CPA Exam - FAR (Financial Accounting and Reporting)Financial ReportingMedium
A company owns a portfolio of marketable securities. At year-end, the fair value of its equity investments for which it does not elect the fair value option and does not have significant influence is lower than their cost. The impairment is considered to be other-than-temporary. How should this impairment be recognized under U.S. GAAP?
- AAs an unrealized loss in net income.
- BAs a direct adjustment to retained earnings.
- CAs a component of other comprehensive income (OCI).
- DAs a realized loss in net income.
Show answer & explanationAnswer & explanation
Correct answer: D. As a realized loss in net income.
For equity investments where the fair value option is not elected and there is no significant influence, changes in fair value are recognized in net income. If the impairment is 'other-than-temporary', it is considered a realized loss and recognized in net income. If it's merely a temporary decline, it would still flow through net income for these types of investments.
Why the other options are wrong
- A. While it is an unrealized loss initially, the 'other-than-temporary' nature effectively makes it a realized loss for accounting purposes, impacting net income directly.
- B. Direct adjustments to retained earnings are rare and typically for prior period adjustments or certain changes in accounting principle, not for investment impairment.
- C. OCI recognition is for available-for-sale debt securities, or for equity investments where the fair value option is elected through OCI, not for equity investments without significant influence when impaired.
Equity Investment Impairment (No Significant Influence)
For equity investments where the investor does not have significant influence and has not elected the fair value option through OCI, an 'other-than-temporary' decline in fair value below cost is recognized as a realized loss in net income.
- Applies to equity investments measured at fair value through net income (FV-NI).
- All fair value changes, including impairments, flow through net income.
- Distinction between temporary and other-than-temporary impairment is less relevant post-ASU 2016-01 for FV-NI equity investments, as all fair value changes go to net income. However, the term 'other-than-temporary' implies a more permanent reduction, reinforcing the loss recognition.
Memory trick: Equity's deep dip, net income's slip.