How Temporary Is ‘Temporarily Impaired’?

Few issues recently put before the Financial Accounting Standards Board elicited more comment than last year's attempt to define accounting treatme...
Ed ZwirnJune 27, 2005

When is an investment more-than-temporarily impaired, and how should a company measure and recognize that impairment?

Emerging Issues Task Force Issue 03-1 provides guidance on the meaning of the phrase “other-than-temporary impairment” and its application to several types of investments, including debt securities classified as “held-to-maturity” and “available-for-sale” under Financial Accounting Standard 115. EITF 03-1-a — which delayed the effective date of paragraphs 10 to 20 of 03-1 until key issues surrounding the definition of impairment have been clarified — generated 252 letters in the comment period that ended late last year.

At that time, the board decided to wait until after it met with the International Accounting Standards Board to determine whether FASB and IASB needed to formally add a project to converge their impairment models for financial instruments. At that meeting, in April, the two boards decided not to converge their models, leaving room for FASB to proceed independently.

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At this Wednesday’s meeting, FASB will resume its discussion of EITF 03-1-a. The board has specifically been asked to provide guidance on the following questions for debt securities that are impaired because of interest-rate or sector-spread increases and that are analyzed for impairment under paragraph 16 of 03-1:

• At what unit of account should an investor assert its ability and intent to hold to a forecasted recovery?

• Is there a level of impairment that could be considered temporary that would not create the need for an assertion about the ability and intent to hold an investment until a forecasted recovery?

• If an interest-rate-impaired or sector-spread-impaired security for which the investor had previously asserted the ability or intent to hold until an expected recovery is later expected to be sold prior to recovery, when is the impairment considered other than temporary? Are there circumstances in which this change of ability or intent would not necessarily call into question the investor’s ability or intent to hold other securities to recovery?

During last year’s comment period, a summary of the letters prepared by FASB staff found that “the vast majority” of respondents took the issuance of 03-1-a as an opportunity to request that the board rescind 03-1 in its entirety. Respondents identified 03-1 problems including the anomalous results its methodology would produce for interest-rate-impaired debt, the heavy burden its requirements would place on preparers, and its lack of convergence with International Accounting Standard 39.

Of those responses that didn’t call for the outright elimination of 03-01, one that attracted attention revolved around the “tainting” question: the circumstances under which the sale of an impaired asset prior to recovery would call into question the investor’s intent to hold other securities. In its comment letter, Wells Fargo expressed its strong disagreement “with any proposal to inject a ‘tainting’ concept for debt securities designated as available for sale under the accounting standards,” arguing that “this concept is not compatible with the realities of investment portfolio management and how companies constantly reposition their assets and liabilities to take advantage of market volatilities, sector spreads, credit changes and market dynamics.”

In other items on the agenda for Wednesday:

• FASB will continue discussing its Fair Value Measurement exposure draft to clarify the guidance on the fair value definition and the fair value hierarchy.

• The board will discuss issues related to initial and subsequent estimates of fair value of derivative instruments under EITF Issue 02-3, Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities.

• The board will also discuss the definition of a multiple component instrument and possible separation approaches.

In other FASB business, on June 17 the board released for comment by August 1 a proposed staff position that would provide initial and subsequent measurement guidance for investment in life settlement contracts. The staff position, Technical Bulletin 85-4-a, recommends a cost accumulation (investment method) model as more appropriate for this activity and a better reflection of the economic substance of life settlement contracts. No income would be recognized until the insured dies, at which time the difference between the carrying cost of a life settlement and the face value of its underlying life insurance policy should be recognized.

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