Weathering the "Other-Than-Temporary" Impairment Storm: Properly Apply New FASB Staff Position EITF 99-20-1 to Your Investment Securities

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EXECUTIVE SUMMARY

* Accounting guidance requires entities to categorize an investment security into one of three categories upon acquisition: held to maturity ("HTM"), trading, or available for sale ("AFS"). In addition to defining the three classifications of securities, an entity is required to assess both the classification of AFS and HTM securities each reporting period and to determine whether any declines in fair value below amortized cost should be considered other than temporary.

* There are two primary accounting models for assessing impairment on securities. EITF 99-20 applies to all credit-sensitive mortgage- and asset-backed securities and certain prepayment-sensitive securities and FAS 115 applies to all other securities, except investments accounted for under the equity-method. Subsequent to the issuance of FSP EITF 99-20-1, the models are essentially the same.

* Companies must disclose, (in tabular format) the amount of unrealized losses and the aggregated fair value of investments with unrealized losses in investment securities whose fair value is less than book value and for which an other-than-temporary impairment charge has not been taken. Additional narrative disclosure is required to provide insight into an entity's rationale for concluding that existing impairment(s) is temporary.

* Entities should consider all available evidence in determining whether an other-than-temporary charge should be recognized. Greater weight should be placed on evidence that is objective and verifiable than subjective assumptions. The application of a "bright line" or "rule of thumb" test is not appropriate.

* Entities should employ a systematic methodology that is applied consistently and includes formal documentation of the factors considered when assessing impairment.

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As if a recession, the credit crisis and the housing downturn were not causing enough stress, many companies, and their accountants and auditors, must also consider an accounting issue that has become increasingly pressing--should their investments be considered "other-than-temporarily impaired"? This issue is relevant not only for financial institutions but for any company that holds corporate debt, structured investment securities (CDOs, mortgage-backed and other asset-backed securities) or equities.

Some market analysts and members of the financial press have blamed U.S. GAAP's fair value accounting requirements for exacerbating financial markets instability. Frequently critics attribute the problem to the application of FASB Statement no. 157, Fair Value Measurements. However, Statement no. 157 provides guidance on how to measure fair value, not when assets should be recorded at fair value.

The real controversy comes from accounting standards that require entities to measure certain assets or liabilities at lair value. During market downturns, the accounting requirements relating to recognition of impairment on investment securities become especially contentious. These rules require accountants to make subjective assessments in determining when impairment should be considered "other than temporary," and if so, to write down the impaired asset to its fair value with a charge to current-period earnings. Companies are generally reluctant to take such impairment charges because once a new cost basis is established from the write-down, any subsequent appreciation in fair value of the impaired security may not be recognized until the security is sold. At the same time, the decision not to recognize impairment is subject to close scrutiny by analysts and regulators.

This article discusses current accounting requirements relating to the assessment of impairment of equity securities with readily determinable fair values and all debt securities, including the effects of the recently issued FASB Staff Position no. EITF 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. …