In accordance with generally accepted accounting principles, management of a company that is a holder of individual debt securities classified as either available-for-sale or held-to-maturity must determine whether a decline in fair value below the amortized cost basis is other than temporary. In assessing whether a decline is other-than-temporary, FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, indicates that if it is probable that the investor will be unable to collect all amounts due (i.e., principal and interest) according to the contractual terms of a debt security not impaired at acquisition, an other-than-temporary impairment is considered to have occurred. If the decline in fair value is judged to be other than temporary, the cost basis of the individual security should be written down to fair value as a new cost basis. It should be observed that a decline in fair value assessed to be other than temporary should not be interpreted to mean a permanent impairment (or decline).
The assessment of whether a decline in fair value is other than temporary should be determined by management for each reporting period (annual and interim periods). Whether management determines that a decline in fair value of a security below cost is temporary or other-than-temporary, it must document the decision process to support that conclusion. Appropriate documentation would include, but not be limited to, an analysis of the security's market value (e.g., amount and duration of decline), the rating of the security available from external sources, the financial performance of the issuer, and trends in the issuer's industry. It should be noted that for securities such as collateralized mortgage obligations, this analysis also should include an evaluation of the liquidity of the underlying collateral.
FASB Staff Position (FSP) No. FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, describes three steps that management should use in determining when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. In applying the first step, an investment is impaired if the fair value of the investment is less than its cost. For a cost-method investment for which a fair value has not been estimated, the FSP provides impairment indicators, which should be used in evaluating whether an event or change in circumstances has occurred during the reporting period that may have a significant adverse effect on the fair value of the investment. When the cost or carrying value of an investment is impaired, then step two of the FSP is applied.
Step two requires an assessment of whether the impairment is either temporary or other than temporary. An investor must apply guidance that is pertinent to the determination of whether an impairment is other than temporary, such as paragraph 16 of Statement No. 115, paragraph 6 of APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock, and EITF Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets.”
Step three provides that when it is determined that the impairment is other than temporary, then an impairment loss must be recognized in earnings equal to the entire difference between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the assessment is made. In periods subsequent to the recognition of an other-than-temporary impairment loss for debt securities, an investor should account for the other-than-temporary impaired debt security as if the debt security had been purchased on the measurement date of the other-than-temporary impairment. |
