Question

Hawkins Incorporated (“the Company”), incorporated in Tennessee, is principally engaged in the manufacture and sale of clothing. The Company has three lines of business: (1) outerwear, (2) t-shirts, and (3) tank tops. Hawkins was extremely successful in its early years when it partnered with colleges and universities to create outerwear, t-shirts, and tank tops for athletes, students, and alumni. This partnership also enabled Hawkins to hire a group of college graduates with a proven track record and a passion for investing in the stock market. Together, Hawkins and these graduates created a new investment department in 2017. Hawkins management set aside a portion of the previous years’ profits for the investment department to invest in equity and debt securities for the Company. Hawkins has three investments remaining in the department’s portfolio as of December 31, 2017. Hawkins classified all equity and debt securities as either available for sale or held to maturity under the Company’s investment policy.

The accounting department is preparing financial statements for the fiscal year ended December 31, 2017, and the auditors have asked Hawkins whether any of its investments are other-than-temporarily impaired. The CFO of Hawkins needs to present the investment department’s financial results at the next operating committee meeting so the committee can decide whether to continue the investment program and if so, determine the amount of funds that should be allocated. In looking at the accounting records provided by the accounting department, the CFO is beginning to question the investment department’s expertise because all investments have declined in value relative to each investment’s original purchase price.

The accounting manager compiled the following information about each of the investments in order to determine whether the investment is other-than-temporarily impaired as of December 31, 2017. Each investment is classified as long term in the December 31, 2017 balance sheet.

Hawkins purchased 50 shares of Willis Co. common stock on April 5, 2017, at $100 a share and classified its investment as available for sale. In July, the share price dropped to $75, and from August through November, the price fluctuated between $70 and $80 per share. On December 31, 2017, the price was $82. On February 18, 2018, the date Hawkins’ financial statements are issued, the price of the stock was $87.

On February 11, 2017, Hawkins purchased bonds issued by Mulder Co. As of December 31, 2017, the amortized cost of the bonds is $1,500 and the fair value is $30. Mulder Co. is going through a restructuring because it was significantly affected by a hurricane in August. Hawkins does not believe the restructuring will ultimately be successful.

Hawkins owns a debt security issued by Briscoe Incorporated with an amortized cost of $800 and a fair value of $720 at December 31, 2017.

The present value of the cash flows Hawkins expects to receive, taking into consideration the credit quality of Briscoe, discounted at the security’s original effective interest rate is $740 at December 31, 2017. Hawkins intends to sell this security prior to maturity.

Required:

1.    Assuming Hawkins has determined its investment in Willis Co. stock is other-than-temporarily impaired, how much should be recorded as an impairment charge as of December 31, 2017?

2.    Assuming the same facts as in (1), but Hawkins has not yet determined whether an impairment exists or the amount of any possible impairment. For Willis Co. stock, would Hawkins still conclude that the investment is other-than-temporarily impaired, and would the impairment charge as of December 31, 2017, be different if the stock price at issuance of the financial statements (February 18, 2018) was $95 instead of $87.

3.    For the Mulder Co. bonds, should Hawkins record an other-than-temporary impairment at December 31, 2017? Why or Why not?

4.    For the Briscoe debt security, what amount, if any, should be recorded as the other-than-temporary impairment at December 31, 2017? Does the answer change if Hawkins does not intend to sell the security and it is more likely than not that it will not be required to sell the security?

Be sure to provide authoritative support for the positions taken on these investments.

Answer 1

An entity shall assess at the end of each reporting period whether there is any objective evidence that a financial asset or group of financial assets is impaired. If any such evidence exists, the entity shall determine the amount of any impairment loss.

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.

1

Wills Co. Stock

Since it is to be assumed that investment in Wills Co. stock is 'Other than temporarily impaired', impairment loss of Rs. $ 18 (being excess of purchase price of stock over its market value as on 31st December, 2017) shall be recorded in profit & loss.

Since in our case there is a prolonged decline in value of Wills Co. stock , the investment in Wills Co. stock shall be treated as 'Other than temporarily impaired'.

Further, the stock price at the date of issuance of financial statement of $ 95 indicates further increase in stock price and hence no impairment loss is to be booked in this case.

2

Mulder Co. Bonds

Significant financial difficulty of the issuer or obligor indicates that there is objective evidence that a financial asset is impaired.

Since in our case there is decline in market value of Mulder Co. Bonds ($30) below its amortised cost ($1500) and further the fact that Mulder Co. is going through a restructuring as it was significantly affected by a hurricane in August & Hawkins does not believe the restructuring will ultimately be successful, it can be said that there is objective evidence that asset is impaired and hence can be concluded that the investment in Mulder Co. Bonds are 'Other than temporarily impaired'.

3

Briscoe debt security

Scenario 1 - Hawkins intends to sell this security prior to maturity

In case of Debt Secutities that are intended to be sold before maturity, impairment loss is recognized as difference between its amortised cost and its fair value as on date of balance sheet. In the above mentioned scenario, imparment loss of $ 80 (being difference between its amortised cost of $800 and fair value of $720)

Scenario 2 - Hawkins intends does not intend to sell the security and it is more likely than not that it will not be required to sell the security

In case of Debt Secutities that are not intended to be sold before maturity or it is more likely than not that it will not be required to sold the security, impairment loss is recognized as the difference between the asset’s carrying amount and the present value of estimated future cash flows(excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective interest rate (ie the effective interest rate computed at initial recognition). In the above mentioned scenario, imparment loss of $ 60 (being difference between its amortised cost of $800 and present value of the cash flows discounted at the security’s original effective interest rate of $740)