A company holds an investment in another entity's equity securities. The company intends to hold the investment for the long term and does not have a readily determinable fair value for these securities. The company elects the practical expedient to measure the investment at cost, less any impairment, plus or minus changes resulting from observable price changes of identical or similar investments. What is the appropriate accounting treatment for an impairment loss on this investment?
- AReclassify the investment to a different category before recognizing impairment.
- BDo not recognize an impairment loss until the investment is sold.
- CRecognize the impairment loss in net income.
- DRecognize the impairment loss in Other Comprehensive Income (OCI).
Show answer & explanationAnswer & explanation
Correct answer: C. Recognize the impairment loss in net income.
When an equity investment without a readily determinable fair value is measured using the practical expedient (cost, less impairment, plus/minus observable price changes), any recognized impairment loss is recorded directly in net income. This differs from available-for-sale debt securities where impairment might be split between OCI and net income, or from equity method investments.
Why the other options are wrong
- A. Incorrect. Reclassification is not the primary accounting treatment for impairment.
- B. Incorrect. Impairment losses must be recognized when the fair value of the investment falls below its carrying amount and the decline is considered other-than-temporary.
- D. Incorrect. OCI is typically used for unrealized gains/losses on available-for-sale securities or cash flow hedges, not for impairment of this type of equity investment.
Equity Investments without Readily Determinable Fair Value (Practical Expedient)
For equity investments without a readily determinable fair value, an entity may elect a practical expedient to measure them at cost, less any impairment, plus or minus changes resulting from observable price changes of identical or similar investments. Impairment losses are recognized in net income.
- Applies to equity investments where fair value cannot be readily determined.
- Practical expedient: cost minus impairment, adjusted for observable price changes.
- Impairment losses are recognized in net income.
- No subsequent reversals of impairment losses are permitted.
- Observable price changes (up or down) are also recognized in net income.
Memory trick: No FV, No OCI – Impairment goes straight to the Income Statement, no detours!