Title: Recognition and Presentation of Other-Than-Temporary Impairments

Transcription

1 FASB STAFF POSITION No. FAS and FAS Title: Recognition and Presentation of Other-Than-Temporary Impairments Date Posted: April 9, 2009 Objective 1. The objective of an other-than-temporary impairment analysis under existing U.S. generally accepted accounting principles (GAAP) is to determine whether the holder of an investment in a debt or equity security for which changes in fair value are not regularly recognized in earnings (such as securities classified as held-to-maturity or available-for-sale) should recognize a loss in earnings when the investment is impaired. An investment is impaired if the fair value of the investment is less than its amortized cost basis. 2. This FASB Staff Position (FSP) amends the other-than-temporary impairment guidance in U.S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. Background 3. If the fair value of a debt security is less than its amortized cost basis at the measurement date, U.S. GAAP requires that an entity assess the impaired security to determine whether the impairment is other than temporary. Before this FSP, to conclude that an impairment was other than temporary an entity was required, among other considerations, to assert that it had the intent and ability to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value in accordance with SEC Staff Accounting Bulletin (SAB) Topic 5M, Other Than Temporary Impairment of Certain Investments in Debt and (FSP FAS and FAS 124-2) 1

2 Equity Securities, and other authoritative literature. If the impairment was determined to be other-than-temporary, then an impairment loss was recognized in earnings equal to the entire difference between the investment s amortized cost basis and its fair value at the balance sheet date. 4. On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the Act) was signed into law. Section 133 of the Act mandated that the U.S. Securities and Exchange Commission (SEC) conduct a study on mark-to-market accounting standards. The SEC submitted its study, Report and Recommendations Pursuant to Section 133 of the Emergency Economic Stabilization Act of 2008: Study on Mark-To-Market Accounting, to Congress on December 30, One of the recommendations in the study was that the FASB reassess current impairment accounting models for financial instruments. The SEC recommended that the FASB evaluate the need for modifications (or the elimination) of current OTTI [other-thantemporary impairment] guidance to provide for a more uniform system of impairment testing standards for financial instruments. The SEC also noted that a model that would require that only credit losses be recognized in income with the remaining decline in fair value of an investment being recognized in other comprehensive income has the potential to provide investors with both fair value information as well as transparent information regarding the cash flows management expects to receive by holding investments, rather than through accessing the market currently. 5. On January 12, 2009, the Board issued FSP EITF , Amendments to the Impairment Guidance of EITF Issue No , to make the accounting for other-thantemporary impairments in EITF Issue No , Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets, more consistent with the accounting in FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, However, constituents continued to express concerns that the requirements for recognition and measurement of impairment losses for investments in debt securities are different from those for loans. Those constituents also observed that financial statements do not provide users with sufficient information about the amount of cash the entity expects to collect by holding the (FSP FAS and FAS 124-2) 2

3 asset. Some constituents asserted that current market conditions have caused temporary declines in value that go well beyond the cash flows that are no longer expected to be collected. 6. This FSP incorporates other-than-temporary impairment guidance for debt securities from SAB Topic 5M and other authoritative literature, modifies and expands it to address the unique features of debt securities, and clarifies the interaction of the factors that should be considered when determining whether a debt security is other than temporarily impaired. 7. For debt securities, the Board is modifying the existing requirements that to avoid recognizing an other-than-temporary impairment an investor must assert that it has both the intent and the ability to hold a security for a period of time sufficient to allow for an anticipated recovery in its fair value to its amortized cost basis. Instead, the Board believes it is more operational for an entity to assess whether the entity (a) has the intent to sell the debt security or (b) more likely than not will be required to sell the debt security before its anticipated recovery (for example, if its cash or working capital requirements or contractual or regulatory obligations indicate that the debt security will be required to be sold before the forecasted recovery occurs). If either of these conditions is met, the investor must recognize an other-than-temporary impairment. 8. Additionally, the Board decided to modify the terminology used to assess the collectibility of cash flows from probable that the investor will be unable to collect all amounts due to the recovery of the entire cost basis of the security to clarify that an entity should not wait for an event of default or other actual shortfall of cash to conclude that some or all of the cash flows are not likely to be collected. In the Board s view, in assessing whether the entire amortized cost basis of the security will be recovered, the entity should compare the present value of the cash flows expected to be collected from the security with the amortized cost basis of the security. The Board intends that the term cash flows expected to be collected should represent the cash flows that the entity is likely to collect after a careful assessment of all available information, including the factors described in paragraph 25 of this FSP. difference between the present value of the cash flows expected to be collected and the amortized cost basis is hereafter referred to as the credit loss. The (FSP FAS and FAS 124-2) 3

4 9. In instances in which a determination is made that a credit loss exists but the entity does not intend to sell the debt security and it is not more likely than not that the entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis (that is, the amortized cost basis less any current-period credit loss), this FSP changes the presentation and amount of the other-than-temporary impairment recognized in the statement of earnings (or the performance indicator of not-for-profit entities within the scope of the AICPA Audit and Accounting Guide, Health Care Organizations). In those instances, the impairment is separated into (a) the amount of the total impairment related to the credit loss and (b) the amount of the total impairment related to all other factors. The amount of the total otherthan-temporary impairment related to the credit loss is recognized in earnings (or the performance indicator). The amount of the total impairment related to all other factors is recognized in other comprehensive income (or outside the performance indicator). The total other-than-temporary impairment is presented in the statement of earnings with an offset for the amount of the total other-than-temporary impairment that is recognized in other comprehensive income. This new presentation provides additional information about the amounts that an entity does not expect to collect related to a debt security. 10. In instances in which a determination is made that a credit loss exists but the entity does not intend to sell the debt security and it is not more likely than not that the entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis, this FSP more closely aligns the amounts recognized in earnings for impairments of investments in debt securities and impairments of loans classified as held-for-investment. However, unlike loans, the total other-than-temporary impairment recognized in comprehensive income for a debt security reflects the difference between fair value and the security s remaining amortized cost basis at the measurement date. 11. Investors have informed the Board that two key financial metrics they use in evaluating many financial institutions are Tangible Common Equity and Net Interest Margin. This FSP has little or no effect on total Tangible Common Equity. This FSP does not result in a change in the carrying amount of debt securities in the statement of financial position (that is, available-forsale securities are reported at fair value and held-to-maturity securities are reported at their amortized cost basis unless they are other-than-temporarily impaired, in which case they are (FSP FAS and FAS 124-2) 4

5 adjusted to fair value at that time). However, this FSP does require that the portion of an otherthan-temporary impairment not related to a credit loss for a held-to-maturity security be recognized in a new category of other comprehensive income and be amortized over the remaining life of the debt security as an increase in the carrying value of the security (with no effect on earnings unless the security is subsequently sold or there are additional decreases in cash flows expected to be collected). Compared with current requirements, this FSP does change the Net Interest Margin to better reflect the cash flows expected to be collected by an entity. It requires that the amortized cost basis of the security be adjusted by the credit loss only when the 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 remaining amortized cost basis. 12. This FSP expands and increases the frequency of existing disclosures about other-thantemporary impairments for debt and equity securities. For example, it requires a more detailed, risk-oriented breakdown of major security types and related information currently required by Statement 115. In addition, this FSP requires that the annual disclosures in Statement 115 and FSP FAS and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, be made for interim periods (including the aging of securities with unrealized losses). This FSP also requires new disclosures to help users of financial statements understand the significant inputs used in determining a credit loss, as well as a rollforward of that amount each period. These collective disclosure enhancements significantly improve the information provided to users about impaired securities. 13. This FSP does not amend existing recognition and measurement guidance for other-thantemporary impairments of equity securities because the Board does not believe the requirement for an entity to assess whether the entity more likely than not will be required to sell a security before its recovery is more operational for equity securities. 14. The Board understands that the staff of the SEC s Office of the Chief Accountant plans to amend SAB Topic 5M to conform with the guidance for debt securities in this FSP. 15. Beyond making short-term changes in this FSP, the FASB has a joint project with the International Accounting Standards Board to more broadly improve and achieve convergence of their respective standards on accounting for financial instruments. That project is being (FSP FAS and FAS 124-2) 5

6 conducted on an expedited basis with a goal of working toward convergence. The FASB anticipates a joint Exposure Document will be issued later in This FSP includes amendments to Statement 115 and FSP FAS and FAS and conforming changes to other standards, including Issue and AICPA Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer. All paragraphs in this FSP have equal authority. Paragraphs in bold set out the main principles. (FSP FAS and FAS 124-2) 6

7 FASB Staff Position Scope 17. The recognition guidance in paragraphs of this FSP applies to debt securities classified as available-for-sale and held-to-maturity that are subject to other-thantemporary impairment guidance within: a. Statement 115 b. FSP FAS and FAS c. EITF Issue 99-20, as amended by FSP EITF d. AICPA Statement of Position For debt securities that are within the scope of FASB Statement No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations, and that are held by an entity that reports a performance indicator as defined in AICPA Accounting and Audit Guide, Health Care Organizations, throughout this FSP, the term earnings shall be replaced with performance indicator, and other comprehensive income shall be replaced with outside the performance indicator. 18. The presentation and disclosure guidance in paragraphs of this FSP applies to debt and equity securities that are subject to the disclosure requirements of Statement 115 and FSP FAS and FAS Recognition Evaluating Whether an Impairment of a Debt Security Is Other Than Temporary 19. If the fair value of a debt security is less than its amortized cost basis at the balance sheet date, an entity shall assess whether the impairment is other than temporary. Amortized cost basis includes adjustments made to the cost of an investment for accretion, amortization, collection of cash, previous other-than-temporary impairments recognized in earnings (less any cumulative-effect adjustments recognized in accordance with paragraphs 45 and 46 of this FSP), and fair value hedge accounting adjustments. (FSP FAS and FAS 124-2) 7

8 20. 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. 21. If an entity does not intend to sell the debt security, the entity shall consider available evidence to assess whether it more likely than not will be required to sell the security before the recovery of its amortized cost basis (for example, whether its cash or working capital requirements or contractual or regulatory obligations indicate that the security will be required to be sold before a forecasted recovery occurs). If the entity more likely than not will be required to sell the security before recovery of its amortized cost basis, an other-than-temporary impairment shall be considered to have occurred. 22. If the entity does not expect to recover the entire amortized cost basis of the security, the entity would be unable to assert that it will recover its amortized cost basis even if it does not intend to sell the security. Therefore, in those situations, an other-thantemporary impairment shall be considered to have occurred. In assessing whether the entire amortized cost basis of the security will be recovered, an entity shall compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If present value of cash flows expected to be collected is less than the amortized cost basis of the security, the entire amortized cost basis of the security will not be recovered (that is, a credit loss exists), and an other-than-temporary impairment shall be considered to have occurred. 23. In determining whether a credit loss exists, an entity shall use its best estimate of the present value of cash flows expected to be collected from the debt security. One way of estimating that amount would be to consider the methodology described in paragraphs of FASB Statement No. 114, Accounting by Creditors for Impairment of a Loan, for measuring an impairment on the basis of the present value of expected future cash flows. Paragraph 14 of Statement 114 provides guidance on this calculation. Briefly, the entity would discount the expected cash flows at the effective interest rate implicit in the security at the date of acquisition. 24. For debt securities that are beneficial interests in securitized financial assets within the scope of Issue 99-20, an entity shall determine the present value of cash flows expected to be (FSP FAS and FAS 124-2) 8

9 collected by considering the guidance in paragraph 12(b) of Issue for determining whether there has been a decrease in cash flows expected to be collected from cash flows previously projected. In other words, the cash flows estimated at the current financial reporting date shall be discounted at a rate equal to the current yield used to accrete the beneficial interest. Additionally, for debt securities accounted for in accordance with SOP 03-3, an entity shall consider that standard in estimating the present value of cash flows expected to be collected from the debt security. A decrease in cash flows expected to be collected on an asset-backed security that results from an increase in prepayments on the underlying assets shall be considered in the estimate of the present value of cash flows expected to be collected. 25. There are numerous factors to be considered when estimating whether a credit loss exists and the period over which the debt security is expected to recover. The following are a few examples of the factors that shall be considered. This list is not meant to be all-inclusive. a. The length of time and the extent to which the fair value has been less than the amortized cost basis b. Adverse conditions specifically related to the security, an industry, or a geographic area (for example, changes in the financial condition of the issuer of the security, or in the case of an asset-backed debt security, in the financial condition of the underlying loan obligors, including changes in technology or the discontinuance of a segment of the business that may affect the future earnings potential of the issuer or underlying loan obligors of the security or changes in the quality of the credit enhancement) c. The historical and implied volatility of the fair value of the security d. The payment structure of the debt security (for example, nontraditional loan terms as described in FSP SOP , Terms of Loan Products That May Give Rise to a Concentration of Credit Risk) and the likelihood of the issuer being able to make payments that increase in the future e. Failure of the issuer of the security to make scheduled interest or principal payments f. Any changes to the rating of the security by a rating agency g. Recoveries or additional declines in fair value subsequent to the balance sheet date. (FSP FAS and FAS 124-2) 9

10 26. In making its other-than-temporary impairment assessment, an entity shall consider all available information relevant to the collectibility of the security, including information about past events, current conditions, and reasonable and supportable forecasts, when developing the estimate of cash flows expected to be collected. That information generally should include the remaining payment terms of the security, prepayment speeds, the financial condition of the issuer(s), expected defaults, and the value of any underlying collateral. To achieve that objective, the entity should consider, for example, industry analyst reports and forecasts, sector credit ratings, and other market data that are relevant to the collectibility of the security. An entity also should consider how other credit enhancements affect the expected performance of the security, including consideration of the current financial condition of the guarantor of a security (if the guarantee is not a separate contract as discussed in paragraph 8 of FSP FAS and FAS 124-1) and/or whether any subordinated interests are capable of absorbing estimated losses on the loans underlying the security. The remaining payment terms of the security could be significantly different from the payment terms in prior periods (such as for some securities backed by nontraditional loans). Thus, an entity should consider whether a security backed by currently performing loans will continue to perform when required payments increase in the future (including balloon payments). An entity also should consider how the value of any collateral would affect the expected performance of the security. If the fair value of the collateral has declined, an entity needs to assess the effect of that decline on the ability of the entity to collect the balloon payment. Determination of the Amount of an Other-Than-Temporary Impairment Recognized in Earnings and Other Comprehensive Income 27. When an other-than-temporary impairment has occurred, the amount of the other-than-temporary impairment recognized in earnings depends on whether 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. 28. 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 otherthan-temporary impairment shall be recognized in earnings equal to the entire difference between (FSP FAS and FAS 124-2) 10

11 the investment s amortized cost basis and its fair value at the balance sheet date. In assessing whether the entity more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit losses, an entity shall consider the factors in paragraph 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 (a) the amount representing the credit loss and (b) the amount related to all other factors. 30. The amount of the total other-than-temporary impairment related to the credit loss shall be recognized in earnings. The amount of the total other-than-temporary impairment related to other factors shall be recognized in other comprehensive income, net of applicable taxes. 31. The previous amortized cost basis less the other-than-temporary impairment recognized in earnings shall become the new amortized cost basis of the investment. That new amortized cost basis shall not be adjusted for subsequent recoveries in fair value. However, the amortized cost basis shall be adjusted for accretion and amortization as prescribed in paragraph 32. Accounting for Debt Securities after an Other-Than-Temporary Impairment 32. 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-thantemporary 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 guidance as interest income. An entity shall continue to estimate the present value of cash flows expected to be collected over the life of the debt security. For debt securities accounted for in accordance with Issue 99-20, an entity should look to that standard to account for changes in cash flows expected to be collected. For all other debt securities, if upon subsequent evaluation, there is a significant increase in the cash flows expected to be collected or if actual cash flows are significantly greater than cash flows (FSP FAS and FAS 124-2) 11

12 previously expected, such changes shall be accounted for as a prospective adjustment to the accretable yield in accordance with SOP 03-3 even if the debt security would not otherwise be within the scope of that standard. This FSP does not address when a holder of a debt security would place a debt security on nonaccrual status or how to subsequently report income on a nonaccrual debt security. Debt Securities Classified as Available-for-Sale 33. Subsequent increases and decreases (if not an additional other-than-temporary impairment) in the fair value of available-for-sale securities shall be included in other comprehensive income. Debt Securities Classified as Held-to-Maturity 34. The other-than-temporary impairment recognized in other comprehensive income for debt securities classified as held-to-maturity shall be accreted from other comprehensive income to the amortized cost of the debt security over the remaining life of the debt security in a prospective manner on the basis of the amount and timing of future estimated cash flows. That accretion shall increase the carrying value of the security and shall continue until the security is sold, the security matures, or there is an additional other-than-temporary impairment that is recognized in earnings. If the security is sold, paragraphs 8 and 11 of Statement 115 provide guidance on the effect of changes in circumstances that would not call into question the entity s intent to hold other debt securities to maturity in the future. Presentation 35. In periods in which an entity determines that a security s decline in fair value below its amortized cost basis is other than temporary, the entity shall present the total otherthan-temporary impairment in the statement of earnings with an offset for the amount of the total other-than-temporary impairment that is recognized in other comprehensive income in accordance with paragraph 30, if any. 36. The following is an example of the presentation on the face of the statement of earnings: Total other-than-temporary impairment losses ($10,000) (FSP FAS and FAS 124-2) 12

13 Portion of loss recognized in other comprehensive income (before taxes) 4,000 Net impairment losses recognized in earnings ($ 6,000) 37. An entity also shall separately present, in the financial statement where the components of accumulated other comprehensive income are reported, amounts recognized therein related to held-to-maturity and available-for-sale debt securities for which a portion of an other-thantemporary impairment has been recognized in earnings. Disclosures 38. An entity shall disclose information for interim and annual periods that enables users of its financial statements to understand the types of available-for-sale and held-tomaturity debt and equity securities held, including information about investments in an unrealized loss position for which an other-than-temporary impairment has or has not been recognized. In addition, for interim and annual periods, an entity shall disclose information that enables users of financial statements to understand the reasons that a portion of an other-than-temporary impairment of a debt security was not recognized in earnings and the methodology and significant inputs used to calculate the portion of the total other-than-temporary impairment that was recognized in earnings. 39. In satisfying the principle in paragraph 38 an entity shall identify major security types consistent with how it manages, monitors, and measures its securities on the basis of the nature and risks of the security. An entity shall consider the (shared) activity or business sector, vintage, geographic concentration, credit quality, or economic characteristic in determining whether disclosure for a particular security type is necessary and whether it is necessary to separate further a particular security type in greater detail. When complying with the disclosure requirements in paragraph 19 of Statement 115, a financial institution shall include the following major security types, although additional types also may be necessary: equity securities (segregated by industry type, company size, or investment objective); debt securities issued by the U.S. Treasury and other U.S. government corporations and agencies; debt securities issued by states of the United States and political subdivisions of the states; debt securities issued by foreign governments; corporate debt securities; residential mortgage-backed securities; commercial mortgage-backed securities; collateralized debt obligations; and other (FSP FAS and FAS 124-2) 13

14 debt obligations. For purposes of this requirement, the term financial institutions includes banks, savings and loan associations, savings banks, credit unions, finance companies, and insurance companies. 40. For securities classified as available-for-sale or held-to-maturity, an entity shall disclose the amortized cost basis by major security type that the entity discloses in accordance with Statement 115 as of each date (interim and annual) for which a statement of financial position is presented. Additionally, an entity shall provide all disclosures required by Statement 115 on a quarterly basis. 41. An entity shall disclose, by major security type, the information required by FSP FAS and FAS for each interim and annual reporting period presented. The information required by paragraph 17 of FSP FAS and FAS also shall be presented for debt securities for which an other-than-temporary impairment was recognized and only the amount related to a credit loss was recognized in earnings. 42. For periods in which an other-than-temporary impairment of a debt security is recognized and only the amount related to a credit loss was recognized in earnings, an entity shall disclose, by major security type, the methodology and significant inputs used to measure the amount related to the credit loss. Examples of significant inputs include, but are not limited to, performance indicators of the underlying assets in the security (including default rates, delinquency rates, and percentage of nonperforming assets), loan to collateral value ratios, thirdparty guarantees, current levels of subordination, vintage, geographic concentration, and credit ratings. 43. For each interim and annual reporting period presented, an entity shall disclose a tabular rollforward of the amount related to credit losses recognized in earnings in accordance with paragraph 30, which shall include at a minimum: a. The beginning balance of the amount related to credit losses on debt securities held by the entity at the beginning of the period for which a portion of an other-than-temporary impairment was recognized in other comprehensive income b. Additions for the amount related to the credit loss for which an other-than-temporary impairment was not previously recognized (FSP FAS and FAS 124-2) 14

15 c. Reductions for securities sold during the period (realized) d. Reductions for securities for which the amount previously recognized in other comprehensive income was recognized in earnings because the 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 e. Additional increases to the amount related to the credit loss for which an other-thantemporary impairment was previously recognized when the 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 f. Reductions for increases in cash flows expected to be collected that are recognized over the remaining life of the security (see paragraph 32) g. The ending balance of the amount related to credit losses on debt securities held by the entity at the end of the period for which a portion of an other-than-temporary impairment was recognized in other comprehensive income. Effective Date and Transition 44. The FSP shall be effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, Earlier adoption for periods ending before March 15, 2009, is not permitted. If an entity elects to adopt early either FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, or FSP FAS and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments, the entity also is required to adopt early this FSP. Additionally, if an entity elects to adopt early this FSP, it is required to adopt FSP FAS This FSP does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In periods after initial adoption, this FSP requires comparative disclosures only for periods ending after initial adoption. 45. This FSP shall be applied to existing and new investments held by an entity as of the beginning of the interim period in which it is adopted (for example, as of April 1, 2009, if an entity adopts the FSP for periods ending after June 15, 2009). For debt securities held at the beginning of the interim period of adoption for which an other-than-temporary impairment was (FSP FAS and FAS 124-2) 15

16 previously recognized, if an entity does not intend to sell 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 (after considering the guidance in paragraphs of this FSP), the entity shall recognize the cumulative effect of initially applying this FSP as an adjustment to the opening balance of retained earnings with a corresponding adjustment to accumulated other comprehensive income. The cumulative effect on retained earnings shall be calculated by comparing the present value of the cash flows expected to be collected determined in accordance with the methodology in paragraphs 23 and 24 with the amortized cost basis of the debt security as of the beginning of the interim period in which this FSP is adopted. The cumulative-effect adjustment shall include related tax effects. The discount rate used to calculate the present value of the cash flows expected to be collected shall be the rate in effect before recognizing any other-than-temporary impairments and not a rate that has been adjusted to reflect those impairments. 46. The amortized cost basis of a security for which an other-than-temporary impairment was previously recognized shall be adjusted by the amount of the cumulative-effect adjustment before taxes. The difference between the new amortized cost basis and the cash flows expected to be collected shall be accreted in accordance with existing guidance as interest income (see paragraph 32). 47. In the period of adoption, an entity shall provide the disclosures required by FASB Statement No. 154, Accounting Changes and Error Corrections, for changes in accounting principles. The provisions of this FSP need not be applied to immaterial items. (FSP FAS and FAS 124-2) 16

17 This FSP was adopted by the affirmative votes of three members of the Financial Accounting Standards Board. Messrs. Linsmeier and Siegel dissented. Messrs. Linsmeier and Siegel dissent to issuance of this FSP for two reasons. First, they believe that to the extent there is an other-than-temporary impairment, it should be measured as the entire difference between the fair value and the carrying value of the impaired item with that change fully reflected in net income as an unrealized loss. Messrs. Linsmeier and Siegel believe that investors generally have opined that their preference is for the fair value of financial instruments to be reflected in net income. While other financial statement users might have different views, the difference in opinion often is due to concerns about regulatory capital, as most users find increased worth in fair value information. Messrs. Linsmeier and Siegel note that investors changed their focus in recent months from analyzing Tier One Capital to Tangible Common Equity. Tier One Capital reverses from regulatory capital unrealized fair value losses on securities reported in other comprehensive income. In the current markets, investors are focusing more on Tangible Common Equity consistent with a preference for reporting full fair value changes in capital. Critical to this analysis is the inclusion of unrealized fair value losses on debt and equity securities within net income and not other comprehensive income. This FSP serves to increase the unrealized losses reported in other comprehensive income, exacerbating investors concerns with Tier One Capital information. Thus, Messrs. Linsmeier and Siegel do not believe that investors generally will be served by requiring a bifurcation of the fair value write-down between net income and other comprehensive income, as is required in certain circumstances by this FSP. Messrs. Linsmeier and Siegel believe that the primary purpose of financial reporting is to serve investors; therefore, if a bifurcation of the full fair value change into credit and noncredit components is needed to facilitate bank regulators in their regulatory capital decisions, that bifurcation should be provided on the face of the income statement with both components recognized in earnings consistent with investors preferences. Bank regulators then can choose whether or not to include the noncredit portion of the fair value change in their regulatory capital requirements. Messrs. Linsmeier and Siegel also object to bifurcating the impairment loss into credit and noncredit components because they do not believe the expected loss approach (as prescribed in this FSP) can isolate the credit loss from other losses (particularly liquidity risk) as is advocated by those supporting this approach. In current market conditions, liquidity risk is (FSP FAS and FAS 124-2) 17

18 inextricably intertwined with credit risk, representing the discount associated with uncertainty about the collectibility of contractual cash flows in the security. Second, Messrs. Linsmeier and Siegel object to the change in the trigger for the nonrecognition of the full impairment loss in net income. The previous GAAP requirements permitted nonrecognition of the full impairment loss when an entity could assert its intent and ability to hold the instrument to recovery of its amortized cost basis. Instead, this FSP permits nonrecognition of the noncredit portion of the full impairment loss in net income if the entity can assert that it 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 to its amortized cost basis. While Messrs. Linsmeier and Siegel understand that the primary objective of this change is to make the held-torecovery concept more operational, they also recognize that a likely result of this change is a reduction in the amount of impairment losses recognized in net income. A 1991 U.S. Treasury report cited delayed recognition of impairment losses as having an exacerbating effect on the length and ultimate cost of the savings and loan crisis. There also are potential parallels to the experience in Japan when delays in recognition of losses resulted in the so-called lost decade in the 1990s. Similarly, Messrs Linsmeier and Siegel are concerned that to the extent the proposed FSP results in delayed recognition of impairment losses in net income, there also may be a negative effect on investor confidence. Finally, Messrs. Linsmeier and Siegel believe that there potentially may be other standard-setting issues that need to be addressed within the current other-than-temporary impairment model. However, they would prefer to address those concerns in the joint mediumterm project with the International Accounting Standards Board (IASB). Messrs. Linsmeier and Siegel believe that there is a high risk that the unilateral change to the recognition and presentation of other-than-temporary impairments could create the opportunity for an accounting arbitrage with pressure for FASB and IASB standards to converge to the standard perceived most lenient. In addition, when one standard setter enacts changes on its own, there is a failure to achieve convergence of accounting standards, which continues the challenges faced by investors in comparing global financial institutions reporting under two different accounting models. (FSP FAS and FAS 124-2) 18

19 Members of the Financial Accounting Standards Board: Robert H. Herz, Chairman Thomas J. Linsmeier Leslie F. Seidman Marc A. Siegel Lawrence W. Smith (FSP FAS and FAS 124-2) 19

20 Appendix A AMENDMENTS TO EXISTING PRONOUNCEMENTS A1. FASB Statement No. 60, Accounting and Reporting by Insurance Enterprises, is amended as follows: [Added text is underlined and deleted text is struck out.] a. Paragraph 50 as amended: Realized gains and losses on all investments (except those that are accounted for as either hedges of net investments in foreign operations or cash flow hedges as described in Statement 133) shall be reported in the statement of earnings as a component of other income, on a pretax basis. Realized gains and losses shall be presented as a separate item in the statement of earnings or disclosed in the notes to the financial statements. Realized gains and losses shall not be deferred, either directly or indirectly. Realized gains and losses on the sale of assets other than investments, such as real estate used in the business, shall be reported in accordance with APB Opinion No. 30, Reporting the Results of Operations. Losses arising from an other-than-temporary impairment shall be presented in accordance with FSP FAS and FAS 124-1, The Meaning of Other-Than- Temporary Impairment and Its Application to Certain Investments. A2. FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, is amended as follows: a. Paragraph 16, and its related footnote 4, as amended: For individual securities classified as either available-for-sale or held-tomaturity, an enterprise shall determine whether a decline in fair value below the amortized cost basis is other than temporary. (If a security has been the hedged item in a fair value hedge, the security s amortized cost basis shall reflect the effect of the adjustments of its carrying amount made pursuant to paragraph 22(b) of Statement 133.) For example, if it is probable that the investor 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. 4 If the decline in fair value is judged to be other than temporary, the cost basis of the individual security shall be written down to fair value as a new cost basis and the amount of the write-down shall be included in earnings (that is, accounted for as a realized loss).the enterprise shall apply the guidance in FSP FAS and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, to determine whether the decline in fair value is other than temporary and how an other-than-temporary impairment should be recognized. The amortized cost basis shall be written down by the amount of an other-than-temporary impairment recognized in earnings. The new amortized cost basis shall not be (FSP FAS and FAS 124-2) 20

21 changed for subsequent recoveries in fair value. Subsequent increases in the fair value of available-for-sale securities shall be included in other comprehensive income pursuant to paragraph 13; subsequent decreases in fair value, if not an other-than-temporary impairment, also shall be included in other comprehensive income. 4 A decline in the value of a security that is other than temporary is also discussed in FSP FAS115-1 and FAS124-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments," AICPA Statement on Auditing Standards No. 92, Auditing Derivative Instruments, Hedging Activities, and Investments in Securities, and in SEC Staff Accounting Bulletin No. 59, Accounting for Noncurrent Marketable Equity Securities. b. Paragraph 18A is added after the heading Disclosures as follows: The disclosures in this Statement are required for interim and annual periods. c. Paragraph 19, as amended: For securities classified as available-for-sale, all reporting enterprises shall disclose the amortized cost basis, the aggregate fair value, the total other-thantemporary impairment recognized in accumulated other comprehensive income, the total gains for securities with net gains in accumulated other comprehensive income, and the total losses for securities with net losses in accumulated other comprehensive income, by major security type as of each date for which a statement of financial position is presented. For securities classified as held-tomaturity, all reporting enterprises shall disclose the amortized cost basis, the aggregate fair value, gross unrecognized holding gains, gross unrecognized holding losses, the net carrying amount, the total other-than-temporary impairment recognized in accumulated other comprehensive income, and the gross gains and losses in accumulated other comprehensive income for any derivatives that hedged the forecasted acquisition of the held-to-maturity securities, by major security type as of each date for which a statement of financial position is presented. Major security types shall be based on the nature and risks of the security. An enterprise should consider the (shared) activity or business sector, vintage, geographic concentration, credit quality, or economic characteristic in determining whether disclosure for a particular security type is necessary and whether it is necessary to further separate a particular security type into greater detail. In complying with this requirement, financial institutions 6 shall include in their disclosure the following major security types, although additional types also may be necessaryincluded as appropriate: a. Equity securities (segregated by industry type, company size, or investment objective) b. Debt securities issued by the U.S. Treasury and other U.S. government corporations and agencies c. Debt securities issued by states of the United States and political subdivisions of the states d. Debt securities issued by foreign governments (FSP FAS and FAS 124-2) 21

22 e. Corporate debt securities f. Residential Mmortgage-backed securities g. Commercial mortgage-backed securities h. Collateralized debt obligations gi. Other debt securitiesobligations. A3. FASB Statement No. 130, Reporting Comprehensive Income, is amended as follows: a. Paragraph 17, as amended: Items included in other comprehensive income shall be classified based on their nature. For example, under existing accounting standards, other comprehensive income shall be classified separately into foreign currency items, gains or losses associated with pension or other postretirement benefits, prior service costs or credits associated with pension or other postretirement benefits, transition assets or obligations associated with pension or other postretirement benefits, and unrealized gains and losses on certain investments in debt and equity securities classified as available-for-sale, and amounts recognized in other comprehensive income for debt securities classified as available-for-sale and held-to-maturity related to an other-than-temporary impairment recognized in accordance with FSP FAS and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, when a portion of the impairment was not recognized in earnings. Additional classifications or additional items within current classifications may result from future accounting standards. b. Paragraph 19: An enterprise shall determine reclassification adjustments for each classification of other comprehensive income, except as noted in paragraph 19A. The requirement for a reclassification adjustment for Statement 52 foreign currency translation adjustments is limited to translation gains and losses realized upon sale or upon complete or substantially complete liquidation of an investment in a foreign entity. c. Paragraph 19A is added as follows: An enterprise shall only determine reclassification adjustments for amounts recognized in other comprehensive income related to other-than-temporary impairments of debt securities classified as held-to-maturity when the loss is realized as a result of a sale of the security or an additional credit loss occurs. If the security is sold, paragraphs 8 and 11 of Statement 115 provide guidance on the effect of changes in circumstances that would not call into question the entity s intent to hold other debt securities to maturity in the future. If the heldto-maturity debt security is not sold and additional credit losses do not occur, the amount recognized in other comprehensive income shall be accounted for in accordance with FSP FAS and FAS (that is, the amount shall be (FSP FAS and FAS 124-2) 22

23 amortized over the remaining life of the debt security in a prospective manner on the basis of the amount and timing of future estimated cash flows). A4. FSP FAS and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, is amended as follows: a. Paragraph 3A is added as follows: FSP FAS and FAS 124-2, Recognition and Presentation of Other-Than- Temporary Impairments, amends the recognition, presentation, and disclosure guidance in this FSP. b. Paragraph 4b: Debt and equity securities that are within the scope of Statement 124 and that are held by an investor that reports a "performance indicator" as defined in the AICPA Accounting and Audit Guide, Health Care Organizations. Throughout this standard, the term earnings shall be replaced with performance indicator, and other comprehensive income shall be replaced with outside the performance indicator for debt securities that are within the scope of Statement 124. c. Footnote 2: Amortized ccost basis includes adjustments made to the cost basis of an investment for accretion, amortization, collection of cash, previous other-thantemporary impairments recognized in earnings (less any cumulative-effect adjustments recognized in accordance with the transition provisions of FSP FAS and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments), and hedging fair value hedge accounting adjustments. d. Paragraph 13: When the fair value of an investment is less than its amortized cost basis at the balance sheet date of the reporting period for which impairment is assessed, the impairment is either temporary or other than temporary. 4 In addition to the guidance in this FSP, Aan investor shall apply other guidance that is pertinent to the determination of whether an impairment is other than temporary, such as paragraph 16 of Statement 115 (which references SEC Staff Accounting Bulletin Topic 5M, Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities), paragraph 6 of Opinion 18, and EITF Issue No , "Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets." e. Paragraph 13A and its related heading are added as follows: (FSP FAS and FAS 124-2) 23