Earlier this month, FASB Staff Position FAS 115-2, Recognition and Presentation of Other-Than-Temporary Impairments, went into effect. FAS 115-2 changes the way in which other-than-temporary impairments, or OTTI, are evaluated and accounted for. “Under FSP FAS 115-2, an impairment for debt securities, in certain circumstances, is separated into the credit loss amount recognized in earnings and the amount related to all other factors (noncredit loss) recognized in other comprehensive income,” said the Office of Thrift Supervision in a May 14, 2009, memorandum.

FAS 115-2 changes the accounting for debt securities whose value has dropped; equities aren’t impacted. Figuring out the new rules requires parsing through sentences boasting double negatives to determine whether or not an impairment is temporary, says Jay Hanson, partner and national director of accounting with McGladrey & Pullen, LLP.

The change really centers on “the presumption regarding the intent and ability of the organization to hold the security,” according to a June 2009 Insurance Research Note from Goldman Sachs Asset Management. Previously, the owner of the security had to “maintain the positive intent and ability to hold a security to the recovery of invested principle” in order to conclude than any impairment was temporary and need not be reflected in earnings, Goldman says.

No longer. Now, in order to classify an impairment as temporary, the owner has to say that it’s not planning to sell the instrument, and it is not more likely than not (there’s the double negative) that it will be required to sell the security before its value recovers. The change from a positive assertion (that the organization intends to hold a security) to a negative one (that the organization doesn’t intend to sell the security) could shift investment strategies, Hanson says.

Moreover, when a loss is deemed other than temporary, the owner has to split it into two: the credit loss, which is recognized in earnings, and the noncredit loss, which is recognized in other comprehensive income, or OCI. Here, the calculations can get complicated, Hanson says. “The devil’s in the details.” In order to separate the economic, or noncredit loss from the credit loss, financial executives will need to make detailed projections of the expected cash flows from the security. These are based on a range of factors, including the historic volatility of the security and any changes to its rating, according to McGladrey & Pullen’s April 10, 2009, Accounting Insights newsletter.

While larger organizations should have the resources to complete all the necessary number-crunching, smaller firms are likely to struggle, Hanson notes. At this point, the FASB has not indicated that compliance with FAS 115-2 can be optional, he adds. Treasurers will need to work with the CFO and accounting staff to gather and analyze the data needed to comply, he adds.

At the same time, treasurers will want to keep tabs on the joint efforts of the FASB and International Accounting Standards Board to apply this same sort of accounting treatment to even more financial instruments, Hanson says. The shift would make earnings more volatile for many firms. While few CFOs would want that, the effort is moving ahead. “It’s definitely a stay-tuned situation,” he adds. ###