Week 3

Case Study 10-7

Scenario A
The client has indicated in their memo that the debt securities which have declined in fair
value are not other-than-temporarily impaired and therefore the client does not intend to record
an impairment loss in earnings. They have provided some applicable facts which support this
decision and which are in accordance with the requirements outlined in the Codification:
They did not intend to sell the debt securities. Under ASC 320-10-35-33A, the intent to
sell a debt security automatically creates an other-than-temporary impairment.
They determined that they would not likely be required to sell the securities before
recovery of their amortized cost bases. This is the second requirement provided in
section ASC 320-10-35-33B.
The client also has indicated that they fully expect to recover the amortized cost bases of the
securities because there is no evidence that the debtor will not continue to make payments as
scheduled. The Codification does indicate that such an assessment should be made, however
ASC 320-10-35-33F through 33I quite clearly indicate that there are numerous factors to be
considered when determining if the security can be recovered. The client did not effectively
communicate that they had considered multiple factors, other than the fact that the payments
have continued to be made as scheduled. Furthermore, I am concerned that although as of the
balance sheet date the client did not intend to sell the securities, within a month that decision had
changed. I feel that despite the written documentation they provided the auditors as of March
31
st
, the sale of these debt securities should still be taken into consideration.
I suggest that the appropriate accounting for these securities as of the March 31, 2010
balance sheet date is that they be treated as other-than-temporarily impaired and as such, a
write-down accounted for as a realized loss should be recorded (SEC Staff Accounting Bulletin
No. 59). This decision is based on ASC 320-10-35-33F which indicates under item a. that a
factor to be considered is the length of time and the extent to which the fair value has been less
than the amortized cost basis. The client has indicated to us the Municipal bonds and Corporate
bonds have been impaired for 18 months and 32 months respectively. This time more than
exceeds the fiscal year for which we are reporting, indicating that the impairment is other-than
temporary. Furthermore, item g. of that same section of the codification suggests that we
consider transactions or further declines in fair value after the balance sheet date. Although the
client did not indicate the fair value had declined further, we do know that the debt securities
were sold, indicating again that they better qualify as other-than-temporarily impaired securities.
If the fair value of the debt securities declined below historical cost by only 2 percent, I
would take that information into consideration because ASC 320-10-35-33F item number c. does
point out that a factor to consider is the historical and implied volatility of the fair value of the
security. However, AU Section 332.47 clearly states that judgment is required in determining
whether factors exist that indicate that an impairment loss has been incurred at the end of the
reporting period. These judgments are based on subjective as well as objective factors, including
knowledge and experience about past and current events and assumptions about future events
(AU Section 332.47, p 1933). Based on this responsibility and all information and assumptions
provided, I would still recommend that the client write-down the impaired debt securities.
Scenario B
The client, Company X, provided a thorough evaluation of the decline in fair value for the
securities they owned which were classified as available-for-sale. Their evaluation appears from
my standpoint to be in accordance with what is suggested in the Staff Accounting Bulletin Topic
5.M which states that management should consider all available evidence to evaluate the
realizable value of its investment in equity securities classified as available-for-sale (ASC 320-
10-S99). The same bulletin provides the following factors to consider when determining if the
securities are other than temporary and if a write-down of the carrying value is required:
a. The length of the time and the extent to which the market value has been less than
cost;
b. The financial condition and near-term prospects of the issuer, including any specific
events which may influence the operations of the issuer such as changes in
technology that may impair the earnings potential of the investment or the
discontinuance of a segment of the business that may affect the future earnings
potential; or
c. The intent and ability of the holder to retain its investment in the issuer for a period of
time sufficient to allow for any anticipated recovery in market value (ASC 320-10-
S99).
Based on the information provided by Company X, it is apparent that the length of the
impairment has been less than one year, and even within that year, the fair value has begun to
rise from $80 per share to $85 per share. Furthermore, Company X analyzed and prepared
forecasts indicating that recovery could be expected by April 2011. From the information
provided, it appears that they were not aware of the pending changes that were later announced
by Company B. These factors indicate that in fact, Company Xs securities classified as
available for sale are not other than temporary and do not need to be written down on the
December 31, 2010 financial statements. However, I would note that if Company X had any
indication as of December 31, 2010 that Company B would be making organizational changes,
then it would then be necessary for them to report the securities which were classified as
available for sale as other than temporary and respectively write them down on the balance
sheets of the company.