Appendix D — ASC 323-740 After the Adoption of ASU 2023-02

D.6 Subsequent Measurement

ASC 323-740

35-2 Under the proportional amortization method, the investor amortizes the initial cost of the investment in proportion to the income tax credits and other income tax benefits allocated to the investor. The amortization amount shall be calculated as follows:

The initial investment balance less any expected residual value of the investment, multiplied by
The percentage of actual income tax credits and other income tax benefits allocated to the investor in the current period divided by the total estimated income tax credits and other income tax benefits expected to be received by the investor over the life of the investment.

35-5 Any expected residual value of the investment shall be excluded from the proportional amortization calculation. Non-income-tax-related benefits received from operations of the limited liability entity shall be included in pre-tax earnings when realized or realizable. Gains or losses on the sale of the investment, if any, shall be included in pre-tax earnings at the time of sale.

35-6 An investment shall be tested for impairment when events or changes in circumstances indicate that it is more likely than not that the carrying amount of the investment will not be realized. An impairment loss shall be measured as the amount by which the carrying amount of an investment exceeds its fair value. A previously recognized impairment loss shall not be reversed.

D.6.1 The Proportional Amortization Calculation

In each period after the initial investment in a tax equity structure accounted for by using the proportional amortization method, the investor amortizes the initial cost of the investment, less any expected residual value, into the income tax benefit/expense line item in the investor’s income statement.

The ASC master glossary defines residual value as the “estimated fair value of an intangible asset at the end of its useful life to an entity, less any disposal costs.” While that definition includes a reference to an intangible asset, we believe that the definition is applicable to the proportionate amortization method. In the determination of the expected residual value of a tax equity investment, the exit call/put option price should generally be considered the expected residual value. When calculating proportional amortization each period, investors are not required to discount, and subsequently accrete, to the expected residual return.

The cost of the investment is amortized in proportion to the income tax credits and other income tax benefits expected to be received over the life of the underlying tax equity project. The calculation is as follows:

This includes (1) any unconditional and legally binding future contributions to be made and (2) the cost of any future contributions that are contingent on a future event that is determined to be probable. These deferred equity contributions should be discounted and recognized as part of the initial investment balance.

Example D-2

On January 1, 20X1, Company A makes a $200,000 tax equity investment2 in an LLC holding a wind project in exchange for a 5 percent limited partnership interest. Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to use the proportional amortization method to account for its tax equity investments in this tax credit program in accordance with ASC 323-740-25-4.
Company A has not applied the practical expedient.
PTCs will be received annually for a period of 10 years on the basis of the total kilowatt-hours of energy generated by the underlying wind project each year.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A will receive cash proceeds based on a fixed percentage of the project’s cash generated during the life of the project.
Company A’s statutory tax rate is 25 percent.
The estimated residual value of A’s investment is zero.
All cash flows (except the initial investment) occur at the end of each year.

See table below.

D.6.2 Additional Investments Made After Initial Measurement

After making the initial investment, an entity may make an additional investment that was not included in the initial cost (i.e., it was not contractually required, or a contingent commitment that was previously determined to not be probable became probable). If the investment continues to qualify for the proportional amortization method after the additional investment is made, the proportional amortization calculation should be adjusted to reflect the additional investment. In addition, the entity should adjust the calculation to reflect any additional income tax credits and other income tax benefits expected to be realized as a result of the additional investment. See Section D.6.3 for additional guidance on when an investor is required to reassess whether an investment continues to qualify for the proportional amortization method.

There are two different ways that investors can adjust proportional amortization calculations to reflect additional investments that are not included in the initial cost of the investment:

They can create a separate amortization schedule for the additional investment and recognize the amortization calculated in this separate schedule in addition to the amortization calculated on the original schedule. (The schedule should be similar to that in Example D-2.)
The original amortization schedule can be adjusted prospectively to reflect the additional investment amount, income tax credits, and other income tax benefits expected to be received.

Both methods described above would result in recognition of the same amortization in each period.

Example D-3

On January 1, 20X1, Company A makes a $200,000 tax equity investment3 in an LLC holding a wind project in exchange for a 5 percent limited partnership interest. On January 1, 20X3, A makes an additional $100,000 investment in the LLC holding the wind project in exchange for an additional 5 percent limited partnership interest that was not contemplated at the time of the initial investment.

Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to use the proportional amortization method to account for its tax equity investments in this tax credit program in accordance with ASC 323-740-25-4.
Company A has not applied the practical expedient.
The $100,000 additional investment made in 20X3 resulted in a corresponding increase to the tax basis of the investment.
PTCs will be received annually for a period of 10 years on the basis of the total kilowatt-hours of energy generated by the underlying wind project each year.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A will receive cash proceeds on the basis of a fixed percentage of the project’s cash generated during the life of the project.
Company A’s statutory tax rate is 25 percent.
The estimated residual value of A’s investment is zero.
All cash flows (except the initial investment) occur at the end of each year.

See table below.

D.6.3 Practical Expedient

ASC 323-740

35-4 As a practical expedient, an investor is permitted to amortize the initial cost of the investment in proportion to only the income tax credits allocated to the investor if the investor reasonably expects that doing so would produce a measurement that is substantially similar to the measurement that would result from applying the requirement in paragraph 323-740-35-2.

Under the proportional amortization method as described in ASC 323-740, an investor amortizes the initial cost of the investment in proportion to the income tax credits and other income tax benefits received. As a practical expedient, an investor applying the proportional amortization method may choose to amortize the initial cost of the investment in proportion to only the income tax credits allocated to the investor if the investor reasonably expects that doing so would produce a measurement that is substantially similar to the measurement that would result from applying the full proportional amortization method described in ASC 323-740-35-2 (as illustrated in Example D-2).

There is no bright line test for determining whether the practical expedient can be applied. Instead, an investor will need to use significant judgment to determine whether the practical expedient would produce a measurement that is substantially similar to that of the proportional amortization method. Factors to consider include, but are not limited to, the net effect on income tax expense each period and the period over which the predominant portion of the investment would be amortized.

Below are some examples of when the use of the practical expedient would produce a measurement that is or is not substantially similar to the measurement produced by the proportional amortization method.

Substantially Similar	Not Substantially Similar
Application of the practical expedient would cause 100 percent of the investment to be amortized into the income tax line item over a period of 10 years (see Example D-4), while application of the proportional amortization method would cause 86 percent of the investment to be amortized into the income tax line item over the same 10-year period (see Example D-2). Application of the practical expedient would result in a net impact to income tax expense of $500 a year for 10 years, while application of the proportional amortization method would result in a net impact on income tax expense of $450 a year for 10 years and $33 a year for an additional 15 years.	Application of the practical expedient would cause 100 percent of the investment to be amortized into the income tax line item over a period of 10 years (see Example D-4), while application of the proportional amortization method would cause 50 percent of the investment to be amortized into the income tax line item over the same 10-year period. Application of the practical expedient would result in a net impact to income tax expense of $500 a year for 10 years, while application of the proportional amortization method would result in a net impact to income tax expense of $2,000 a year for 10 years and $(1,000) a year for an additional 15 years.

Substantially Similar

Not Substantially Similar

Application of the practical expedient would cause 100 percent of the investment to be amortized into the income tax line item over a period of 10 years (see Example D-4), while application of the proportional amortization method would cause 86 percent of the investment to be amortized into the income tax line item over the same 10-year period (see Example D-2).
Application of the practical expedient would result in a net impact to income tax expense of $500 a year for 10 years, while application of the proportional amortization method would result in a net impact on income tax expense of $450 a year for 10 years and $33 a year for an additional 15 years.

Application of the practical expedient would cause 100 percent of the investment to be amortized into the income tax line item over a period of 10 years (see Example D-4), while application of the proportional amortization method would cause 50 percent of the investment to be amortized into the income tax line item over the same 10-year period.
Application of the practical expedient would result in a net impact to income tax expense of $500 a year for 10 years, while application of the proportional amortization method would result in a net impact to income tax expense of $2,000 a year for 10 years and $(1,000) a year for an additional 15 years.

Below are examples of the application of the practical expedient.

Example D-4

On January 1, 20X1, Company A makes a $200,000 tax equity investment4 in an LLC holding a wind project in exchange for a 5 percent limited partnership interest. Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to use the proportional amortization method to account for its tax equity investments in this tax credit program in accordance with ASC 323-740-25-4.
Company A qualifies for, and elects to use, the practical expedient.
PTCs will be received annually for a period of 10 years on the basis of the total kilowatt-hours of energy generated by the underlying wind project each year.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A will receive cash proceeds on the basis of a fixed percentage of the project’s cash generated during the life of the project.
Company A’s statutory tax rate is 25 percent.
The estimated residual value of A’s investment is zero.
All cash flows (except the initial investment) occur at the end of each year.

See table below.

Example D-5

On January 1, 20X1, Company A makes a $200,000 tax equity investment5 in an LLC holding a wind project in exchange for a 5 percent limited partnership interest. On January 1, 20X3, A makes an additional $100,000 investment in the LLC holding the wind project in exchange for an additional 5 percent limited partnership interest that was not contemplated at the time of the initial investment.

Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to use the proportional amortization method to account for its tax equity investments in this tax credit program in accordance with ASC 323-740-25-4.
Company A qualifies for, and elects to use, the practical expedient.
The $100,000 additional investment made in 20X3 resulted in a corresponding increase to the tax basis of the investment.
PTCs will be received annually for a period of 10 years on the basis of the total kilowatt-hours of energy generated by the underlying wind project each year.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A will receive cash proceeds on the basis of a fixed percentage of the project’s cash generated during the life of the project.
Company A’s statutory tax rate is 25 percent.
The estimated residual value of A’s investment is zero.
All cash flows (except the initial investment) occur at the end of each year.

See table below.

D.6.4 Reassessment

ASC 323-740

25-1C At the time of the initial investment, a reporting entity shall evaluate whether the conditions in paragraphs 323-740-25-1 through 25-1B have been met to elect to apply the proportional amortization method on the basis of facts and circumstances that exist at that time. A reporting entity shall subsequently reevaluate the conditions upon the occurrence of either of the following:

A change in the nature of the investment (for example, if the investment is no longer in a flow-through entity for tax purposes)
A change in the relationship with the underlying project that could result in the reporting entity no longer meeting the conditions in paragraphs 323-740-25-1 through 25-1B.

D.6.4.1 Changes in Circumstances After Initial Measurement

Under ASC 323-740-25-1C, an entity is required to reassess the applicability of the proportional amortization method when there is either a “change in the nature of the investment” or a “change in the relationship with the underlying [tax equity] project that could result in the [investment] no longer meeting” the scope requirements for the application of ASC 323-740. Changes that would trigger the need for reassessment include, but are not limited to, (1) the investee is no longer a pass-through entity for tax purposes, (2) the investee no longer generates income tax credits, or (3) an additional investment is made that was not contractually required or a contingent commitment that was previously determined to not be probable became probable.

However, there is an exception to this third trigger. Investments in wind projects are commonly structured so that the initial investment amount includes the majority (but not all) of the total investment expected to be received. Each year after the initial investment, each investor is required to make a small additional investment (a “pay-go” payment), which is calculated on the basis of the actual amount of PTCs generated by the wind project. Because these pay-go amounts are calculated on the basis of PTCs generated, they could be viewed as contingent and not probable as of the date of the initial investment. We believe that these regular pay-go payments would not constitute a change in the nature of the investment or a change in the relationship with the underlying project and, therefore, do not trigger the need for reassessment of the applicability of the proportional amortization method.

D.6.4.2 Changes in Laws or Rates

Questions have arisen regarding whether an entity needs to reevaluate whether a tax equity project yields an overall benefit (the criterion in ASC 323-740-25-1(b)) when a change in tax law is enacted. To determine whether a change in tax law represents a change in the nature of the investment or in the relationship with the investee, either of which would require reassessment of the applicability of ASC 323-740, investors should evaluate the specific impact of the change in tax law. Such an assessment requires significant professional judgment.

Although a change in tax rate may affect whether the criteria in ASC 323-740-25-1 are met after the initial investment, we do not believe that a change in tax rate represents either a change in the nature of the investment or a change in the relationship with the investee as those terms are contemplated in ASC 323-740-25-1C. Therefore, an entity is not required to reassess whether it is still appropriate to apply the proportional amortization method solely because of the change in tax rates.

We believe that, alternatively, if the change in the tax law has a broader impact that affects more than just the tax rate, an entity should assess the nature of the change to determine whether it represents either a change in the nature of the investment or a change in the relationship with the investee. Examples of changes in tax laws that would generally trigger the need to reassess the applicability of the proportional amortization method include:

Changing a credit from nontransferable or nonrefundable to transferrable or refundable.
Changing how a credit is generated (e.g., a change in the criteria that need to be met for a tax equity project to generate credits).
Changing the rate at which the credits are generated (e.g., a change in the LIHTC rate from 9 percent each period to 5 percent each period).

If the total expected tax benefit changes because of a change in tax rates and the investment continues to be accounted for under the proportional amortization method, an investor must revise the amortization of the investment to ensure that cumulative amortization over the life of the investment equals the initial carrying amount (less any residual value). If the change in total expected income tax benefits is the result of a change in tax rates and the investor has not elected to use the practical expedient, the proportion of benefits already allocated to the investor will increase in relation to the total expected income tax credits and other income tax benefits. As a result, we believe that there are two acceptable approaches for adjusting amortization.

Under the first approach, the investor would record a cumulative catch-up adjustment to the carrying amount of the investment on the basis of the amount of income tax credits and other income tax benefits that have been allocated to the investor in proportion to the revised amount of total expected income tax benefits. This approach is consistent with the guidance in ASC 323-740, which requires that the initial cost of the investment be amortized in proportion to the income tax credits and other income tax benefits that have been allocated to the investor.

Under the second approach, the investor would adjust amortization prospectively. This treatment is consistent with accounting for a change in estimate that does not affect the carrying amount of an asset or liability but alters the subsequent accounting for existing or future assets or liabilities under ASC 250. See Example D-6 for an illustration of the prospective adjustment to the proportional amortization calculation in response to a change in tax rate.

In selecting an approach to adjust amortization, an investor should consider whether it has, in effect, made a policy election in prior periods when adjusting amortization to take into account changes in expected income tax benefits that are due to factors other than changes in tax rates. If so, using a different approach to account for the change in tax rate would be a change in accounting principle that would need to be assessed for preferability.

If a significant portion of an investor’s yield is tied to income tax benefits, as is expected with tax equity investments, the investor may need to test its investment for impairment when there is a change in estimate or a change in tax law. More specifically, to evaluate whether it is more likely than not that the carrying amount of the tax equity investment will not be realized, the investor would need to compare (1) the carrying amount of the investment, after any cumulative catch-up is considered, with (2) the undiscounted amount of the remaining expected income tax credits and other income tax benefits.

D.6.4.3 Changes in Estimates After Initial Recognition

ASC 250-10-20 defines a change in accounting estimate, in part, as “[a] change that has the effect of adjusting the carrying amount of an existing asset or liability or altering the subsequent accounting for existing or future assets or liabilities.” Changes in accounting estimates occur when new information is obtained.

The accounting for a change in estimate is based on the cause of the change. Generally, changes in the amount or timing of anticipated income tax benefits to be generated by a tax equity investment, or the residual value of a tax equity investment, are accounted for prospectively and typically would not be considered a change in circumstances that would trigger the need to reassess the applicability of the proportional amortization method. Investors should carefully consider whether adjustments made to the proportional amortization calculation are the result of a change in estimate or the correction of an error.

D.6.5 Impairment Considerations

Investors are required to assess their investment for impairment if the occurrence of an event or a change in circumstances indicates that it is more likely than not that the carrying amount of the investment will not be realized. ASC 323-740-35-6 states, in part, that an “impairment loss shall be measured as the amount by which the carrying amount of an investment exceeds its fair value.”

Events or changes in circumstances that may indicate that a tax equity investment is impaired include, but are not limited to, (1) changes in income tax rates, (2) material changes in the residual value, and (3) changes in the income tax credits and other income tax benefits to be generated by the investment. See Section D.6.4 for additional guidance on the potential need to reassess whether a tax equity investment qualifies for ASC 323-740 when these changes occur.

We believe that, in a manner consistent with the requirements of ASC 360 for long-lived assets, an investor should use undiscounted amounts when determining whether an impairment of a tax equity investment is necessary. However, on the basis of the guidance in ASC 323-740-35-6, we believe that impairment should be calculated by using discounted amounts since that is what would be required in a fair value measurement of the investment.

D.6.5.1 Presentation of Impairment Expense

ASC 323-740 does not specify where in the income statement an impairment charge related to a tax equity investment should be recorded. Under the proportional amortization method, the amortization of the cost of the investment is netted against the income tax benefits received within the income tax expense line. An impairment is a recognition of the fact that the unamortized cost of acquiring the benefits exceeds the remaining expected benefits, but it does not change the nature of the initial investment as an investment in income tax credits and other income tax benefits. Accordingly, we believe that the impairment of an investment accounted for by using the proportional amortization method would be recorded as a component of income tax expense.

Since tax equity investments are usually recovered through income tax credits and other income tax benefits, the impairment assessment of such investments often focuses on these benefits. However, secondary markets for such investments exist and, therefore, recovery may occur through sale. When developing the guidance in ASU 2023-02, the EITF was cognizant of the various methods of recovery and referred to “fair value” in the guidance.

The example below illustrates a possible impairment assessment, including the undiscounted cash flow assessment, for a tax equity investment accounted for in accordance with ASC 323-740.

Example D-6
On January 1, 20X1, Company A makes a $200,000 tax equity investment6 in an LLC holding a wind project in exchange for a 5 percent limited partnership interest. Further assume that: Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to use the proportional amortization method to account for its tax equity investments in this tax credit program in accordance with ASC 323-740-25-4. Company A has not applied the practical expedient. PTCs will be received annually for a period of 10 years on the basis of the total kilowatt-hours of energy generated by the underlying wind project each year. Book and tax depreciation are determined by using a straight-line method over 25 years. Company A’s initial statutory tax rate is 25 percent. On January 1, 20X4, a new tax law was passed that reduced A’s statutory tax rate to 12 percent. The estimated residual value of A’s investment is zero. All cash flows (except the initial investment) occur at the end of each year. See table below. Because of the new tax law enacted in 20X4 that decreased A’s statutory tax rate from 25 percent to 12 percent, the total benefits expected to be generated by the tax equity investee decreased. As a result, on January 1, 20X4 (the date the new tax law was enacted), the total undiscounted cash flows (i.e., the sum of anticipated income tax credits, other income tax benefits, plus non-income tax benefits) was less than the investment balance. Accordingly, A recorded an impairment of $8,505, which was the difference between the investment balance on January 1, 20X4, and the expected future benefits after adjusting for the change in tax rates. Note that as discussed in Section D.6.4.2, there are two acceptable approaches for adjusting the amortization calculation in response to a change in tax rates. This example illustrates the prospective adjustment approach.

Example D-6

On January 1, 20X1, Company A makes a $200,000 tax equity investment6 in an LLC holding a wind project in exchange for a 5 percent limited partnership interest. Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to use the proportional amortization method to account for its tax equity investments in this tax credit program in accordance with ASC 323-740-25-4.
Company A has not applied the practical expedient.
PTCs will be received annually for a period of 10 years on the basis of the total kilowatt-hours of energy generated by the underlying wind project each year.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A’s initial statutory tax rate is 25 percent.
On January 1, 20X4, a new tax law was passed that reduced A’s statutory tax rate to 12 percent.
The estimated residual value of A’s investment is zero.
All cash flows (except the initial investment) occur at the end of each year.

See table below.

Because of the new tax law enacted in 20X4 that decreased A’s statutory tax rate from 25 percent to 12 percent, the total benefits expected to be generated by the tax equity investee decreased. As a result, on January 1, 20X4 (the date the new tax law was enacted), the total undiscounted cash flows (i.e., the sum of anticipated income tax credits, other income tax benefits, plus non-income tax benefits) was less than the investment balance. Accordingly, A recorded an impairment of $8,505, which was the difference between the investment balance on January 1, 20X4, and the expected future benefits after adjusting for the change in tax rates.

Note that as discussed in Section D.6.4.2, there are two acceptable approaches for adjusting the amortization calculation in response to a change in tax rates. This example illustrates the prospective adjustment approach.

Footnotes

For simplicity, assume that the investment balance does not reflect any deferred equity contributions.

See footnote 2.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.