Stable Mable's investment loss classification under FASB Statement 115

¶ … Tale of Stable Mable's Unstable Investment

John Smith

Accounting 101

Stable Mable is a privately held company with a fiscal year ending on September 30th. Because of its private status, the only external reporting requirement on the company is that they must provide audited annual financial statements to shareholders and other financial leaders.

In order to seek additional levels of income, Stable Mable invested $20 million into a mutual bond fund in October of 1997. By the end of the following fiscal year, the investment went south and had an unrealized holding loss of $1.3 million. Stable Mable had to classify and establish just how to adjust their financial statements for the investment's losses. Their options were to account for the losses as realized losses or to exclude the losses from earnings as a separate component of shareholders' equity.

In addition, decisions made now could effect future financial statements because Stable Mable is considering an IPO offering. Investors would like to see the financial statement process in accordance with the SEC's accounting standards.

Review Generally Accepted Accounting Principles (GAAP) Rules

Each day, accountants make decisions as to how they should record business transactions. Decisions are often based on the financial objectives of the organization they work for but at other times the accountants use Generally Accepted Accounting Principles (GAAP). GAAP rules are not a fixed set of rules -- they are simply guidelines or a group of objectives and conventions that govern how financial statements are prepared.

A review of Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities (Issued 5/93):

Statement 115 addresses accounting and reporting for investments in equity securities and those investments are to be classified in categories:

Debt securities that the enterprise has the positive intent and ability to hold to maturity are classified as 'held-to-maturity' securities and reported at amortized cost.

Debt and equity securities not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders' equity.

As is true with most GAAP, the definition for "impairment" is a company interpretation. Although the regulations are complex, the fundamentals are relatively easy to understand. Under the new rules, all goodwill is to be assigned to the company's reporting units that are expected to benefit from that goodwill. Then the goodwill must be tested (at least annually) to determine if the recorded value of the goodwill is greater than the fair value. If the fair value is less than the carrying value, the goodwill is deemed "impaired" and must be charged off.

Apply rules to key issues

The rules that apply to the key issues are that when Stable Mable first adopted the FASB Statement 115, they classified the investment as available-for-sale and therefore they interpreted that the loss should be a separate component of shareholders' equity.

When they performed the impairment analyses at the fiscal year end 1998 they incorrectly concluded that the decline in the fair value of the Fund Investment below its amortized cost basis was not 'other-than-temporary'.

At that point the company and the independent auditors should have accepted that it was probable that Stable Mable would not be able to collect all amounts due according to the contractual terms of the debt security. They should have classified the impairment as other-than -temporary.

Recommendations

It is recommended that Stable Mable should have recorded the impairment charge on the Fund Investment as of September 1998.

The impairment analysis for fiscal year end September 30, 1998 was incorrectly labeled as not 'other-than-temporary' so they did not properly take the necessary impairment charge.

Conclusion

The impairment charge provides investors with a way to monitor companies like Stable Mable's management and their decision-making track record. Companies that have to write off losses due to impairment have not made good investment decisions. Management's that bite the bullet and take an honest all-encompassing charge should be viewed more favorably than those who slowly bleed a company to death by deciding to take a series of recurring impairment charges, thereby providing a false reality.

An "Impairment Charge" is a new term for writing off worthless goodwill. While impairment charges have gone relatively unnoticed, they will get more attention as the weak economy and faltering stock market force more charge-offs. This will also increase concerns about corporate balance sheets.

Individuals need to be aware of these risks and factor them into their investing decision-making process.

Smith -