 Hello and welcome to the session in which we would look at impairment of value for that investment. What is the big idea? Well, simply put when you make an investment in a debt simply put when you lend money This is what what do we mean by investment in debt when you lend money when you buy a bond There's always a risk of not receiving your money. What does that mean? It means when you lend someone money that individual may not pay you for many reasons Maybe the company goes out of business. Maybe do the economic condition their industry is suffering Whatever the reason is you may not be able to get your money. It's the same concept as selling on credit What do we mean by selling on credit? Well, remember every time we saw long we sell on credit There's a risk of not receiving the full amount or a partial amount of our money The best way to kind of start this discussion is to review the impairment of receivable Because once you review the impairment of receivable, you understand how the impairment of that instrument work simply put We make a sale for let's just for the sake of simplicity a sale for ten thousand dollar to ABC company We debit account receivable we credit sales for ten thousand and we hope we are going to receive this amount There at some point at the end of the year We might have to estimate bad Expense and let's assume we estimated $50,000 of bad that expense for the company and we credit allowance for 50,000 allowance for bad debt there at some point after we estimate We may figure out that ABC company will not be paying us once ABC company once we determine It's not gonna pay us. We are going to debit the allowance and credit the account receivable for ABC company, which is ten thousand And ten thousand so what happened is this receivable? Simply becomes is is is written off and became an expense as part of the fifty thousand So this is how we do the impairment for the receivable. Okay, and what we did is we learned about the the current Expected credit loss or seesaw model to measure the impairment of receivable. Okay for that investment anything That's you know that investment that securities and loans simply put the account receivable is a form of a loan They are that are reported at amortized cost, which is they are follow the same approach as receivable So it's very similar approach, which is the current expected credit loss model That model takes into account current conditions. So how do you determine how much losses to book past experience? Future expectation so on and so forth in the literature There's no specific instruction on how much to write to write off how much to estimate because each industry is different Each company is different the economy the economic situation Evolves over time in this topic impairment of receipt impairment of that investment became a front Front-page issue when we had the financial crisis during 2007 2008 were out of nowhere Many of these debt investments became worthless. So that's why now they want you to look at Current condition past experience and look at future expectation When you are determining try to guess determining the amount of the loss that you have to write The amount of the loss, I'm sorry The accounting treatment depends on the asset being measured and we're gonna break our assets into three different types of assets The first will be receivables which we which we looked at loans Which is kind of similar to receivable like notes receivable and debt Securities but those debt securities are held to maturity HTM because we could have that to maturity is HTM We could have that to maturity is available for sale and we could have that to maturity is trading now If you don't know what held to maturity when you want to go back to held to maturity investment But simply put if we have receivable loans and debt securities HTM They are treated the same as receivable which is losses are recognized in their income What does that mean? It means we estimate that expense and we credit the allowance So this is when we estimate the bet that expense This is where it hits the income statement Then eventually we will debit allowance and credit the asset itself, which we'll see in an example So simply put held to maturity debit by that expense credit allowance We will work an example to show you how we write down the asset itself The second asset class are that investment that goes through other comprehensive income through other Other comprehensive income it means the gains and the losses the unrealized gain and unrealized losses We booked them through other comprehensive income the category specifically is called available for sale now available for sale They use a different model. Here's how we book the impairment for available for sale if the fair value is Greater or equal to the amortized cost. Well, then we don't have to worry about anything We don't have to book any losses any credit losses if the fair value is less Then the amortized cost then the expected the credit loss is recognized in that income Therefore the loss will be recognized in credit in net income However, we have to keep in mind the credit losses are limited So you cannot book between you cannot book more than the difference between the fair value and the amortized cost Don't worry. We'll see an example But if you're not write this down write it down So the credit losses are limited between the fair value and the amortized cost now the third category are trading securities and equity securities where gain and losses go through income statement, obviously Any credit losses goes through the income statement as well So impairment loss measure as the difference between the lower of amortized cost and fair value for dealing with that securities Lower of cost or fair value of dealing with equity security simply put you look at the cost or amortized cost for that You compare it at a fair value you book the difference in net income Now the best way to illustrate those concept is to actually look at an example with journal entries Before we look at the example I would like to remind you whether you are an accounting student or a CPA candidate to take a look at my website Farhat lectures calm. I don't replace your CPA review course. 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Let's take a look at the first example and this is going to be held to maturity Adam company holds held to maturity bond securities with a pair value Power value and amortized cost 1.5. So amortized costs 1.5 the fair value of these securities is 1.3 What does that mean? It means we think we can only collect 1.3 million of this amount Well, here we are using again the allowance method. Therefore once we know that that's it We're gonna have with that's it. We're gonna have to write down the investment. We debit the allowance 200,000 Credit the debt investment 200,000 simply put we wrote down the investment and we reduce the allowance Remember sometime in the past so sometime before this entry we had bad debt expense recorded Okay, so keep in mind that we had some amount of bad debt expense and some amount of allowance And now all we're doing is we're reducing the allowance and writing off the account So this is how we write down Impair the asset itself now debt investments available for sale again. We have different rules Let's review them real quick if the fair value greater than the amortized cost. No credit losses is recognized if Not if it's not means if fair value is less is less than the amortized cost Well, then we have we have a loss and the impairment loss is limited to the amount that the fair value is less than the amortized cost The best way to illustrate these concepts is to look at any an example So we're gonna be looking at three different independent situation a b and c and those are available for sale securities in Situation a we have amortized cost of two million fair value two million 120 Well, the first thing what we notice is fair value is greater than amortized cost Therefore, we have no impairment of value. We are told there's an expected credit losses. There's a good chance. We may not receive 120,000, that's fine. I mean if we don't receive that 120,000, we're gonna go back to our amortized cost but we are also told that there's an unrealized holding gain of 120,000 well if we have an unrealized holding game, we're gonna have to book the unrealized holding game we're gonna debit fair value adjustment of of 120,000 and we're gonna credit unrealized holding gain we have holding gain of 120,000 simply put we don't have any impairment in this example if anything we have a gain and we booked the gain for 120,000 which is great. Let's take a look at the second scenario scenario b We have amortized cost of two million fair value of one million nine hundred and sixty. Well, the difference is 40,000 remember the loss will be limited to that total loss Expected credit loss of 120 and expected credit loss recognized in that income is 40,000 Well, what does that mean? It means the the customer may not pay up to 120,000 for the two million Okay, that's fine But today right now we can sell the asset if we want to because this is available for sale securities We can sell it for one million nine hundred and sixty therefore our losses should be limited to one million nine hundred and sixty Therefore we debit bed that expense forty thousand credit allowance forty thousand for situation B Remember available for sale securities there available for sale It means we can sell them if we choose to we can sell them any time we would like to well Guess what if we know let's assume that's a real situation We know that the customer is not going to pay one hundred and twenty thousand But right now we can get out of the investment sell it for one million nine hundred and sixty We get out of it rather than losing one twenty one twenty We would just sell it for forty thousand less than the Amortized cost now. Why do we debit bed that expense credit allowance because This situation might reverse. Maybe this maybe the credit worthiness Might improve the economic situation might improve and we can reverse it where we call debit allowance credit by that expense, but the point is The only thing you will look is the forty thousand, okay? Now situation C Amortized cost two million fair value one million eight hundred and sixty now we have a total losses of One hundred and forty thousand and here's what we are told of this amount The credit losses portion is One hundred and twenty one hundred and twenty and this should be loss Credit losses one hundred and twenty so the expected credit loss recognized in that income is one hundred and twenty And this has to do with the credit loss credit loss means the customer is not going to pay that much Now here we have basically we have to break down because we have to book one hundred and forty We are limited to one hundred and forty, but we have to break it between two type of losses We have one hundred and twenty thousand due to credit losses. It means the customers will not going to pay Okay, this is one twenty just like the previous like just like in the previous scenario be the credit losses are forty thousand and We have a loss of twenty thousand We have a loss of twenty thousand that has to do with other than the credit loss economic condition general economic condition in Interest rate overall interest rate Industry conditions something has nothing to do with the credit loss of the borrower and lender therefore we debit unrealized holding loss of twenty thousand credit fair value adjustment twenty thousand simply put this entry here situation Situation see other than credit losses is the opposite of a and a we had a gain on this available for sale investment here We have an unrealized loss What should you do? You should go to farhatlectures.com and look at additional mcqs to learn more about this topic It's very important that you understand this work work examples Look at it additional resources. 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