FSP 115-a

TWO NEW FSPs On March 17, 2009, the FASB issued proposed FSP FAS 115-a, FAS 124-a, and EITF 99-20-b, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP 115-a”). FSP 115-a deals with whether impairments of debt and equity securities are considered temporary or other-than-temporary and, for debt securities, requires separate presentation of the credit and non-credit components of another-than-temporary impairment (“OTTI”). Non-credit losses on debt securities would be recorded in OCI if it is not likely that the investor will sell the security prior to recovery; credit losses would hit earnings. If made final, FSP 115-a would be effective for most public companies as of March 31, 2009, beginning with the first quarter’s 10-Q. SUMMARY OF FSP 115-a An investment is impaired if its fair value is less than its cost. Impairments are either temporary or other-than-temporary. The effects of other-than-temporary impairments are usually recorded in the income statement, so most companies prefer to consider an impairment as temporary. FSP 115-a deals with how to tell whether impairments of debt and equity securities are temporary or other-than-temporary and, for debt securities, requires separate presentation of the two components of an OTTI. The proposed guidance changes the way companies determine whether an impairment is temporary or other-than-temporary. Under current rules, there are several indicators to determine whether an impairment is other-than-temporary, including the magnitude and duration of the impairment, forecasted recovery of fair value, and whether management has the intent and ability to hold an impaired asset until recovery. This FSP changes the last indicator from “intent and ability to hold” to “no intention to sell and won’t have to sell before recovery”. For debt securities which management has no intention of selling and which (more likely than not) will not have to be sold prior to the recovery of its cost basis, the proposed rule requires separate presentation of the two components of OTTI: impairment losses related to credit (the “performance indicator”) and losses related to non-credit (the “residual”). The credit component would be determined using the best estimate of the portion of the impairment that relates to an increase in credit risk. This estimate might be determined, for example, by analogizing the measurement methodology described in ¶12-16 of FAS 114, Accounting By Creditors for Impairment of a Loan. The credit component would be recognized in earnings, with the residual component going to OCI. For both debt and equity securities, in cases where there is an intention to sell or it is more likely than not that the security will be sold prior to recovery, an OTTI would be recognized immediately in earnings. The fair value of the new investment would become the new cost basis and would not be adjusted upwards for future recoveries in value. For held-to-maturity securities, the residual component of an OTTI loss that is recognized in OCI would be prospectively amortized on the balance sheet (with the asset as the offset) over the remaining life of the debt instrument based on the amount and timing of future estimated cash flows. IMPACT OF 115-a Other-than-temporary or not FSP 115-a relaxes the other-than-temporary indicator by moving from “intent to hold” to the less restrictive “no intention to sell”. This should provide all companies slightly greater freedom to avoid OTTIs. For example, if a company asserts an intention to hold, then sells, they have contradicted their intention. However, if a company has no intention to sell, and then sells after encountering conditions favorable to selling, there less of a contradiction. For companies without ability to hold, the move from “ability to hold” to “won’t have to sell before recovery” will have little or no effect on whether the impairment is considered other-than-temporary, because the assertion of “ability to hold” is implicit in “won’t sell before recovery”. For example, if a company does not have the ability to hold an impaired asset, they will not be able to assert that they are likely not to sell it before recovery, because they do not have the ability to hold it. Companies with the ability to hold, on the other hand, would now need to demonstrate that (more likely than not) they will not sell the impaired asset prior to recovery in order to consider the impairment as not being other-than-temporary. Therefore, the proposed guidance may put companies with the ability to hold these securities in a slightly better position to avoid calling an impairment other-than-temporary. Balance sheet or income statement This proposed rule could have significant impact on accounting for impairments of auction rate securities, where, for example, the residual portion of OTTI’s related to debt securities could avoid a sizable hit to the income statement. Companies should take a fresh look at impaired securities, such as auction rate securities, to determine whether the impairment is temporary or other-than-temporary.