Introduction
O.T.T. Incorporated, principally engaged in the manufacture and sale of clothing, has six investments remaining in the department’s portfolio as of December 31. According to ASC, this memo analyzes whether any of its investments are other-than-temporary impaired, and determines the amount of the impairment.
Facts
Investment 1 — Happy New Year & Co.
OTT purchased 11 shares of Happy New Year & Co. stock on at $20 a share on Jan. 3, 20X1, and the price dropped to $15 in March and remained steady till Dec. 31, 20X1. OTT management does not believe the decline in price to be permanent and has asserted that it does not intend to sell this investment in the future.
Investment 2 – Beary Beary
OTT held notes of Beary Beary with an amortized cost of $95 and a fair value of $88 on Dec. 31, 20X1. OTT’s investment committee established a policy requiring the sale of this security when the fair value declines below $90.
Investment 3 – Buy-A-Lot Company
OTT held bonds of Buy-A-Lot Company with an amortized cost of $100 and a fair value of $88 as of December 31, 20X1. The company’s credit rating upgraded from BBB to BBB+ that management has asserted it does not intend to sell this investment.
Investment 4 – March Madness Incorporated
On March 25, 20X1, OTT bought 50 shares of March Madness Incorporated stock at $100 a share, classifying its investment as available for sale. As of December 31, 20X1, the price of the stock was $72. On January 31, 20X2, the date the Company’s financial statements are issued, the price of the stock went up to $75.
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Investment 5 — Tohoku Toys
OTT held bonds issued by Tohoku Toys with an amortized cost of $25 and a fair value of $5 as of December 31, 20X1. Tohoku Toys is going through a restructuring because it was significantly affected by a severe earthquake in April 20X1. OTT does not believe that the restructuring will ultimately be successful.
Investment 6 — Chatterbox
OTT holds a debt security issued by Chatterbox with an amortized cost of $100 and a fair value of $90 as of December 31, 20X1. The present value of the cash flows OTT expects to receive, discounted at the security’s original effective interest rate is $92 as of December 31, 20X1. OTT intends to sell this security.
Issues
The other-than-temporary impairment depends on two issues:
·Whether the fair value of the investment is less than its cost. ·The impairment is either temporary or other than temporary depending on other guidance when the fair value is less than its cost.
Discussion
Investment 1—Happy New Year & Co.
ASC 323-10-35-32: “A loss in value of an investment that is other than a temporary decline shall be recognized. Evidence of a loss in value might include, but would not necessarily be limited to, absence of an ability to recover the carrying amount of the investment or inability of the investee to sustain an earnings capacity that would justify the carrying amount of the investment.” ASC 320-10-35-34: “If it is determined in Step 2 that the impairment is other than temporary, then an impairment loss shall be recognized in earnings equal to the entire difference between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the assessment is made.” Because the share price had a large decline from $20 to $15 and remained steady around $15 in most of time, it seems the share is absence of an ability to recover the carrying amount of the investment. Therefore, other-than-temporary impairment has occurred, and loss of $55 (11*$5) should be recorded.
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Investment 2 – Beary Beary
ASC 320-10-35-33A: “If an entity intends to sell the debt security (that is, it has decided to sell the security), an other-than-temporary impairment shall be considered to have occurred.” The company intends to sell the investment because the fair value is below $90. Therefore, other-than-temporary impairment has occurred, and loss of $7 ($95-$88) should be recorded.
Investment 3 – Buy-A-Lot Company
ASC 320-10-35-33F: “Changes in the quality of the credit enhancement should be considered when estimating whether a credit loss exists and the period over which the debt security is expected to recover.” Although the fair value of the investment was lower than the amortized cost, the credit rating had been upgraded from BBB to BBB+, and the investment does not intend to be sold. These evidence show that the bond is expected to recover, so no other-than-temporary impairment has occurred.
Investment 4 – March Madness Incorporated
ASC 320-10-35-34: “The fair value of the investment would then become the new amortized cost basis of the investment and shall not be adjusted for subsequent recoveries in fair value.” Based on ASC 320-10-35-34 I mentioned above, the other-than-temporary impairment should be recoded as $28 ($100-$72) as of December 31, 20X1. On January 31, 20X2, when the price of the stock went up to $75, the other-than-temporary impairment should be recoded as $25 ($100-$75).
If the share price was $95 instead of $75 on January 31, 20X2, I think no other-than-temporary impairment needs to be recorded, because there is no material decrease occurred.
Investment 5 — Tohoku Toys
ASC 320-10-35-35: “In periods after the recognition of an other-than-temporary impairment loss for debt securities, an entity shall account for the other-than-temporarily impaired debt security as if the debt security had been purchased on the measurement date of the other-than-temporary impairment at an amortized cost basis equal to the previous amortized cost basis less the other-than-temporary impairment recognized in earnings. For debt securities for which other-than-temporary impairments were recognized in earnings, the difference between the new amortized cost basis and the cash flows expected to be collected shall be accreted in accordance with existing applicable guidance as interest income.” Although Tohoku Toys is undergoing a restructuring because of earthquake, OTT does not believe the restructuring will be successful. Based on authoritative literature mentioned above, the other-than-temporary impairment shall be recognized as $20 ($25-$5) when no addition evidence provided.
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Investment 6 — Chatterbox
–Alternative 1:
SAB 320-10-35-34B: “If an entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary impairment shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date.” Based on the authoritative literature, if OTT intends to sell this security, the other-than-temporary impairment shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis ($100) and its fair value ($90), which is $10. –Alternative 2:
SAB 320-10-35-34C: “If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary impairment shall be separated into both of the following: a. The amount representing the credit loss.
b. The amount related to all other factors.
Different from alternative 1, if OTT does not intend to sell the security and it is not more likely than not that it will be required to sell the security, the credit loss will be $8 ($100-$92) and other factor loss will be $2 ($10-$8).
