accounting update part 3 chicago regional training conference indianapolis, indiana june 14, 2006...

Accounting UpdatePart 3

Chicago Regional Training ConferenceIndianapolis, Indiana

June 14, 2006

Robert F. Storch, Chief AccountantDivision of Supervision and Consumer Protection

Federal Deposit Insurance CorporationWashington, DC

• Under FAS 115, an institution must determine whether an impairment of an individual available-for-sale or held-to-maturity security is other than temporary

– An impairment occurs whenever the fair value of a security is less than its (amortized) cost basis

– If an impairment is other than temporary, the cost basis of the individual security must be written down to fair value through earnings, establishing a new cost basis for the security

Other-Than-Temporary ImpairmentOther-Than-Temporary Impairment

• FASB Staff Position (FSP) Nos. FAS 115-1 and FAS 124-1 issued 11/3/05

– Nullifies the measurement and recognition guidance contained in EITF 03-1, the effective date of which the FASB had previously delayed

– Carries forward the disclosure requirements in EITF 03-1

– References existing other-than-temporary impairment guidance, which institutions were already expected to apply for regulatory reporting purposes


• Besides FAS 115, existing guidance includes – SEC Staff Accounting Bulletin (SAB) No. 59,

Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities (Topic 5.M. in the Codification of SABs)

– AICPA Statement on Auditing Standards (SAS) No. 92, Auditing Derivative Instruments, Hedging Activities, and Investments in Securities

– EITF Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets


• FSP FAS 115-1 incorporates EITF D-44:– When an institution has decided to sell an

impaired security and it does not expect the fair value of the security to fully recover prior to the expected time of sale, the security shall be deemed other-than-temporarily impaired in the period in which the decision to sell is made.

• An institution must also recognize a loss when an impairment is deemed other than temporary even if a decision to sell has not been made


• SAB 59 and SAS 92 identify examples of factors to be considered in evaluating impairment

– Length of time and extent to which fair value has been less than cost

– Financial condition of issuer of security• Has deterioration occurred?• Has rating been downgraded?• What are issuer’s near-term prospects?

– Interest payments not made or dividends reduced or elimination

– Intent and ability of institution to retain investment until anticipated recovery in fair value


• Each institution’s investment or accounting policies should provide for the quarterly evaluation of individual impaired securities to determine whether any other-than-temporary impairments have occurred

– These are case-by-case evaluations based on facts and circumstances surrounding each security

– Evaluations should be documented to show management’s consideration of all relevant factors, including those in SAB 59 and SAS 92, in reaching its conclusions concerning impairment


• Revised Uniform Agreement on the Classification of Assets and Appraisal of Securities Held by Banks and Thrifts issued in June 2004 incorporates impairment concept into the agencies’ general debt security classification guidelines

– Provides that other-than-temporary impairment will be classified Loss, but temporary impairment will not be


• SAB 59 and SAS 92 identify examples of factors to be considered in evaluating impairment

– Length of time and extent to which fair value has been less than cost

– Financial condition of issuer of security• Has deterioration occurred?• Has rating been downgraded?• What are issuer’s near-term prospects?

– Interest payments not made or dividends reduced or elimination

– Intent and ability of institution to retain investment until anticipated recovery in fair value


Accounting for Stock OptionsAccounting for Stock Options

• FASB Statement 123(Revised), “Share-Based Payment,” issued 12/04

• FAS 123(R) requires all entities to recognize compensation cost equal to the fair value of share-based payments granted to employees

– Stock options– Restricted stock

• Took effect 1/1/06 for all companies with calendar year fiscal years


• Measurement– Fair value is computed at date of grant and

never remeasured• Exception for liability awards, i.e., awards

calling for settlement in cash or other assets

– Absent an observable market price, use a valuation technique based on established principles of financial economic theory, e.g., option pricing model


• Measurement– Fair value estimate must incorporate

• Exercise price of award• Expected term of award• Current price of the underlying stock• Expected price volatility of the underlying

stock• Expected dividends on the underlying stock• Risk-free interest rate


• Measurement– For a nonpublic company, expected price

volatility can use historical volatility of an appropriate industry sector index

• Results in “calculated value” rather than “fair value”


• Recognition of compensation cost– Over requisite service period, generally the

same as the vesting period– Cliff vesting schedule, e.g., 100% of award

vests after four years of service -- Straight-line cost recognition

– Graded vesting schedule, e.g., 25% of award vests at end of each of four years of service -- Either straight-line or accelerated cost recognition


• Recognition of compensation cost– Estimate forfeitures of options at date of

grant– Adjust estimate in subsequent periods

when available information suggests actual forfeitures will differ

• Treat as change in accounting estimate

– When options on holding company stock are granted to bank employees, recognize compensation cost at bank level


• Recognition of tax effects– Options are either incentive stock options

(ISOs) or nonqualified stock options (NSOs) for tax purposes

• ISO must satisfy several statutory requirements

• All other options are NSOs• NSOs are more prevalent• NSOs normally generate tax deduction for

employer when option is exercised, but ISOs do not


• Recognition of tax effects– For NSOs, as compensation cost is

recognized over the service period, record a deferred tax asset equal to compensation expense times tax rate

– Currently, tax deduction for NSOs equals difference between fair value of stock on exercise date and amount employee pays to exercise option


• Recognition of tax effects– Upon exercise of NSOs, reverse deferred tax

asset• If tax deduction exceeds compensation

expense, excess benefit is credited to surplus• If tax deduction is less than compensation

expense, deferred tax asset in excess of tax benefit is charged to surplus to the extent of previous excess tax benefits; otherwise charged to current period income tax expense

accounting update part 3 chicago regional training conference indianapolis, indiana june 14, 2006...

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