Chapter 1 — Overview | DART – Deloitte Accounting Research Tool

...

ASC 323-10

05-4 Investments held in stock of entities other than subsidiaries, namely corporate joint ventures and other noncontrolled entities usually are accounted for in accordance with either the recognition and measurement guidance in Subtopic 321-10 or the equity method. This Subtopic provides guidance on application of the equity method. The equity method is an appropriate means of recognizing increases or decreases measured by generally accepted accounting principles (GAAP) in the economic resources underlying the investments. Furthermore, the equity method of accounting closely meets the objectives of accrual accounting because the investor recognizes its share of the earnings and losses of the investee in the periods in which they are reflected in the accounts of the investee. The equity method also best enables investors in corporate joint ventures to reflect the underlying nature of their investment in those ventures.

05-5 The equity method tends to be most appropriate if an investment enables the investor to influence the operating or financial decisions of the investee. The investor then has a degree of responsibility for the return on its investment, and it is appropriate to include in the results of operations of the investor its share of the earnings or losses of the investee. Influence tends to be more effective as the investor’s percent of ownership in the voting stock of the investee increases. Investments of relatively small percentages of voting stock of an investee tend to be passive in nature and enable the investor to have little or no influence on the operations of the investee.

05-6 In addition to the joint venture guidance included in this Topic, the accounting and reporting for real estate joint ventures is addressed in Subtopic 970-323.

When determining the appropriate accounting for its ownership interest in an investee,1 the investor2 must consider the form and substance of the investment as well as the legal form of the investee. If the investor does not control the investee and is not required to consolidate it (see Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest (the “Consolidation Roadmap”) for further information regarding considerations related to whether consolidation is required), the investor determines whether it should account for such an investment under the equity method of accounting. If the investment does not meet the criteria for the use of the equity method of accounting, it should be recorded at fair value in accordance with ASC 321 unless the measurement alternative is elected3 or in accordance with ASC 320 in instances in which the investment represents a debt security.

Generally, the equity method of accounting should be applied when the investor has the ability to exercise significant influence over the operating and financial decisions of the investee. The ability to exercise significant influence over the investee is mainly driven by the investor’s ownership interest in the investee (see Section 3.2); however, to have significant influence, the investor must have an investment in common stock or in-substance common stock4 (see Section 2.5). There are also other factors that may indicate that the investor has the ability to exercise significant influence, such as board representation, participation in policy-making processes, veto rights, material intra-entity transactions, interchange of managerial personnel, technological dependency, and others (see Section 3.3). Therefore, when determining whether it has an ability to exercise significant influence over the investee, the investor must consider all relationships and interests (voting and nonvoting) that involve the investee.

In addition, the legal form of an investee is important in the determination of whether the equity method of accounting is appropriate. Although ASC 323-10 provides guidance on investments in the common stock of corporations (including corporate joint ventures), many of the provisions in ASC 323-10 also apply to investments in noncorporate entities, such as partnerships, limited liability companies (LLCs), and unincorporated joint ventures (see Section 2.2). For example, investments in partnerships and certain LLCs that maintain specific ownership accounts for each investor have unique rules that can result in an investor’s application of the equity method of accounting with as little as 3 percent to 5 percent of the ownership interest in the investee, as further discussed in Chapter 2.

The decision tree below illustrates the relevant questions to be considered in the determination of whether the investment should be accounted for under the equity method of accounting.

The presentation of equity method investments is often referred to as a “one-line consolidation.” The equity method investment is initially recorded at cost; however, the investor must account for the differences between the cost of an investment and the underlying equity in the net assets of the investee (i.e., basis differences) as if the investee was a consolidated subsidiary (see Chapter 4). Subsequently, the carrying amount of the equity method investment is adjusted to recognize the investor’s proportionate share of the investee’s earnings or losses or changes in capital (see Chapter 5), generally in the periods in which they are reflected in the accounts of the investee.

ASC 323-10 also outlines additional disclosure requirements that must be considered (see Chapter 6).

ASC 323-740 includes guidance on the application of the proportionate amortization method, which can be applied to tax equity investments meeting certain criteria (see Appendix C and Appendix D).

Some investors are affected by both U.S. GAAP and IFRS® Accounting Standards. Significant differences between the guidance in ASC 323-10 and the equivalent guidance under IFRS Accounting Standards are discussed in Appendix B.

Appendix A of this Roadmap includes defined terms from the glossaries of ASC 323-10, ASC 970-323, and ASC 974-323.

Connecting the Dots

Throughout this Roadmap, “joint ventures” refers to “corporate joint ventures,” as defined by ASC 323-10-20. The investors (i.e., venturers) in a joint venture typically apply the equity method of accounting to their investment. Although the provisions for the equity method are usually the same for joint ventures as for any other legal entity, there are some unique accounting considerations for the venturers and the joint venture itself. We address the distinctive characteristics of joint ventures in Chapter 7 and the related accounting by the joint venture and the venturers in Chapters 8, 9, and 10, respectively.

The table below summarizes some of the possible outcomes illustrated in the above decision tree.

Consolidation (ASC 810)	Equity Method5 (ASC 323)	Fair Value (ASC 321)
Applies to financial interests that provide the holder with a controlling financial interest in the investee. Requires consolidation of the investee. See Deloitte’s Consolidation Roadmap.	Applies to investments in common stock or in-substance common stock of an investee in which: The investee is a corporation. The investor does not have a controlling financial interest in the investee. The investor has significant influence over the investee. The investor does not elect the fair value option for its investment.	Applies to investments in equity securities that do not give the investor a controlling financial interest in the investee or significant influence over the investee. Changes in fair value are recognized through earnings.

Footnotes

Throughout this Roadmap, “investee” refers to the entity that issued the equity instrument that is being analyzed for potential accounting under the equity method of accounting.

Throughout this Roadmap, “investor” refers to the party applying or determining whether it should apply the equity method of accounting to its investment.

Under ASC 321, entities may elect a practicability exception to fair value measurement if (1) they do not qualify for the practical expedient in ASC 820-10-35-59 and (2) the equity security does not have a readily determinable fair value. Specifically, ASC 321-10-35-2 states, in part, that an entity may “measure an equity security without a readily determinable fair value that does not qualify for the practical expedient to estimate fair value in accordance with paragraph 820-10-35-59 at its 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 shall measure the equity security at fair value as of the date that the observable transaction occurred.”

Unless stated otherwise, throughout this Roadmap, references to common stock include in-substance common stock.

An investment in a partnership or LLC that maintains specific ownership accounts may also be subject to the equity method of accounting. Generally, ownership of greater than 3 percent to 5 percent in a limited partnership triggers equity method accounting.

Confidential and Proprietary — for Use Solely by Authorized Personnel

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.