IAS 39.

61-1 - Impairment: Meaning of significant or prolonged decline in fair value (January 2009) Issue What is the meaning of significant and what is the meaning of prolonged, in relation to determining whether an available for sale (AFS) equity security is considered impaired? Fact pattern Paragraph 61 of IAS 39 Financial Instruments: Recognition and Measurement lists as indicators of impairment a number of factors which indicate that the cost of the investment in the equity instrument may not be recovered. It goes on to state that a "significant or prolonged decline in the fair value of an investment in an [AFS] equity instrument below its cost is also objective evidence of impairment". Conclusion It should be emphasised that the reference is to a significant or prolonged decline, not a significant and prolonged decline. It is therefore not acceptable to consider an AFS equity security as impaired only when the decline in fair value is both significant and prolonged. Every fact pattern will need to be assessed on a case-by-case basis, taking into account the characteristics of the market and applying judgment. The following should be considered when arriving at a conclusion for each situation: Significant It is unlikely that interpreting significant as a fixed percentage decline in fair value compared to cost will always be appropriate, as what is significant will depend on the circumstances. For example, it could be argued that the higher the historical volatility of the share price, the greater the decline in fair value before it is likely to be regarded as significant. However, the most important consideration is whether the cost of the security will be recovered. Whilst there can be no general quantitative guideline, a less than a 10% decline in fair value is unlikely to be considered significant for investments actively traded in a liquid market, whereas a decline in fair value of greater than 20% is likely to be considered significant. For a less liquid investment which has been particularly volatile historically, it may be possible to make a case that a higher decline in fair value is not significant, but a decline of over 30% would be considered significant other than in exceptional circumstances specific to the client or the security (as opposed to the market in general). If a client proposes using a higher significant threshold than 30%, the engagement team must consult the Area IFRS Desk (see Consultation Policy, below). Prolonged Again, whilst there can be no general guideline, a period of less than 6 months is unlikely to be considered prolonged. It would be difficult to justify a period longer

than 12 months as not prolonged. If a client proposes using a longer prolonged period than 12 months, the engagement team must consult the Area IFRS Desk (see Consultation Policy, below). The entity will need to document the basis for determination of the period considered prolonged. It should be noted that besides the significant or prolonged criteria, IAS 39.61 requires the evaluation of other information in determining impairment. The higher or longer the clients thresholds for determining whether a decline is significant or prolonged, the more comprehensive the evaluation will need to be of the potential impact of the other indicators. Consistent application The basis for determining what is considered significant or prolonged must be applied consistently within a financial period as well as from period to period. Disclosure The entity must clearly disclose for each type of security held and in quantitative terms, the basis for determining what is considered significant or prolonged; and indicate they are applied consistently. Consultation policy If a client proposes using a higher significant threshold than 30% or a longer prolonged period than 12 months, the engagement team must consult the Area IFRS Desk, providing a written rationale for the proposed approach. Depending on the circumstances, the Area IFRS Desk will decide whether the matter should be referred to an IPSP. Consultation will also be appropriate if there is any doubt as to how this Q&A should be applied. Whilst clients may be discussing their particular situation with regulators and regulators may also be providing more general guidance, to the extent that the positions taken by regulators are inconsistent with the principles set out in this Q&A, and a client wishes to follow that regulatory guidance, consultation will still be required. Guidance While a securitys price volatility should be taken into account in determining what is significant, it is the historical volatility that will normally be relevant rather than the recent short term volatility: it cannot be argued that the volatility arising from a sudden sharp decline in price means that the decline is not significant. However, a sustained downward decline in value is more likely to be considered significant than a sharp drop close to the period end when there is a high expectation of recovery in the near future, especially if the market value has substantially recovered before the accounts are complete. As the reference is to a significant or prolonged decline, it is not possible to argue that a large decline in fair value is not significant just because it is recent. However, whilst there is no further qualification of the words significant or prolonged in the standard, it would seem unreasonable to insist on an impairment charge in respect of a decline in value that persists only for a very short period, especially since the charge

is irreversible. An example would be a decline which occurs close to the year-end and reverses shortly thereafter, before the financial statements are finalised. If there is doubt as to whether a decline in value is significant in such circumstances, the client team should consult the Area IFRS desk. Sometimes preparers or commentators will argue that the market is irrational and does not represent fair value. It would not be appropriate to regard a market value decline as not significant just because it is inconsistent with a fundamental analysis, ie, a net asset value, using discounted cash flows, or analysts projections. Further, whether or not an entity intends to hold the security for the long term is irrelevant to the assessment, as is the size of the holding, or the existence of unrealised profits on other AFS equities as the calculation cannot be made on a collective basis. Also, as equity securities are considered not to be monetary assets, the assessment is based on the fair value of the security as measured in the entitys functional currency, not by reference to the currency in which the security is quoted. In addition, it cannot be argued that a decline in the price of an individual security is not significant just because the rest of the market has suffered a similar decline it is more appropriate to view such a scenario as a significant decline of the whole market. Reasons for conclusion Paragraph 58 of IAS 39 requires an entity to assess at the end of each reporting period whether there is objective evidence that a financial asset or group of financial assets is impaired. If any such evidence exists, the entity shall apply paragraph 67 (for available-for-sale financial assets) to determine the amount of any impairment loss. Paragraph 59 provides examples of loss events that provide objective evidence that a financial asset or group of assets is impaired. However, these loss events focus primarily on debt instruments. Nevertheless, par. 61 of IAS 39 refers to par. 59 also for equity instruments. Par. 61 of IAS 39 states that an AFS equity security is considered impaired if the cost of the investment may not be recovered. It then continues to say A significant or prolonged decline in the fair value of an investment in an equity instrument below its cost is also objective evidence of impairment. This means a significant or prolonged decline in the fair value below cost is not just an indicator of impairment, it is objective evidence of an impairment and requires the application of paragraph 67. It should be emphasised that the reference is to a significant or prolonged decline, not a significant and prolonged decline as can be found in US GAAP. The IASB deliberately deviated from US GAAP on this point, thereby creating another GAAP difference and making the impairment test more onerous than US GAAP, at least on this particular point. It is therefore not acceptable under IFRS to consider an AFS equity security to be impaired only when the decline in fair value is both significant and prolonged. Significant

The term significant is used widely in IFRS/IAS Standards. However, the only quantitative reference to the definition of significant exists in paragraph 6 of IAS 28 Investments in Associates: "If an investor holds, directly or indirectly (eg through subsidiaries), 20 per cent or more of the voting power of the investee, it is presumed that the investor has significant influence, unless it can be clearly demonstrated that this is not the case. Conversely, if the investor holds, directly or indirectly (eg through subsidiaries), less than 20 per cent of the voting power of the investee, it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence." The reference in paragraph 6 of IAS 28 is a measurement definition for purposes of accounting for an investment in an associate and is not necessarily appropriate in this situation. It is appropriate to vary the threshold for what is "significant" depending on the equity instrument, since they trade with different expectations of price volatility which will necessarily give rise to different interpretations of what is considered significant. In the Guidance section above circumstances and arguments are listed that may indicate a higher threshold is more appropriate. It also contains circumstances and arguments that are not considered relevant. Prolonged The term prolonged is not used anywhere else in IFRS. The objective of the IASB in setting 'prolonged' as a criterion was to create a period over which a decline in market value will have been sufficiently observed as to be objective evidence of impairment. IFRS does not contain any quantitative measure of prolonged. It is considered that 12 months will be long enough a period to be considered prolonged in most circumstances. In the Guidance section above circumstances and arguments are listed that may indicate a longer period is more appropriate. It also contains circumstances and arguments that are not considered relevant Consultation policy By its very nature a Q&A like this will never be able to contemplate all circumstances an entity may find itself in, nor all arguments that can be mounted to consider an AFS equity instrument to be impaired or not. Nevertheless, consistency in the application of IAS 39.61 is paramount. Therefore, this Q&A requires consultation when a client argues an AFS equity security is not impaired despite its decline in fair value compared to cost of more than 30% or that the prolonged period exceeds 12 months. These are arbitrary cut-offs. However, the higher the decline in fair value compared to cost or the longer the period the more robust the evidence must be to avoid

impairment. The consultation policy is meant to allow Area IFRS desks to seek this consistency in application.

Approved by the FIWG: January 2009 Approved by the IFRS Policy Committee: January 2009