Impaired

Marketable
Securities:
A Growing Problem in Today’s Economic Environment

By Peter R. Alfele, CPA

T
currently available on a securities exchange
he recent economic downturn and declining investment such as the New York Stock Exchange, or
in the case of mutual funds, the per share
markets have left many companies holding portfolios of price is widely published. The term “mar-
impaired marketable securities. As a result, financial report- ketable securities” is frequently used to refer
to investments that encompass both debt
ing executives must analyze their portfolios to decide how to report securities and equity securities with readily
these losses and to defend their assertion that temporary losses will determinable fair values.

be recovered. Recording and

Reporting investments
in securities
Companies investing in the securities of
other entities are required to report their
holdings based on a variety of factors. First,
an entity must determine the nature of its
investment by classifying it as either a debt
security or an equity security.
Debt securities are characterized by a
debtor/creditor relationship and generally
include investments such as U.S. Treasury
securities, U.S. government agency secu-
rities, municipal securities and corporate
bonds. Equity securities, such as common,
preferred or other capital stock, gener-
ally represent an ownership interest in an
enterprise. Equity securities may also take
the form of a right to acquire or dispose of
an ownership interest (e.g., warrants, rights
and call or put options).
Once the nature of a security has been
defined, an entity must further analyze its
equity securities to determine if the fair
value is “readily determinable.” Generally,
the fair value of an equity security is readily
determinable if sales prices or quotations are
classification
The purchase of a marketable security
is initially recorded at cost. At acquisition,
companies must classify their marketable
securities into three groupings, based on
their type (debt vs. equity) and on manage-
ment’s intent to hold the security. These
include:
•• Held to maturity: Securities pur-
chased with the positive intent and
ability to hold to maturity.This category
only applies to debt securities because
equity securities, by definition, do not
have maturity dates.

26 Financial Reporting • Disclosures • March/April

 If your company is holding impaired
marketable securities, it’s time to decide
how to report these losses.

•• Trading: Securities bought and held

principally to be sold in the near-term.
Trading securities are held usually by
financial institutions and similar enti-
ties, and typically have a holding period
measured in hours and days rather than
months or years.
•• Available for sale: Securities that
do not meet the criterion to be clas-
sified as held to maturity or trading.
Classification is important because secu-
rities are reported in vastly different ways
depending on how they are categorized.
This article focuses on the accounting
requirements of the “available for sale” cat-
egory as the majority of operating businesses
classify their securities as such.
As available for sale securities are sold,
any difference between the purchase price
and the sales price is reported in earnings.
Securities held are adjusted to the fair value
of the investment on the reporting date.
Recognizing that fair value adjustments may
cause volatility in an entity’s operating earn-
ings, standard setters directed these “unreal-
ized holding gains/losses” to be reported in
other comprehensive income (OCI).
OCI is a segregated component of fi-
nancial statements used to capture certain
economic events of unrecognized transac-
tions of a period. Because items included
in OCI are usually excluded from analysis
of a company’s performance in its core
activities, management may be inclined to
report negative results in OCI rather than
earnings.
The impairment condition
A marketable security is considered
impaired when its fair value is less than its
cost. Once impaired, financial reporting
standards require companies to further
analyze their investment securities and dis-
close management’s determination of the
potential to recover the price paid.
Accounting for impaired marketable
securities classified as available for sale
involves a determination of whether a
decline is temporary. This determination
is a critical matter of judgment because
of the reporting ramifications. If the loss
is considered temporary, the adjustment
is reported in OCI and may be w

Financial Reporting • Disclosures • March/April 27

To avoid unneccessary scrutiny, management
should consistently apply a systemic approach
for classifying impaired securities.
subsequently recovered if the value of the in-
vestment returns. However, if management
considers the loss other-than-temporary, the
loss is charged to operations and subsequent
recoveries of fair value are not included in
operating results until the investment is
sold.
The impairment analysis
In performing an impairment analysis,
the accounting standards outline a three-step
process to 1.) determine when a security is
deemed impaired; 2.) determine if the loss
is temporary; and 3.) measure and recognize
the loss.
As described above, an investment is
generally considered impaired when its
fair value is less than its cost. Cost includes
adjustments for accretion, amortization,
any previous impairment losses and hedg-
ing. The review for impaired securities
must be conducted in each reporting period
(including interim periods) at the individual
security level. An analysis of a portfolio or
provision of a general allowance is not an
acceptable practice. However, separate
lots of equity securities bearing the same
Committee on Uniform Security Identifi-
cation Procedures (CUSIP) number that
were purchased at different dates may be
combined on an average cost basis if the
company follows this practice to determine
its realized gains and losses.
Once a company has identified the indi-
vidual securities that are in a loss position,
management must conclude whether the
loss is temporary or other-than-temporary.
While the accounting literature does not
specifically define the term “other-than-
temporary,” it emphasizes that the phrase
should not be interpreted to mean “per-
manent.”
Absent that guidance, standard-setters
point to publications of regulators to lend
some insight. In Securities and Exchange
Commission (SEC) Staff Accounting Bulletin
No. 59, Other than Temporary Impairment of
Certain Investments in Equity Securities, the SEC
28 Financial Reporting • Disclosures • March/April
staff urge that all available evidence should
be considered and provided three factors
that, either individually or in combination,
may indicate that a security’s impairment is
other-than-temporary:
•• Time and extent of loss: As the
length of time needed for recovery
grows and/or the magnitude of the loss
increases, the likelihood that impairment
is other-than-temporary also increases.
Assertions that securities that have been
“underwater” for extensive periods of
time are only temporary would need
to be supported by more compelling
evidence than those that have recently
declined to a loss position.
•• Issuer’s financial condition: An
examination of the fiscal health of the
investee may shed some light on when
a turnaround in performance could be
expected. Investees faced with signifi-
cant changes in technology or who have
recently reported the discontinuance of
certain operations may provide clues that
a recovery is not eminent.
•• Intent and ability of the holder:
An introspective look at the investor’s
forecasted cash or working capital de-
mands may indicate that the company
must sell the securities in question in
order to meet its own obligations before
the investment is expected to recover.
In addition, while the determination of
the other-than-temporary impairment is
to be hypothetically made as of the bal-
ance sheet date, the sale of the security
subsequent to the balance sheet date and
before the release of the statements is
strong, although not by itself conclusive,
indication that an other-than-temporary
loss should be recorded.
The conclusion that an impaired loss is
other-than-temporary requires a great deal
of judgment. In order to avoid unnecessary
scrutiny, management should consistently
apply a systematic approach for classifying
impaired securities. For instance, estab-
lishing evaluation criteria in advance and
documenting the factors considered in the
analysis and the conclusions reached will
lend credibility to management’s asser-
tions.
Reporting impairment
losses
Once a loss is considered other-than-
temporary, the difference between the cost
and fair value of the investment at the bal-
ance sheet date is reported in earnings. The
new cost basis is not changed for subsequent
recoveries in fair value. A recovery in fair
value is not recorded in earnings until the
security is sold.
In addition, accounting standards require
a company to disclose its investments that
are in a loss position, grouped by those
that have been in a continuous loss for less
than 12 months and those that have been
underwater for more than 12 months.
Management must also include a narrative
discussion essentially defending its position
that unrealized losses are only temporary.
This narrative should be straightforward
and discuss what caused the loss as well as
specific evidence supporting the expected
recovery. While this narrative presents
management with an opportunity to elabo-
rate on its intentions, it should be based on
defendable facts and objective viewpoints.
Income tax
considerations
Although financial reporting standards
require companies to write down the basis
of securities deemed to be other-than-
temporarily impaired, federal income tax
regulations do not permit a deduction for
such losses until the security is actually sold.
As such, securities whose cost basis has been
reduced by an impairment charge produce
book-tax differences that result in deferred
tax assets and the corresponding income
tax provision is allocated to earnings (as
opposed to OCI).
Comparison to Interna- Conclusion
tional Financial Reporting During periods of economic instability,
Standards (IFRS) a financial reporting executive’s judgment
The valuation of marketable securities faces higher scrutiny. Decisions with regard
is an area where U.S. reporting standards to impaired marketable securities require a
differ substantially from the rules followed great deal of care and should be approached
by the global business community. While objectively and systematically in order to
both U.S. reporting requirements and IFRS provide meaningful disclosures about a
require impairment assessments based on company’s investments and lend credibility
relatively subjective criteria at each bal- to the financial statements. 
ance sheet date, the IFRS model is quite
different.
For instance, the notion that a holding
loss is “other-than-temporary” is not con- Peter R. Alfele, CPA,
sidered under IFRS. Additionally, the IFRS is a partner at Cherry,
analysis permits assets to be evaluated in Bekaert & Holland, LLP,
groups where U.S. standards require that in Virginia Beach. He
the review be conducted at the security has more than 12 years
level. Further, while U.S. standards point of experience providing
to “indications” of impairment (time and audit and accounting
extent of loss, issuers financial condition, services to a variety of
commercial enterprises and closely
intent and ability of the holder), IFRS gener-
held, middle market businesses.
ally requires certain occurrences before an
Contact him at palfele@cbh.com
impairment loss is recorded. or search and connect with him on
Specifically, recording a loss under IFRS LinkedIn.
requires “objective evidence of impairment
as a result of one or more events” and that
the “loss event (or events) has an impact on
the estimated future cash flows of the finan-
cial asset or group of financial assets that can
be reliably estimated.” Finally, unlike U.S.
principles that restrict the recognition of
the recovery of an impaired security beyond
its adjusted basis until it is actually sold,
IFRS permits subsequent gains under
certain circumstances.

U.S. reporting
standards differ
substantially from
the rules followed by
the global business
community in
the valuation of
marketable securities.

Financial Reporting • Disclosures • March/April 29