An investor records an impairment charge in earnings when the decline in value below the carrying amount of its equity method investment is determined to be other than temporary. “Other than temporary” does not mean that the decline is of a permanent nature. The unit of account for assessing whether there is an other-than-temporary impairment (OTTI) is the carrying value of the equity method investment as a whole.
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. A current fair value of an investment that is less than its carrying amount may indicate a loss in value of the investment. However, a decline in the quoted market price below the carrying amount or the existence of operating losses is not necessarily indicative of a loss in value that is other than temporary. All are factors that shall be evaluated. Continued operating losses at the investee may suggest that the investor would not recover all or a portion of the carrying value of its investment, and therefore that the decline in value is other than temporary.
ASC 323-10-35-31 A series of operating losses of an investee or other factors may indicate that a decrease in value of the investment has occurred that is other than temporary and that shall be recognized even though the decrease in value is in excess of what would otherwise be recognized by application of the equity method. All available evidence should be considered in assessing whether a decline in value is other than temporary. The relative weight placed on individual factors may vary depending on the situation. Factors to consider in assessing whether a decline in value is other than temporary include:
Investors should also consider the reasons for the impairment and the period over which the investment is expected to recover. The longer the expected period of recovery, the stronger and more objective the positive evidence needs to be in order to overcome the presumption that the impairment is other than temporary. As the level of negative evidence grows, more positive evidence is needed to overcome the need for an impairment charge. The positive evidence should be verifiable and objective. Figure EM 4-2 contain examples of negative evidence that may suggest that a decline in value is other than temporary. Figure EM 4-3 contains examples of positive evidence that may suggest a decline in value is not other than temporary. These examples are not all-inclusive, and investors should assess all relevant facts and circumstances. Figure EM 4-2
Figure EM 4-3
In situations where the fair value is known, such as in the case of an investment with a quoted price or when an investee stock transaction occurs, and that fair value is below the investor’s carrying amount, the investor would need to assess whether that impairment is other than temporary. The fact that the fair value is below the carrying amount does not automatically require an impairment charge to be recognized. All facts and circumstances would need to be considered.
Excerpt from ASC 323-10-35-32 A current fair value of an investment that is less than its carrying amount may indicate a loss in value of the investment. However, a decline in the quoted market price below the carrying amount or the existence of operating losses is not necessarily indicative of a loss in value that is other than temporary. All are factors that shall be evaluated. For investments in private companies, information that would usually be considered includes:
Once a determination is made that an OTTI exists, the investment should be written down to its fair value in accordance with ASC 820 at the reporting date, which establishes a new cost basis. Any bifurcation of declines in value between “temporary” and “other than temporary” is not allowed. Subsequent declines or recoveries after the reporting date are not considered in the impairment recognized. A previously recognized OTTI also cannot subsequently be reversed when fair value is in excess of the carrying amount. When an investor records an OTTI charge, the investor is required to attribute the impairment charge to the underlying equity method memo accounts of its investment. The attribution may create new basis differences or impact existing basis differences. ASC 323 does not provide guidance on attributing the amount of an OTTI charge to the investor’s equity method memo accounts. We believe there are several acceptable methods to attribute the charge; however, the method applied should be reasonable given the nature of the OTTI charge. Two acceptable methods include the specific identification method and the fair value method. Under the specific identification method, the investor would create a new basis difference or adjust an existing one for the specific items (e.g., litigation) that resulted in the OTTI charge. Under the fair value method, the investor would reset all its basis difference as if the investor had acquired the investment on the date of recording the OTTI charge. Example EM 4-11 illustrates the adjustment of an existing basis difference under the specific identification method. EXAMPLE EM 4-11 In 20X1, Investor acquired a 40% investment in Investee (a public company) for $25 million. At the date of the acquisition, the book value of the net assets of Investee totaled $50 million and the fair value of the net assets totaled $62.5 million. The assets held by Investee consisted primarily of net current assets with a carrying value and fair value of $30 million and long-lived assets with remaining useful lives of 10 years, a carrying value of $20 million, and a fair value of $32.5 million. As a result, the carrying value of Investor’s proportionate interest in the net assets of Investee was $20 million. The $5 million basis difference was attributed entirely to fixed assets. Five years later (i.e., in year 20X6), Investee lost the contract of a significant customer and experienced some production issues. No impairment charge was recorded within Investee’s financial statements (impairment was tested under the long-lived asset impairment model using the undiscounted future cash flows, which were in excess of the book value of the assets). However, the market price per share of Investee declined below Investor’s investment balance per share, representing a potential impairment of $5 million. Based on all available information, Investor concluded that the decline in value of Investee’s market price per share was other than temporary. For simplicity, all tax implications are ignored. How should Investor subsequently account for negative basis differences created by an impairment charge? Analysis Assuming Investor determines that the decline in value of $5 million is other than temporary, Investor would record an impairment charge of $5 million against the investment in Investee. Given the nature of Investee’s operations and asset base (principally working capital and fixed assets), this loss could be considered attributable to Investee’s fixed assets. As a result, the impairment charge would eliminate the remaining fixed asset basis difference of $2.5 million ($5.0 million × 5/10 years amortized), and create an additional $2.5 million negative basis difference. The negative basis difference would be amortized over the remaining asset lives. Investor would need to determine the appropriate amortization period. While there are 5 years remaining of the original 10-year useful life determined at the date of the initial investment, the estimated remaining lives of Investee’s fixed assets at the date of impairment should be considered in determining the appropriate amortization period. For this example, we have assumed 5 years. Investee’s net income would include $2,000,000 of depreciation expense ($20,000,000 [investee’s carrying value of its fixed assets]/10 years [estimated useful life]), which reflects the carrying value of the fixed assets as reported in Investee’s financial statements. Investor would recognize its proportionate share of Investee’s net income; however, Investor should also amortize $500,000 ($2.5 million/5 years) of the negative basis difference as an increase (credit) to equity method earnings in order to reflect Investor’s lower cost basis in Investee’s fixed assets, which results in lower annual depreciation expense. |