2.1 Overview

This chapter discusses considerations related to scope — that is, which investments should and should not be accounted for under the equity method of accounting.

ASC 323-10 may apply to any entity that has an investment in the common stock and in-substance common stock of an investee. As defined in ASC 323-10-20, common stock (or common shares) is “[a] stock that is subordinate to all other stock of the issuer.” Holders of common stock generally have the right to elect members of the board of directors and to vote on corporate policy, both of which allow those shareholders to influence the operating and financial policies of an investee. Because common stock represents the residual value of an investee, in the event of liquidation, common shareholders have rights to a company’s assets only after all other senior claims (e.g., those of bondholders, preferred shareholders, and other debt holders) are paid in full. In-substance common stock represents an instrument that, although not in the legal form of common stock, has characteristics that are substantively similar to those of common stock.

Before an investor applies ASC 323-10 to an investment in an investee, it should evaluate whether any scope exceptions apply (see Section 2.3) and, if not, whether it has the ability to exercise significant influence over the operating and financial policies of that investee (see Chapter 3). The equity method of accounting applies only when the investor has an investment in common stock or in-substance common stock and, accordingly, should not be used when an investment in common stock (or in-substance common stock) does not exist, even if the investor holds other investments that allow it to exercise significant influence over the investee. However, if the investor holds both common stock (or in-substance common stock) and other investments, it should consider the rights provided by all such instruments in evaluating whether, in combination, they permit the investor to exercise significant influence over the investee.

Many of the provisions in ASC 323-10 apply to investments in the common stock of corporations (including corporate joint ventures), as well as to investments in noncorporate entities, such as partnerships, LLCs, unincorporated joint ventures (see Section 2.2), and any other form of legal entity.

Corporate and unincorporated joint ventures (collectively, “joint ventures”) are a common form of business enterprise. Although an investor in a joint venture will generally account for its investment in a joint venture the same way it would for any other equity method investment under ASC 323-10, there are some nuances, which are discussed in Chapter 10.