Accounting News: Other-Than-Temporary Impairment of
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During the past year and a half, the longstanding accounting concept of
other-than-temporary impairment of investment securities has drawn renewed
attention because of actions by the Financial Accounting Standards Board
(FASB ) and its Emerging Issues Task Force (EITF ). In addition, the federal
banking agencies issued a revised Uniform Agreement on the Classification
of Assets and Appraisal of Securities Held by Banks and Thrifts in
June 2004 that incorporated this concept into the Agreement's general debt
security classification guidelines. In light of these developments, examiners
and bankers should understand the currently applicable accounting guidance
on impairment and its relationship to the evaluation of securities portfolios
Impairment of Securities
From an accounting standpoint, an "impairment" of a debt or equity security
occurs when the fair value of the security is less than its amortized cost
basis, i.e., whenever a security has an unrealized loss. In this situation,
examiners often refer to the security as being depreciated or under water.
The subject of impairment of securities and the need for an institution
to consider its accounting consequences for purposes of reporting in accordance
with generally accepted accounting principles (GAAP) dates back more than
50 years.1 The current source of authoritative
guidance on accounting for investment securities, FASB Statement No. 115 ,
Accounting for Certain Investments in Debt and Equity Securities,
as amended (FAS 115), was originally issued in 1993. FAS 115 is perhaps
best known for requiring investment securities to be categorized into three
categories: held-to-maturity, trading, and available-for-sale. However,
it also requires that an institution determine whether a decline in fair
value below amortized cost for an individual available-for-sale or held-to-maturity
security is other than temporary. If the impairment is judged to be other
than temporary, the cost basis of the individual security must be written
down to fair value, thereby establishing a new cost basis for the security,
and the amount of the write-down must be included in earnings as a realized
FAS 115 further provides that after such a write-down, "the new cost basis
shall not be changed for subsequent recoveries in fair value." A recovery
in fair value, both for an available-for-sale security and a held-to-maturity
security, should not be recognized in earnings until the security is sold.4
As currently defined under GAAP, the fair value of an asset is the amount
at which that asset could be bought or sold in a current transaction between
willing parties, that is, other than in a forced or liquidation sale. Quoted
market prices in active markets are the best evidence of fair value and
must be used as the basis for the measurement, if available.5
Guidance on Evaluating Impairment in FAS 115
FAS 115 provides only one explicit example of other-than-temporary impairment.
Using language that parallels the definition of impairment for a loan in
FASB Statement No. 114, Accounting by Creditors for Impairment of a
Loan, FAS 115 states that if it is probable that an institution "will
be unable to collect all amounts due according to the contractual terms
of a debt security not impaired at acquisition, an other-than-temporary
impairment shall be considered to have occurred." However, FAS 115 also
refers to two other sources of literature that should be considered in evaluating
Securities and Exchange Commission (SEC) Staff Accounting Bulletin
(SAB) No. 59, which has been codified as SAB Topic 5.M, Other Than
Temporary Impairment of Certain Investments in Debt and Equity Securities
(SAB 59); and
American Institute of Certified Public Accountants (AICPA) Statement
on Auditing Standards No. 92, Auditing Derivative Instruments, Hedging
Activities, and Investments in Securities (SAS 92 ).
The impairment guidance in SAB 59 and SAS 92 is discussed
Recognizing that FAS 115 provided limited guidance on evaluating impairment,
the FASB staff addressed this subject in November 1995 in a FAS 115 implementation
guide.6 In the response to Question 46 of
the guide, the FASB staff advised that
recognition of other-than-temporary impairment also may be required
if the decline in a security's value is due to an increase in market interest
rates or a change in foreign exchange rates since acquisition. Examples
of when a decline in the fair value of a debt security may be other than
temporary include situations where the security will be disposed of before
it matures or the investment is not realizable.
The FASB staff's response to the next question in the guide deals with
the disposal of a security prior to maturity, referencing EITF Topic No.
D-44 , Recognition of Other-Than-Temporary Impairment upon the Planned
Sale of a Security whose Cost Exceeds Fair Value. The EITF had discussed
this issue earlier in 1995 after the FASB staff had been asked about the
accounting treatment for a "specifically identified available-for-sale debt
security" that an institution "intends to sell at a loss shortly after the
balance sheet date." The FASB staff indicated that, in this situation, if
the institution "does not expect the fair value of the security to recover
prior to the expected time of sale, a write-down for other-than-temporary
impairment should be recognized in earnings in the period in which the decision
to sell is made."
The EITF Considers Impairment
Despite the various sources of guidance on impairment of securities, accountants
and others expressed concern in 2002 that the accounting literature discussing
the concept of other-than-temporary impairment was ambiguous and had led
to inconsistent application of this literature. Late that year, the FASB's
EITF decided to pursue the development of additional guidance for determining
whether certain investments in securities, including held-to-maturity and
available-for-sale securities, have incurred an other-than-temporary impairment.
In EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment
and Its Application to Certain Investments (EITF 03-1 ), the EITF first
reached a consensus that certain disclosures about securities with impairment
should be included in the footnotes to financial statements prepared in
accordance with GAAP. Ratified by the FASB Board in November 2003, these
new disclosures were first required in annual financial statements as of
The disclosures required by EITF 03-1 provide quantitative and qualitative
information about all held-to-maturity and available-for-sale securities
"in an unrealized loss position for which other-than-temporary impairments
have not been recognized." For each date for which a balance sheet is presented
in the financial statements, an institution must provide a table that shows,
for each category of investment security, the aggregate amount of unrealized
losses on securities with impairment and the aggregate fair value of these
securities. Furthermore, these disclosures must be shown separately for
securities "that have been in a continuous unrealized loss position for
less than 12 months and those that have been in a continuous unrealized
loss position for 12 months or longer." An example of the format for these
quantitative disclosures is shown below. The institution must also provide,
in narrative form, sufficient information about the securities with impairment
as of the most recent financial statement date to enable "users to understand
the quantitative disclosures." In addition, this narrative disclosure must
describe the information the institution "considered (both positive and
negative) in reaching the conclusion that the impairments are not other
In March 2004, the FASB Board ratified the accounting guidance for determining
whether certain investment securities have incurred an other-than-temporary
impairment on which the EITF had reached a consensus. EITF 03-1 established
a three-step process for determining when an investment is impaired, whether
that impairment is other than temporary, and how to measure the impairment
loss if the impairment is deemed to be other than temporary. This process
was to be applied to individual securities whose fair value had declined
below amortized cost.
Securities in an Unrealized Loss Position for Which Other-Than-Temporary
Impairments Have Not Been Recognized 6
Less than 12 months
12 months or greater
Description of Securities
U.S. Treasury securities
Mortgage-backed securities issued by government-sponsored enterprises
Securities issued by states and political subdivisions
Equity securities with readily determinable fair values
Although the accounting guidance in EITF 03-1 was scheduled to take effect
September 30, 2004, it has been indefinitely delayed by the FASB. This delay
occurred after institutions, in preparation for the implementation of the
recognition and measurement provisions of the EITF consensus in mid-2004,
raised questions and concerns as to whether conservative interpretations
of this guidance by certain accounting firms were consistent with what the
EITF and the FASB had intended in EITF 03-1. These concerns were focused
primarily on available-for-sale debt securities that are impaired solely
due to increases in interest rates or sector spreads in the marketplace.
The FASB staff initially sought to clarify the guidance in EITF 03-1 for
such securities through the issuance of a proposed FASB Staff Position in
early September 2004. However, as a result of the more than 200 comments
received, the FASB indicated in November 2004 that it will instead reconsider
the relevant accounting literature on other-than-temporary impairment of
debt and equity securities. The time frame for this reconsideration is not
clear. In the meantime, the FASB has reminded institutions that hold investment
securities that they should continue to apply the existing impairment guidance
in FAS 115, including SAB 59 and SAS 92, which are referenced in FAS 115.
Additionally, the disclosure requirements of EITF 03-1 remain in effect.7
SEC Staff Accounting Bulletin No. 59
The SEC staff originally issued SAB 59 in 1985 to discuss other-than-temporary
impairments of "noncurrent marketable equity securities." SAB 59 also notes
that "other than temporary" should not be interpreted to mean "permanent"
impairment. After the issuance of FAS 115, SAB 59 was updated to encompass
"marketable securities classified as either available-for-sale or held-to-maturity."
Hence, its coverage expanded to include both debt and equity securities.
SAB 59 notes that the fair value of individual investment securities may
decline below cost for various reasons. It states that these declines in
value "require further investigation by management," which "should consider
all available evidence to evaluate the realizable value of its investment."
Numerous factors should "be considered in such an evaluation and their relative
significance will vary from case to case." According to SAB 59, the following
are "only a few examples of the factors which, individually or in combination,
indicate that a decline is other than temporary and that a write-down" to
fair value is required:
The length of the time and the extent to which fair value has been
less than cost;
The financial condition and near-term prospects of the issuer, including
any specific events that may influence the operations of the issuer, such
as changes in technology that may impair its earnings potential or the
discontinuance of a segment of the issuer's business that may affect its
future earnings potential; or
The intent and ability of the institution to retain its investment
for a period of time sufficient to allow for any anticipated recovery
in fair value.
The SEC staff has elaborated on the process that institutions should follow
when determining whether an unrealized loss on an individual security is
other than temporary. In this regard, the SEC staff does not believe it
is appropriate to employ "bright line or rule of thumb tests" to evaluate
impairment. For example, some accountants and institutions have reportedly
used such benchmarks as a 20 percent decline in fair value below cost that
has lasted more than one year as their definition of other-than-temporary
impairment. Although the quantitative disclosures required by EITF 03-1
distinguish between securities that have had unrealized losses for periods
of more than and less than one year, this one-year time period is not an
automatic line of demarcation for inferring when unrealized losses become
other-than-temporary impairments. The SEC staff has noted that an other-than-temporary
decline could occur within a short period of time. This would most likely
be the case if the issuer of the security has experienced significant credit
deterioration, with or without a payment default, or in the event of a planned
sale of a depreciated security. By the same token, depending on the facts
and circumstances, a decline in fair value that continues for more than
one year may be temporary.
When evaluating impairment, the SEC staff has observed the importance
of distinguishing between debt securities and equity securities. Consistent
with FAS 115, equity securities exclude preferred stock that must be redeemed
by the issuer or can be redeemed at the option of the investor. Hence, an
investor must look to a sale of an equity security as the way to recover
the investment rather than holding the security until its contractual maturity,
as would be the case for a debt security. Therefore, the SEC staff has stated
that an investor's "ability to hold an equity security indefinitely would
not, by itself, allow an investor to avoid an other-than-temporary impairment,"
which is compatible with the need to consider the near-term, rather than
long-term, prospects of the issuer of the equity security.
The SEC expects that institutions will use a systematic methodology to
perform their impairment analyses and will fully document all of the factors
considered. Moreover, efforts to forecast recoveries in the fair value of
individual securities are fraught with uncertainty. In cases where the severity
and duration of the unrealized loss on a security increase, the impairment
analysis should become more robust and extensive. The longer the forecasted
recovery period, the less reliable the estimate of when the fair value of
a security will increase up to or beyond its amortized cost. Thus, the SEC
envisions that projected recoveries of fair value will be supported by objective
Investment quality debt securities with "temporary" impairment
Investment quality debt securities with "other-than-temporary" impairment
Sub-investment quality debt securities with "temporary" impairment
Sub-investment quality debt securities with "other-than-temporary" impairment,
including defaulted debt securities
NOTE: Impairment is the amount by which amortized cost exceeds fair value.
AICPA Statement on Auditing Standards No. 92
Issued in 2000, SAS 92 provides guidance to auditors in planning and performing
auditing procedures with respect to investment securities as well as derivatives
and hedging activities. It states that evaluating whether unrealized losses
on individual debt and equity securities are other than temporary "often
involves estimating the outcome of future events." As a consequence, "judgment
is required in determining whether factors exist that indicate that an impairment
loss has been incurred" at the date of the financial statements. These factors
are both subjective and objective and include "knowledge and experience
about past and current events and assumptions about future events."
SAS 92 cites the following as examples of these factors:
Fair value is significantly below cost and:
The decline is attributable to adverse conditions specifically related
to the security or to specific conditions in an industry or in a geographic
The decline has existed for an extended period of time.
Management does not possess both the intent and the ability to hold
the security for a period of time sufficient to allow for any anticipated
recovery in fair value.
The security has been downgraded by a rating agency.
The financial condition of the issuer has deteriorated.
Dividends have been reduced or eliminated, or scheduled interest payments
have not been made.
The institution recorded losses from the security subsequent to the
end of the reporting period.
Several of these factors correspond to those identified by the SEC staff
in SAB 59. In addition, the existence of the final factor as an indicator
of an other-than-temporary impairment loss at the date of the financial
statements is consistent with the guidance in EITF Topic No. D-44 on the
planned sale of a security.
Because management, and not the auditor, is responsible for the preparation
of an institution's financial statements and the proper application of generally
accepted accounting principles, SAS 92 directs the auditor to evaluate management's
impairment assessment process, including the factors management has considered,
and the resulting conclusions. Thus, SAS 92 establishes a clear expectation
that management will maintain appropriate documentation to support its conclusions.
The Uniform Agreement on the Classification of Assets and Appraisal
of Securities Held by Banks and Thrifts , which the federal banking
agencies revised in June 2004, incorporates the other-than-temporary impairment
concept.8 It provides that "[i]f an institution's
process for assessing impairment is considered acceptable, examiners may
use those assessments in determining the appropriate classification of declines
in fair value below amortized cost on individual debt securities." Although
the Uniform Agreement focuses on debt securities, an institution's impairment
assessment process must cover both debt securities and any equity securities
(not held for trading) in order to satisfy applicable accounting standards.
The general debt security classification guidelines set forth in the Uniform
Agreement are presented on the previous page.
Thus, each institution's accounting or investment policies should include
provisions directing management to evaluate individual securities whose
fair value is less than amortized cost at each quarter-end to determine
whether any other-than-temporary impairments have been incurred. These evaluations
should be documented to show how management has considered the factors enumerated
in FAS 115 and its implementation guidance, SAB 59, and SAS 92, and any
other relevant factors, in reaching its conclusions concerning the impairment
of individual securities.
For institutions with audited financial statements or that otherwise prepare
statements in conformity with GAAP, the disclosures required by EITF 03-1
about securities in an unrealized loss position represent a useful tool
for examiners. Optimally, these financial statements should be available
during pre-examination planning. Otherwise, examiners should obtain the
financial statements early in the examination. A review of the required
disclosures will provide insight into the quality of an institution's impairment
assessment process. If the process appears to be adequate at the most recent
year-end, examiners should verify that quarterly evaluations of individual
securities in an unrealized loss position are being properly performed.
Consistent with the Uniform Agreement, an acceptable impairment assessment
process may serve as the basis for any adverse classifications of impairment
on individual investment securities in the examination report.
In contrast, at an institution whose policies do not incorporate an impairment
assessment process or whose process has not been implemented adequately,
examiners should seek management's commitment for appropriate corrective
action. When these deficiencies are present, examiners normally should focus
their impairment review on those available-for-sale and held-to-maturity
securities for which fair value is significantly less than cost. These are
case-by-case evaluations based on the facts and circumstances surrounding
each investment that require the examiner to exercise judgment.9
To support a conclusion that an individual security, whether investment
quality or sub-investment quality, is other-than-temporarily impaired, an
examiner should document the results of his or her consideration of all
relevant factors, including those cited above in the accounting literature.
This documentation should identify clearly the objective evidence used in
the impairment analysis and the sources of this evidence. These findings
should be described in the examination report as the basis for assigning
a Loss classification to the excess of the cost of the security over its
Robert F. Storch Chief Accountant
1 See paragraph 9 of Section A of Chapter
3 of Accounting Research Bulletin No. 43, which was issued by the American
Institute of Certified Public Accountants (AICPA) in 1953, and its predecessor,
Accounting Research Bulletin No. 30, which was issued in 1947.
2 See paragraph 16 of FAS 115 . The impairment
provisions of FAS 115 are not applicable to trading securities because they
are carried on the balance sheet at fair value with unrealized gains and
losses included in earnings.
3 These FAS 115 provisions on impairment
of securities have been incorporated into the instructions for the Reports
of Condition and Income (Call Report). See the Glossary entry for "Securities
Activities" on page A-72 of the instructions.
4 After an available-for-sale security
has been written down for an other-than-temporary impairment, the new cost
basis should be used thereafter to determine the amount of any unrealized
holding gains and losses. These gains and losses (provided the losses do
not represent further other-than-temporary impairments) should be reported
in a separate component of equity capital, i.e., accumulated other comprehensive
5 See, for example, paragraph 68 of FASB
Statement No. 140 , Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities.
6 A Guide to Implementation of Statement
115 on Accounting for Certain Investments in Debt and Equity Securities:
Questions and Answers.
7 See FASB Staff Position No. EITF 03-1-1 .
This FASB Staff Position also references one other existing source of
impairment guidance, EITF Issue No. 99-20, Recognition of Interest Income
and Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets (EITF 99-20). However, excluded from the scope of EITF
99-20 are "beneficial interests in securitized financial assets that (1)
are of high credit quality . . . and (2) cannot contractually be prepaid
or otherwise settled in such a way that the holder would not recover substantially
all of its recorded investment." EITF 99-20 further states that "determining
whether an other-than-temporary impairment of such beneficial interests
exists should be based on SAB 59, SAS 92, and the Statement 115 Special
Report," i.e., the FAS 115 implementation guide. This article does not
address the impairment guidance in EITF 99-20 for those beneficial interests
that are within its scope.
8 See FDIC Financial Institution Letter
(FIL) 70-2004 , dated June 15, 2004.
9 However, as provided in the Uniform Agreement , an unrealized loss on
a debt security for which there has been a payment default will generally
be presumed to be an other-than-temporary impairment.