2.3 Scope Exceptions

ASC 323-10

15-4 The guidance in this Topic does not apply to any of the following:

An investment accounted for in accordance with Subtopic 815-10
An investment in common stock held by a nonbusiness entity, such as an estate, trust, or individual
1. Subparagraph superseded by Accounting Standards Update No. 2012-04.
2. Subparagraph superseded by Accounting Standards Update No. 2012-04.
3. Subparagraph superseded by Accounting Standards Update No. 2012-04.
An investment in common stock within the scope of Topic 810
Except as discussed in paragraph 946-323-45-2, an investment held by an investment company within the scope of Topic 946.

ASC 323-30

15-4 This Subtopic does not provide guidance for investments in limited liability companies that are required to be accounted for as debt securities pursuant to paragraph 860-20-35-2.

One of the steps in the determination of whether an investment is subject to the equity method of accounting is an evaluation of whether the investment meets one of the scope exceptions to the requirements in ASC 323-10.

There are certain investments for which the equity method of accounting generally does not apply, even though an investor may have the ability to exercise significant influence over an investee. The determination of whether an investment is within the scope of ASC 323-10 may require judgment and should be based on an evaluation of all facts and circumstances.

2.3.1 Investments Accounted for in Accordance With ASC 815-10

An investment that is a derivative within the scope of ASC 815-10 is generally accounted for at fair value and, accordingly, is not within the scope of ASC 323-10.

2.3.2 Investments in Common Stock Held by a Nonbusiness Entity

If an investment is held by a nonbusiness entity, such as an estate, trust, or individual (even if that investment allows the investor to exercise significant influence over the investee), the nonbusiness entity is not required to use the equity method to account for an investment in common stock. Accounting for such investments at fair value in accordance with ASC 321 (unless the measurement alternative is elected)2 may better depict the financial position and changes in the financial position of nonbusiness entities, especially given the diverse nature of such entities. However, a nonbusiness entity is not precluded from applying the equity method of accounting if its investment permits it to exercise significant influence over the investee and does not constitute a controlling financial interest. The use of the equity method of accounting by a nonbusiness entity is a policy election, and if elected, should be applied consistently for similar investments. However, the equity method of accounting would generally be applied to investments held by a nonbusiness entity for long-term operating purposes (as opposed to a portfolio or similar investment).

2.3.2.1 Investments Held by Real Estate Investment Trusts

Real estate investment trusts (REITs) are typically formed as trusts, associations, or corporations and are considered business entities (rather than nonbusiness entities) because they have business activities in the form of income-producing real estate or real estate–related assets and are capitalized through the use of a combination of equity and borrowed capital. Since REITs are considered business entities, in the absence of another scope exception, their investments should be analyzed to determine whether the equity method of accounting under ASC 323-10 should be applied.

In some cases, a REIT, to retain its qualification as such, will establish a service corporation to perform services for the REIT or for third parties. As discussed above, such corporations are considered business entities and are within the scope of ASC 323-10. However, a REIT should consider the factors in ASC 974-323-25-1 and the facts and circumstances of each investment to determine whether it has the ability to exercise significant influence over a service organization and therefore should apply the equity method of accounting to its investment in the service corporation (see Section 3.4.1).

2.3.3 Investments in Common Stock Within the Scope of ASC 810

It would be inappropriate for an investor to use the equity method of accounting to account for an investment in common stock that represents a controlling financial interest. Such an investment should be consolidated in accordance with ASC 810-10. This topic is discussed in Deloitte’s Consolidation Roadmap.

However, ASC 323-10 may apply to majority-owned legal entities (1) that are not consolidated because of the exclusions of ASC 810-10-15-10, (2) if the minority shareholder or shareholders have certain approval or veto rights qualifying as substantive participating rights under ASC 810-10-25-1 through 25-14, or (3) if the majority shareholder is determined not to be the primary beneficiary of a VIE under ASC 810-10-25-38 through 25-41. In such instances, the equity method would apply if an investor exercises significant influence over the majority-owned subsidiary. In the rare circumstance in which an investor owning a majority of a subsidiary does not exercise significant influence over that subsidiary, the investment would be accounted for under ASC 321 at fair value (unless the measurement alternative is elected).3

2.3.4 Investments Held by Investment Companies Within the Scope of ASC 946

ASC 946-323

45-1 Except as discussed in the following paragraph, use of the equity method of accounting by an investment company is not appropriate. Rather, those noncontrolling ownership interests held by an investment company shall be measured in accordance with guidance in Subtopic 946-320, which requires investments in debt and equity securities to be subsequently measured at fair value.

45-2 An exception to the general principle in the preceding paragraph occurs if the investment company has an investment in an operating entity that provides services to the investment company, for example, an investment adviser or transfer agent (see paragraph 946-10-55-5). In those cases, the purpose of the investment is to provide services to the investment company rather than to realize a gain on the sale of the investment. If an investment company holds a noncontrolling ownership interest in such an operating entity that otherwise qualifies for use of the equity method of accounting, the investment company should use the equity method of accounting for that investment, rather than measuring the investment at fair value.

2.3.4.1 Investor Is an Investment Company

If an investor qualifies as an investment company under ASC 946,4 it is precluded from using the equity method to account for an investment in an investee, irrespective of whether the investee is an investment company. Investment companies account for their investments in operating companies (other than those providing services to the investment companies as described below) at fair value in accordance with the specialized accounting guidance in ASC 946, regardless of whether the investment companies have the ability to exercise significant influence over the investees. An investment company that has an investment in an entity that is providing services to the investment company, such as an investment adviser or a transfer agent, should apply the equity method of accounting if all other criteria are met.

2.3.4.2 Investor Is Not an Investment Company

An investor that has an interest in an investment company but is not itself an investment company under ASC 946 should apply the equity method of accounting if all other criteria are met.

2.3.5 Investments in Certain Securitization Entities

ASC 860-20

35-2 Financial assets, except for instruments that are within the scope of Subtopic 815-10, that can contractually be prepaid or otherwise settled in such a way that the holder would not recover substantially all of its recorded investment shall be subsequently measured like investments in debt securities classified as available for sale or trading under Topic 320. Examples of such financial assets include, but are not limited to, interest-only strips, other beneficial interests, loans, or other receivables. Interest-only strips and similar interests that meet the definition of securities are included in the scope of that Topic. Therefore, all relevant provisions of that Topic (including the disclosure requirements) shall be applied. See related implementation guidance beginning in paragraph 860-20-55-33.

Investments in certain securitization entities (whether in the form of an LLC, partnership, trust, or similar entity) that can be contractually settled in such a way that the investor may not recover substantially all of its recorded investment are outside the scope of the equity method of accounting and are instead accounted for as debt securities under ASC 320 (i.e., classified as available-for-sale (AFS) or trading securities) or as a derivative within the scope of ASC 815-10, if applicable.

Footnotes

See ASC 321-10-35-2.

See footnote 2.

See ASC 946-10-15-4 through 15-9.

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.