09 January 2012

Deloitte: Accounting for eurozone sovereign debt holdings

In the second quarter of 2011, a decline in the creditworthiness of some eurozone countries became increasingly evident, in particular that of Greece. On July 29 2011, Deloitte issued a Financial Reporting Alert that concluded that for entities reporting under IFRSs, (1) holdings in Greek government bonds (GGBs) and other loans issued by the Greek state maturing in 2020 or earlier were impaired as of June 30, 2011, and (2) it could not be assumed that post-2020 GGBs were not impaired as of June 30, 2011. Entities holding post-2020 GGBs would have to consider all relevant facts and circumstances. For entities applying US GAAP, the alert indicated that loans issued by the Greek state were impaired (other-than-temporarily impaired in the case of GGBs) as of June 30, 2011, irrespective of the maturity date. The alert also concluded that holdings of debt issued by other eurozone states were not impaired as of June 30, 2011, although it encouraged robust disclosures regarding holdings of both Greek and other eurozone sovereign debt holdings.

Since then, Greece’s economic situation has worsened and uncertainty about the creditworthiness of certain other eurozone states, such as Portugal, Ireland, Spain, and Italy, has persisted. In the face of Greece’s continuing economic distress, the European Union is again looking at restructuring Greece’s debt. In an October 26, 2011, Euro Summit Statement, Member States proposed “a voluntary bond exchange with a nominal discount of 50 per cent on notional Greek debt held by private investors”.

Deloitte's assessment of the application of US GAAP impairment indicators is that GGBs and other loans that are issued by the Greek state and held by entities applying US GAAP are impaired (other-than-temporarily impaired in the case of GGBs) as of December 31, 2011. The measurement of the impairment loss depends on the type of investment.

Deloitte's assessment is that GGBs and other loans issued by the Greek state and held by IFRS-applying entities are impaired as of December 31, 2011. Paragraph 59 of IAS 39 includes indicators of impairment, of which at least three are relevant in this instance (significant financial difficulty of the obligor, the lender’s granting a concession to the borrower, and the disappearance of an active market for the asset because of financial difficulties). If there is evidence of impairment, an entity must recognise an impairment loss in profit or loss in accordance with IAS 39. The measurement will depend on how the impaired asset is classified:

• AFS investments — The cumulative fair value loss at period-end is recognised in earnings. This applies to assets currently classified as AFS, as well as to assets reclassified from AFS in previous periods in which an amount continues to be recognised in other comprehensive income.

• Loans and receivables and held-to-maturity investments — The difference between the carrying value and the sum of the best estimate of the recoverable cash flows discounted by the effective interest rate will be recognised in earnings as an impairment loss.

Generally, loans to other eurozone Member States are not considered impaired as of December 31 2011, under both US GAAP and IFRSs. Under US GAAP (but not IFRSs), holdings of sovereign debt securities issued by such Member States are impaired if their fair value is less than their amortised cost basis. In determining whether such impairment should be recognised as an other-than-temporary impairment loss, an entity would assess whether it (1) has the intent to sell the debt security, or (2) more likely than not will be required to sell the debt security before its anticipated recovery. If an entity determines that it does not intend to sell an impaired debt security and that it is not more likely than not that it will be required to sell such a security before recovery of the security’s amortised cost basis, the entity must assess whether it expects to recover the entire amortised cost basis of the security (i.e. whether a “credit” loss exists as described in ASC 320-10-35-33D).

The alert also highlights sales of eurozone sovereign debt classified as held to maturity and transparent disclosures.

Full paper

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