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.
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.