SFAS no. 124, accounting for investments: the rules have changed - Financial Accounting Standards Board's new Statement of Financial Accounting Standard

Healthcare Financial Management, Dec, 1996 by Randall W. Luecke, David T. Meeting, Edward J. Giniat

Under SFAS No. 124 "Accounting for Certain Investments Held by Not-for-Profit Organizations," issued in November 1995, not-for-profit healthcare organizations must report investments in equity securities that have readily determinable market values and all debt securities at fair value.

SFAS No. 124 significantly modifies the way healthcare organizations account for such investments and brings greater accountability to healthcare financial managers regarding the management of their organizations' investments.

FASB has issued a new Statement of Financial Accounting Standard, (SFAS) No. 124, intended to provide nongovernmental, not-for-profit organizations guidance in accounting for certain investments in securities. SFAS No. 124 "Accounting for Certain Investments Held by Not-for-Profit Organizations" is effective for fiscal years beginning after December 15, 1995.

Scope of the Standard

SFAS No. 124 applies to equity securities (except for investments in equity securities that are accounted for under the equity method or for investments in consolidated subsidiaries) that have readily determinable fair values and to all investments in debt securities. The fair value of an equity security is readily determinable if one of the following three criteria is met:

* Sales prices or bid-and-asked quotations for the security are currently available on a securities exchange registered with the Securities and Exchange Commission (SEC) or in the over-the-counter market, provided that these prices or quotations for the over-the-counter market are publicly reported by NASDAQ or by the National Quotation Bureau. Restricted stock does not meet that definition;

* If an equity security is traded only in a foreign market, the foreign market is of a breadth and scope comparable to one of the U.S. markets referred to above; or

* For an investment in a mutual fund, the fair value per share (unit) is determined and published and is the basis for current transactions.

FASB defined the fair value of an asset as the price at which the asset could be bought or sold between willing parties in a current transaction. Market prices in active markets are the best indicators of fair value. Quoted market prices are not always available for debt securities. A reasonable estimate of fair value must be made for all debt securities that do not trade regularly, and should be based on the best data available. Some methods for estimating fair value of debt securities include the following:

* Market prices of similar debt securities;

* Present value of estimated future cash flows;

* Option-pricing models;

* Matrix pricing;

* Option-adjusted spread models; and

* Fundamental analysis.

In addition to Statement No. 124, other authoritative accounting pronouncements that apply to investments held by nongovernmental, not-for-profit healthcare organizations, include SFAS No. 105, "Disclosure of Information about Financial Instruments with Off-Balance-Sheet Risk and Financial Instruments with Concentrations of Credit Risk"; SFAS No. 107, "Disclosures' about Fair Value of Financial Instruments"; and SFAS No. 119, "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments."

Not-for-profit healthcare organizations cannot apply SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Investor-owned healthcare entities should comply with SFAS No. 115 instead of SFAS No. 124. Governmental healthcare entities that apply paragraph 7 of GASB Statement No. 20, 'Accounting and Financial Reporting for Proprietary Funds and Other Governmental Entities That Use Proprietary Fund Accounting" should follow the requirements of SFAS No. 115.

Differences between SFAS No. 124 and No. 115

Although SFAS No. 115 does not apply to not-for-profit organizations, understanding the differences between SFAS No. 124 and No. 115 can help healthcare financial managers better comply with SFAS No. 124. Both statements require that marketable equity securities other than those accounted for under the equity method or consolidated subsidiaries and all investments of debt securities be recorded in financial statements at fair value. The equity method is used for corporate joint ventures and for other investments in which the investor has the ability to exercise significant influence over operating and financial policies. With a 20 percent or more ownership of common stock, it is assumed that significant influence exists unless there is evidence to the contrary. The definition of marketable securities is the same in both standards, and the determination of fair value is similar as well.

SFAS 124 describes one category of investments, while SFAS No. 115 describes three categories of investments. Under SFAS No. 115, securities are classified as "held-to-maturity," "trading," or "available-for-sale," with the accounting being different for each category.

Held-to-maturity securities are debt securities that an organization intends to and has the ability to hold to maturity. They are accounted for and reported at amortized cost, with amortization of discount and premiums included in investment income. A debt security should not be classified as held-to-maturity if the organization intends to hold the security only for an indefinite period or if the organization would sell the security if: