impaired marketable securities - a growing problem

8/14/2019 Impaired Marketable Securities - A Growing Problem

1/4

26 Financial Reporting Disclosures March/April

Reporting investments

in securitiesCompanies investing in the securities o

other entities are required to report theirholdings based on a variety o actors. First,an entity must determine the nature o itsinvestment by classiying it as either a debtsecurity or an equity security.

Debt securities are characterized by adebtor/creditor relationship and generallyinclude investments such as U.S. Treasurysecurities, U.S. government agency secu-rities, municipal securities and corporate

bonds. Equity securities, such as common,

preerred or other capital stock, gener-ally represent an ownership interest in anenterprise. Equity securities may also takethe orm o a right to acquire or dispose oan ownership interest (e.g., warrants, rightsand call or put options).

Once the nature o a security has beendened, an entity must urther analyze itsequity securities to determine i the airvalue is readily determinable. Generally,the air value o an equity security is readilydeterminable i sales prices or quotations are

currently available on a securities exchangesuch as the New York Stock Exchange, orin the case o mutual unds, the per shareprice is widely published. The term mar-ketable securities is requently used to reerto investments that encompass both debtsecurities and equity securities with readilydeterminable air values.

Recording and

classifcation

The purchase o a marketable securityis initially recorded at cost. At acquisition,

companies must classiy their marketablesecurities into three groupings, based ontheir type (debt vs. equity) and on manage-ments intent to hold the security. Theseinclude:

Held to maturity: Securities pur-chased with the positive intent andability to hold to maturity. This categoryonly applies to debt securities becauseequity securities, by denition, do nothave maturity dates.

ImpairedMarketable

Securities:A Growing Problem in Todays Economic EnvironmentBy Peter R. Alfele, CPA

The recent economic downturn and declining investment

markets have let many companies holding portolios o

impaired marketable securities. As a result, nancial report-

ing executives must analyze their portolios to decide how to report

these losses and to deend their assertion that temporary losses will

be recovered.


2/4

Financial Reporting Disclosures March/April 27

Trading: Securities bought and heldprincipally to be sold in the near-term.Trading securities are held usually bynancial institutions and similar enti-ties, and typically have a holding periodmeasured in hours and days rather thanmonths or years.

Available for sale: Securities thatdo not meet the criterion to be clas-sied as held to maturity or trading.

Classication is important because secu-

rities are reported in vastly dierent waysdepending on how they are categorized.This article ocuses on the accountingrequirements o the available or sale cat-egory as the majority o operating businessesclassiy their securities as such.

As available or sale securities are sold,any dierence between the purchase priceand the sales price is reported in earnings.Securities held are adjusted to the air valueo the investment on the reporting date.Recognizing that air value adjustments may

cause volatility in an entitys operating earn-ings, standard setters directed these unreal-ized holding gains/losses to be reported inother comprehensive income (OCI).

OCI is a segregated component o -nancial statements used to capture certain

economic events o unrecognized transac-tions o a period. Because items includedin OCI are usually excluded rom analysiso a companys perormance in its coreactivities, management may be inclined toreport negative results in OCI rather thanearnings.

The impairment condition

A marketable security is consideredimpaired when its air value is less than itscost. Once impaired, nancial reporting

standards require companies to urtheranalyze their investment securities and dis-close managements determination o thepotential to recover the price paid.

Accounting or impaired marketablesecurities classiied as available or saleinvolves a determination o whether adecline is temporary. This determinationis a critical matter o judgment becauseo the reporting ramications. I the lossis considered temporary, the adjustmentis reported in OCI and may be w

If your company is holding impaired

marketable securities, its time to decide

how to report these losses.


3/4

28 Financial Reporting Disclosures March/April

subsequently recovered i the value o the in-vestment returns. However, i managementconsiders the loss other-than-temporary, theloss is charged to operations and subsequentrecoveries o air value are not included inoperating results until the investment issold.

The impairment analysis

In perorming an impairment analysis,the accounting standards outline a three-stepprocess to 1.) determine when a security is

deemed impaired; 2.) determine i the lossis temporary; and 3.) measure and recognizethe loss.

As described above, an investment isgenerally considered impaired when itsair value is less than its cost. Cost includesadjustments or accretion, amortization,any previous impairment losses and hedg-ing. The review or impaired securitiesmust be conducted in each reporting period(including interim periods) at the individualsecurity level. An analysis o a portolio or

provision o a general allowance is not anacceptable practice. However, separatelots o equity securities bearing the sameCommittee on Uniorm Security Identi-cation Procedures (CUSIP) number thatwere purchased at dierent dates may becombined on an average cost basis i thecompany ollows this practice to determineits realized gains and losses.

Once a company has identied the indi-vidual securities that are in a loss position,management must conclude whether theloss is temporary or other-than-temporary.

While the accounting literature does notspecically dene the term other-than-temporary, it emphasizes that the phraseshould not be interpreted to mean per-manent.

Absent that guidance, standard-setterspoint to publications o regulators to lendsome insight. In Securities and ExchangeCommission (SEC) Sta Accounting BulletinNo. 59, Other than Temporary Impairment ofCertain Investments in Equity Securities, the SEC

sta urge that all available evidence should be considered and provided three actorsthat, either individually or in combination,may indicate that a securitys impairment isother-than-temporary:

Time and extent of loss: As thelength o time needed or recoverygrows and/or the magnitude o the lossincreases, the likelihood that impairmentis other-than-temporary also increases.Assertions that securities that have beenunderwater or extensive periods otime are only temporary would needto be supported by more compellingevidence than those that have recentlydeclined to a loss position.

Issuers financial condition: Anexamination o the scal health o theinvestee may shed some light on whena turnaround in perormance could beexpected. Investees aced with signi-cant changes in technology or who haverecently reported the discontinuance ocertain operations may provide clues thata recovery is not eminent.

Intent and ability of the holder:An introspective look at the investorsorecasted cash or working capital de-mands may indicate that the companymust sell the securities in question inorder to meet its own obligations beorethe investment is expected to recover.In addition, while the determination othe other-than-temporary impairment isto be hypothetically made as o the bal-ance sheet date, the sale o the securitysubsequent to the balance sheet date and beore the release o the statements isstrong, although not by itsel conclusive,indication that an other-than-temporaryloss should be recorded.

The conclusion that an impaired loss isother-than-temporary requires a great dealo judgment. In order to avoid unnecessaryscrutiny, management should consistentlyapply a systematic approach or classiying

impaired securities. For instance, estab-lishing evaluation criteria in advance anddocumenting the actors considered in theanalysis and the conclusions reached willlend credibility to managements asser-tions.

Reporting impairment

losses

Once a loss is considered other-than-temporary, the dierence between the costand air value o the investment at the bal-

ance sheet date is reported in earnings. Thenew cost basis is not changed or subsequenrecoveries in air value. A recovery in airvalue is not recorded in earnings until thesecurity is sold.

In addition, accounting standards requirea company to disclose its investments thatare in a loss position, grouped by thosethat have been in a continuous loss or lessthan 12 months and those that have beenunderwater or more than 12 monthsManagement must also include a narrative

discussion essentially deending its positionthat unrealized losses are only temporaryThis narrative should be straightorwardand discuss what caused the loss as well asspecic evidence supporting the expectedrecovery. While this narrative presentsmanagement with an opportunity to elabo-rate on its intentions, it should be based ondeendable acts and objective viewpoints.

Income tax

considerations

Although nancial reporting standards

require companies to write down the basiso securities deemed to be other-than-temporarily impaired, ederal income taxregulations do not permit a deduction orsuch losses until the security is actually soldAs such, securities whose cost basis has beenreduced by an impairment charge producebook-tax dierences that result in deerredtax assets and the corresponding incometax provision is allocated to earnings (asopposed to OCI).

To avoid unneccessary scrutiny, management

should consistently apply a systemic approach

for classifying impaired securities.


4/4

Financial Reporting Disclosures March/April 29

Comparison to Interna-

tional Financial Reporting

Standards (IFRS)

The valuation o marketable securitiesis an area where U.S. reporting standards

dier substantially rom the rules ollowedby the global business community. Whileboth U.S. reporting requirements and IFRSrequire impairment assessments based onrelatively subjective criteria at each bal-ance sheet date, the IFRS model is quitedierent.

For instance, the notion that a holdingloss is other-than-temporary is not con-sidered under IFRS. Additionally, the IFRSanalysis permits assets to be evaluated ingroups where U.S. standards require thatthe review be conducted at the security

level. Further, while U.S. standards pointto indications o impairment (time andextent o loss, issuers nancial condition,intent and ability o the holder), IFRS gener-ally requires certain occurrences beore animpairment loss is recorded.

Specically, recording a loss under IFRSrequires objective evidence o impairmentas a result o one or more events and thatthe loss event (or events) has an impact onthe estimated uture cash fows o the nan-cial asset or group o nancial assets that can

be reliably estimated. Finally, unlike U.S.principles that restrict the recognition othe recovery o an impaired security beyondits adjusted basis until it is actually sold,IFRS permits subsequent gains undercertain circumstances.

Conclusion

During periods o economic instability,a nancial reporting executives judgmentaces higher scrutiny. Decisions with regardto impaired marketable securities require a

great deal o care and should be approachedobjectively and systematically in order toprovide meaningul disclosures about acompanys investments and lend credibilityto the nancial statements.

U.S. reporting

standards differ

substantially fromthe rules followed by

the global business

community in

the valuation of

marketable securities.

Peter R. Alfele, CPA,

is a partner at Cherry,

Bekaert & Holland, LLP,

in Virginia Beach. He

has more than 12 years

of experience providingaudit and accounting

services to a variety of

commercial enterprises and closely

held, middle market businesses.

Contact him at [email protected]

or search and connect with him on

LinkedIn.

impaired marketable securities - a growing problem

Documents