveness is likely to occur, and some gain or loss will be reflected in earnings. Items which may generate ineffectiveness include: (1) different maturity or repricing dates, (2) different underlying (e.g., hedging jet fuel inventory with heating oil futures), (3) location and quality differentials (San Juan Basin gas versusNYMEX or sweet versus sour barrels), and (4) credit differences. As it relates to cash flow hedges, the amount deferred in other comprehensive income is the lesser of (in absolute value terms): (1) estimated changes in the expected future cash flows of the hedged item that are attributable to the hedged risk, and (2) cumulative gain or loss on the derivativeinstrument. In essence, there is a limitation of the amounts pertaining to unrealized gains and/or losses that may be accumulated in other comprehensive income. Therefore, the cumulative gain or loss on the derivative in excess of the estimated changes in expected future cash flows is recorded in the income statement as ineffectiveness.Any changes an entity makes to its method of assessing effectiveness has to be justified and applied prospectively by a discontinuance of the existing hedging relationship and a new designation of the relationship through the use of the improved method. In addition, if an enterprise changes the method of assessing effectiveness on a hedged item, the enterprise also changes the method of assessment for similar hedges.

DISCONTINUANCE OF HEDGE ACCOUNTINGThe discontinuance of hedge accounting occurs in two situations: (1) a failure to meet any of the qualifying hedge criteria, and (2) the derivatives were to expire or be sold, terminated, exercised, or simply de-designated as a hedging instrument.

DISCLOSURESThe disclosure requirements in financial statements for derivatives and hedging activities are quite extensive. Qualitative disclosures should include the objective and strategy, risk management policy, and description of hedged items. In addition, FAS 133 expands the disclosure pertaining to derivatives to include the amount of ineffectiveness reflected in earnings, earnings impact from discontinued hedges, amount of gains and losses included in other comprehensive income to be included in earnings within the next twelve months, and the purpose of derivatives that do not qualify as a hedging instrument.RECENT FASB STATEMENT ON FAIR VALUE MEASUREMENTSOn September 15, 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (FAS 157), Fair Value Measurements. The ruling provides guidance for using fair value to measure assets and liabilities. FAS 157 applies to situations when other standards require (or permit) assets or liabilities to be measured at fair value. It defines fair value,establishes a framework for measuring fair value, and expands disclosures about fair value measurements. Where applicable, FAS 157 simplifies and codifies related guidance within generally accepted accounting principles (GAAP).Prior to FAS 157, there were different definitions of fair value and limited guidance for applying those definitions in GAAP. Fair value definitions were dispersed among many accounting pronouncements, which created inconsistencies and added to the complexity in applying GAAP. In developing FAS 157, the Board considered the need for increasedconsistency and comparability in fair value measurements and for expanded disclosures about fair value measurements. Under FAS 157, fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.The changes to current practice resulting from the application of FAS 157 relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements.

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