Given the continuing economic uncertainties and market volatility, we expect that assessing investments in AFS equity instruments for impairment will be a significant issue for companies holding these investments at year end. In this memorandum, we provide key reminders for complying with the impairment requirements in IAS 39, Financial Instruments: Recognition and Measurement.ant or prolong, recognize impairment in net income.
1. Identify whether a "significant or prolonged" decline in the fair value of an equity investment has occurred at the balance sheet date. If so, recognition of animpairment loss in net income is mandatory.IAS 39 also says that loss recognition isappropriate if other objective evidence ofimpairment exists, e.g. if significant changeswith an adverse effect have taken place inthe technological, market, economic or legalenvironment in which the issuer operatesand indicates that the cost of the investmentmay not be recovered. We would normallyexpect that such information would bereflected in fair value assessments.
2. Make assessments whether a decline in fair value is significant or prolonged at the level of the individual security. Evaluating impairment on a portfolio basisis not appropriate. Where a security hasbeen acquired at different dates and prices,the weighted average cost method, first-infirst-out method or specific identificationmethod can be used to assess impairment,as long as the method is consistently appliedfor both the assessment of impairment andthe determination of realized gains or lossesupon disposal.
3. Use judgment in evaluating whether a decline in fair value is significant or prolonged. The IFRS InterpretationsCommittee ("IFRIC") has emphasized thatit is necessary to apply judgment even ifan entity has developed internal guidanceto assist it in its impairment evaluations.Whether a decline is significant should bejudged relative to the original cost of aninvestment. Whether it is prolonged shouldbe judged by considering the period aninvestment has been underwater. Shareprice volatility over an extended period isa factor that an entity might consider inits assessments, but this requires complexstatistical modelling.
4. Resist the temptation to defer recognition of an impairment loss until a decline is both significant and prolonged. The IFRIC has confirmed this interpretationof IAS 39 is inappropriate.
5. Reject explanations that a decline in fair value is not significant or prolonged because it is attributable to general market conditions or expected to reverse. The IFRIC has emphasized that a decline in the value ofan investment in line with the overall level of decline inthe relevant market does not mean that the investment isunimpaired.
6. Forget about evaluating whether a decline in fair value is "other than temporary", or whether the entity has the intent and ability to hold the investment until recovery occurs. These are old Canadian GAAP and USGAAP criteria, not IFRS.
7. Recognize an impairment loss even if the only reason for the loss is an adverse movement in foreign exchange rates. Evaluation of impairment is relativeto the functional currency of the entity undertaking theevaluation and therefore a decline in the exchange ratecan lead to the recognition of an impairment even if thefair value of the security has increased in the foreigncurrency. For example, an entity with a Canadian dollarfunctional currency holding an investment that can onlybe realized in US dollars should translate the US dollarinvestment at the current exchange rate and recognize animpairment if there is a decline in fair value in Canadiandollars that is significant or prolonged.
8. Measure the impairment loss as the difference between the acquisition cost and the current fair value of the investment, less any impairment loss recognized in an earlier period. If all or a portion of adecline in fair value has occurred in the current period,we believe the entity has the choice of recognizing thedecline first in OCI and then transferring it to net income,or recognizing the loss directly in the income statementand bypassing OCI. For example, if there is a fair valuedecline sitting in accumulated other comprehensiveincome of $100 at the start of the period and a furtherloss of $150 in the period, the entity could eitherrecognize the loss of $150 in OCI for the period andpresent a reclassification adjustment of $250, or show areclassification adjustment of only $100 and recognizethe $150 directly in net income. This is a matter ofaccounting policy.
9. Do not reverse impairment losses if the fair value of an equity investment subsequently recovers. This isprohibited by IAS 39.69.
10. Do not use the carrying amount after the impairment as a basis against which to assess any further declines in value for impairment. Instead, any further declinesin the fair value of a security after an impairment loss areautomatically considered to be further impairments to berecognized in net income.
11. Consider whether the judgments made in respect of impairment assessments represent "critical judgments" requiring disclosure. IAS 1.122 requiresan entity to disclose the judgments that have had "themost significant effect on the amounts recognized inthe financial statements". Disclosure of the reasons forthe judgment is necessary, especially if an entity hasdetermined that a decline in fair value is not significantor prolonged.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
