Simplifying the Transition to the Equity Method of Accounting

Thoughtware Article Published: Mar 01, 2016
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On March 15, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-07, Investments—Equity Method and Joint Ventures (Topic 323); Simplifying the Transition to the Equity Method of Accounting. The narrowly scoped update simplifies accounting for all entities with investments that become qualified for the equity method of accounting resulting from an increase in the level of ownership interest or degree of influence.

Under the new standard, investor entities will add the cost of acquiring an additional equity interest to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment qualifies for equity method accounting. The update eliminates the requirement to retroactively adjust the investment, results of operations and retained earnings on a step-by-step basis as if the equity method had been in effect during all previous periods the investment was held.

When an available-for-sale security becomes eligible for the equity method, the update requires entities to recognize through earnings unrealized gains or losses previously recognized in accumulated other comprehensive income. Because the available-for-sale securities classification has been eliminated under ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, this provision only will apply until an entity adopts ASU 2016-01.

The changes came about because stakeholders believe the requirement to retroactively adopt the equity method adds cost and complexity to financial statement reporting without adding to the usefulness of the information provided to investors. FASB agreed and added the topic to its overarching “simplification initiative.”

The amendments are effective for all entities for fiscal years—and interim periods within those fiscal years—beginning after December 15, 2016, with early application permitted. Entities should prospectively apply the amendments to increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. The transition requires no additional disclosures.

Next Steps

The amendments in ASU 2016-07 were part of FASB’s June 5, 2015, larger proposal to simplify the equity method of accounting. Under the proposal, an investor entity would no longer be required to determine the fair value of an investee’s assets and liabilities, allocate basis differences and track subsequent adjustments to determine the investor’s share of the investee’s periodic equity method earnings. FASB received objections to its proposed approach for basis differences and directed its staff to perform more research before deciding how to move forward. For more information, refer to BKD’s article, “Proposal to Simplify Equity-Method Accounting.”

For additional information on FASB’s simplification Initiative, refer to BKD’s article, “FASB's 2015 Simplification Standards.” For additional information on ASU 2016-01, refer to BKD’s article, “New Measurement & Classification Guidance for Financial Instruments.”

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