Question

Assume you are an auditor, and your client is a public company with a large portfolio of available-for-sale equity securities. The client

reports these securities at fair value, with unrealized gains and losses recognized in “other comprehensive income,”

an equity account, each period.

The client is preparing its quarterly financial statements and is again—for the second consecutive quarter—

recording a decline in market value for several of the securities. These securities’ fair values are now below their

cost. From experience, you know that losses on available-for-sale securities must be recognized in earnings if (1)

the securities are considered impaired (i.e., cost basis in excess of fair value) and (2) if the impairment is considered

“other than temporary.” Your client has asserted that it has the ability and intent to hold the securities, at least until

their value recovers, and believes that the losses need only be recognized in OCI.

Locate the relevant accounting guidance, then draft an email to your audit supervisor (Sean) that

• tells him about this issue,

• explains the general requirement regarding impairment of available-for-sale securities, describes your evaluation of whether the change in security values should be considered an other-than-temporary impairment (and therefore recognized in earnings), and

• suggests next steps.

It may be difficult to reach a definitive conclusion regarding whether impairment is required; however, it is

important that you make your supervisor aware of this issue and the relevant guidance. Consider all sources of

“required reading” in your response. Try to be succinct, while fully addressing the issue (try not to overwhelm your

supervisor with an overly lengthy email).

Answer 1

Issue - The company has a portfolio of equity shares for immediate sales. The company is valuing gain/ loss on shares on Other Comprehensive Income. Now the fair value of shares are less than the book value of its assets and now the issue is whether the loss on impairment should be debited to Profit & Loss or in Other Comprehensive Income.

General Requirement - As per IFRS 9  the classification of financial assets depends on two criteria: the contractual cash flow of the instrument and the entity’s business model for managing its financial instruments. An entity can classify an instrument at amortized cost if contractual cash flows are solely payments of principal and interest and if the business model is to hold instruments to collect contractual cash flows (‘business model test’). If an instrument fails to meet both criteria, then the financial asset should be measured at fair value.  

Next Step - In this case the company's intention is to sell the equity shares, the intention is not to collect the contractual cash flows. So in my view the company should measure the financial asset at fair value. So the amount of loss should be debited to Profit and Loss Account.