Updates to Equity Investment Accounting
In 2016, FASB issued Accounting Standards Update (ASU) 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which added Topic 321, Investments—Equity Securities, and made targeted improvements to accounting for financial instruments. One of those improvements provided an entity with the ability to measure certain equity securities without a readily determinable fair value (RDFV) at cost, minus impairment, if any. If an entity identifies observable price changes in orderly transactions for the identical or a similar investment of the same issuer, it should measure the equity security at fair value as of the date that the observable transaction occurred (also known as the measurement alternative). Equity investments that do not result in the consolidation of an investee and are not accounted for under the equity method of accounting generally are accounted for under Topic 321.
Diverse views have emerged about the application of the measurement alternative and the equity method of accounting since the issuance of ASU 2016-01. ASU 2020-01, Clarifying the Interactions between Topic 321, Topic 323, and Topic 815, resolves two issues that are highlighted below. A third issue relating to the accounting for investee losses when an investor has other equity investments in the investee will require further research. FASB staff concluded this is not a pervasive issue for public entities and will solicit feedback from the Private Company Council on a path forward.
Application or Discontinuation of the Equity Method of Accounting
An entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting for the purposes of applying the measurement alternative in accordance with ASC 321 immediately before applying or upon discontinuing the equity method.
This clarification aligns with the accounting for equity securities with RDFVs, which—in practice—are remeasured immediately before applying and upon discontinuing the equity method.
Appropriate Guidance for Forward Contracts & Purchased Options
The scope of ASC 321 is very confusing. It includes rights to acquire an ownership interest at a fixed or determinable price, i.e., forward purchase contracts or call options, but excludes investments accounted for under the equity method (ASC 323) and derivative instruments (ASC 815). ASC 321 notes that certain forward contracts and purchased options that are not derivative instruments under ASC 815—but involve the acquisition of securities that will be accounted for under ASC 321—have specialized accounting spelled out in ASC 815-10, Certain Contracts on Debt and Equity Securities, which requires those contracts to be measured at fair value in a manner consistent with ASC 321 guidance.
ASC 815-10 has four specific criteria to be met for the specialized fair value accounting noted above to apply. ASU 2020-01 clarifies an entity should not consider the first criteria, “whether—upon the settlement of the forward contract or exercise of the purchased option, individually or with existing investments—the underlying securities would be accounted for under the equity method or the fair value option in accordance with Topic 825.” An entity would evaluate the remaining three characteristics in ASC 815-10 to determine the accounting for those forward contracts and purchased options.
This clarification aligns with existing guidance in ASC 323-10, which requires that “an investor’s voting stock interest … should be based on those currently outstanding securities whose holders have present voting privileges. Potential voting privileges that may become available to holders of securities of an investee should be disregarded.”
Entities would apply this guidance on a prospective basis. For a comprehensive review of ASU 2016-01 requirements, see BKD’s article “Ready for New Classification & Measurement Rules for Financial Instruments?” For additional information, contact your BKD Trusted Advisor™ or visit our website.