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Assume that, on January 1, 2012, an entity acquired a debt security for $1,000 (at par), with a fixed interest rate of 4.5% per annum and a bullet maturity at December 31, 2016. The security is classified under ASC 320 as available for sale. On December 31, 2012, the fair value of the debt security is $700; therefore, the entity assesses whether the impairment is other than temporary. The entity determines that it does not intend to sell the security and it is not more likely than not that it will be required to sell the security. However, based on an evaluation of all available information, the entity does not expect to recover the entire amortized cost basis of the security. Accordingly, as required under the ASC 320-10-35, the entity prepares an analysis of the cash flows expected to be collected from the debt security to determine whether a credit loss exists. On December 31, 2012, the cash flows analysis is performed in accordance with the methodology prescribed under ASC 310 and shows the following results:
Year
Contractual Cash Flows
Cash Flows Expected at December 31, 2012*
Decrease in Expected Cash Flows
Year 1
2012
$ 45
$ 45
$ -
Year 2
2013
45
35
10
Year 3
2014
45
35
10
Year 4
2015
45
35
10
Year 5
2016
1,045
935
110
Total Cash Flows
$ 1,225
$ 1,085
$ 140
Net Present Value of Cash Flows
$ 1,000
$ 800
$ 120
*Discounted at the original effective rate of 4.5% (rate at the debt security's purchase)
Based on the cash flow analysis, the entity determines that a credit loss exists and, therefore, an other-than-temporary impairment has occurred. The entity separates the total impairment of $300 (the cost basis of $1,000 less the fair value of $700 as of December 31, 2012) into (a) the amount representing the decrease in cash flows expected to be collected (i.e., the credit loss) of $120 and (b) the amount related to all other factors of $180 (i.e., the noncredit component). After the recognition of the OTTI, the debt security's adjusted cost basis will be $880 (i.e., the previous cost basis less the credit loss recognized in earnings) and its carrying value will be $700 (i.e., fair value).
Initial Investment (amortized cost at Jan. 1, 2012)
$ 1,000
Plus: Interest recognized to date
45
Less: Cash collected to date
(45)
Credit Loss
(120)
Amortized cost basis at December 31, 2012
$ 880
Noncredit Loss
(180)
Fair value at December 31, 2012
$ 700
In accordance with ASC 320-10-35, the entity will recognize an OTTI in earnings of $120 for the credit loss, and recognize the remaining impairment loss of $180 separately in other comprehensive income. Note that, on the face of the statement of earnings, the entire $300 impairment will be presented, with the $180 noncredit impairment deducted from that amount in a separate line to arrive at the net credit impairment recognized in earnings of $120.
Presentation on income statement
Total other than temporary impairment
$ 300
Portion of impairment loss recognized in OCI
(180)
Net other-than-temporary impairment loss recognized in earnings
$ 120
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