5.2 Equity Method Losses That Exceed the Investor’s Equity Method Investment Carrying Amount

ASC 323-10

35-19 An investor’s share of losses of an investee may equal or exceed the carrying amount of an investment accounted for by the equity method plus advances made by the investor. An equity method investor shall continue to report losses up to the investor’s investment carrying amount, including any additional financial support made or committed to by the investor. Additional financial support made or committed to by the investor may take the form of any of the following:

Capital contributions to the investee
Investments in additional common stock of the investee
Investments in preferred stock of the investee
Loans to the investee
Investments in debt securities (including mandatorily redeemable preferred stock) of the investee
Advances to the investee.

See paragraphs 323-10-35-24 and 323-10-35-28 for additional guidance if the investor has other investments in the investee.

35-20 The investor ordinarily shall discontinue applying the equity method if the investment (and net advances) is reduced to zero and shall not provide for additional losses unless the investor has guaranteed obligations of the investee or is otherwise committed to provide further financial support for the investee.

35-21 An investor shall, however, provide for additional losses if the imminent return to profitable operations by an investee appears to be assured. For example, a material, nonrecurring loss of an isolated nature may reduce an investment below zero even though the underlying profitable operating pattern of an investee is unimpaired.

35-22 If the investee subsequently reports net income, the investor shall resume applying the equity method only after its share of that net income equals the share of net losses not recognized during the period the equity method was suspended.

ASC 970-323

35-3 An investor that is liable for the obligations of the venture or is otherwise committed to provide additional financial support to the venture shall record its equity in real estate venture losses in excess of its investment, including loans and advances.

35-4 The following are examples of such circumstances:

The investor has a legal obligation as a guarantor or general partner.
The investor has indicated a commitment, based on considerations such as business reputation, intra-entity relationships, or credit standing, to provide additional financial support. Such a commitment might be indicated by previous support provided by the investor or statements by the investor to other investors or third parties of the investor’s intention to provide support.

35-5 An investor, though not liable or otherwise committed to provide additional financial support, shall provide for losses in excess of investment when the imminent return to profitable operations by the venture appears to be assured. For example, a material nonrecurring loss of an isolated nature, or start-up losses, may reduce an investment below zero though the underlying profitable pattern of an investee is unimpaired.

35-6 An investor in a real estate venture shall report its recorded share of losses in excess of its investment, including loans and advances, as a liability in its financial statements.

35-7 If an investor does not recognize venture losses in excess of its investment, loans, and advances and the venture subsequently reports net income, the investor shall resume applying the equity method only after its share of such net income equals the share of net losses not recognized during the period in which equity accounting was suspended.

35-8 If it is probable that one or more investors cannot bear their share of losses, the remaining investors shall record their proportionate shares of venture losses otherwise allocable to investors considered unable to bear their share of losses. This does not apply for real property jointly owned and operated as undivided interests in assets if the claims or liens of investors’ creditors are limited to investors’ respective interests in such property.

35-9 When the venture subsequently reports income, those remaining investors shall record their proportionate share of the venture’s net income otherwise allocable to investors considered unable to bear their share of losses until such income equals the excess losses they previously recorded. An investor who is deemed by other investors to be unable to bear its share of losses shall continue to record its contractual share of losses unless it is relieved from the obligation to make payment by agreement or operation of law.

35-10 The accounting by an investor for losses otherwise allocable to other investors shall be governed by the provisions of Subtopic 450-20 relating to loss contingencies. Accordingly, the investor shall record a proportionate share of the losses otherwise allocable to other investors if it is probable that they will not bear their share. In this connection, each investor shall look primarily to the fair value of the other investors’ interests in the venture and the extent to which the venture’s debt is nonrecourse in evaluating their ability and willingness to bear their allocable share of losses. An investor may not be able to apply the general rule to an investment in an undivided interest because the extent to which the interests of other investors are encumbered by liens may not be known. However, there may be satisfactory alternative evidence of an ability and willingness of other investors to bear their allocable share of losses. Such evidence might be, for example, that those investors previously made loans or contributions to support cash deficits, possess satisfactory financial standing (as may be evidenced by satisfactory credit ratings), or have provided adequately collateralized guarantees.

35-11 See Section 323-10-35 for additional guidance regarding accounting by equity method investor for investee losses when the investor has both loans and equity interest.

As discussed in Section 5.1, an investor records its proportionate share of an equity method investee’s earnings or losses. In situations in which the investor’s share of equity method losses (recorded through a combination of earnings and OCI) equals or exceeds its equity method investment balance plus any advances, equity method loss recognition should generally be discontinued (i.e., the investor should stop reflecting the equity method investee’s losses and any subsequent accounting for basis differences in its financial statements) unless the investor has provided or committed to provide the investee with additional financial support or the investor has guaranteed the investee’s obligations. Additional financial support could come in many forms as noted in ASC 323-10-35-19, including additional contributions, investments in common stock, guarantees, loans, and other advances. An obligation or commitment to provide further financial support to the investee could arise because of legal or implied obligations, assumption of liabilities, or other indications, such as reputational concerns or prior funding of losses. We believe that operational dependence (e.g., if the investee licenses technology to the investor that is significant to the investor’s operations or the investee provides necessary products or services at less than market price) could imply that the investor would not abandon the investee and may indicate that the investor would provide additional financial support.

Further, the investor should continue to record its share of the equity method investee’s losses even when its equity method investment balance plus any advances has been reduced to zero when the investee’s imminent return to profitability is assured. If such return to profitability no longer appears assured, the investor should stop recognizing excess losses from the date of the determination and reverse its related liability with an adjustment to the equity method gain or loss from the investee. The investor should consider disclosing the adjustment.

If the investor is required to continue recording its share of equity method investee losses, it should present any losses that exceed its equity method investment balance (negative equity method investment) as a liability.

If the investor suspends equity method loss recognition, it should separately track its unrecorded share of the investee’s losses, other comprehensive losses, and any adjustments related to subsequent accounting for basis differences in its memo accounts. The investor should record future equity method earnings reported by the investee only after the cumulative losses in the memo accounts have been reduced to zero (i.e., the net income or OCI should first be applied to those memo accounts). Upon returning to profitability, an investor should only restore its equity method investment balance to its equity in the investee’s net assets; it should not restore the remaining balance of unamortized basis differences that were not recognized after losses reduced its investment balance to zero.

The treatment described in this section is different from the consolidation procedures described in ASC 810-10 when an investor consolidates a less than wholly owned subsidiary. Specifically, noncontrolling interests are considered equity of the consolidated group that participate fully in the risks and rewards of the subsidiary. Accordingly, with limited exception, losses generally continue to be attributed to noncontrolling interests regardless of whether a deficit would be accumulated. See Section 6.3 of Deloitte’s Roadmap Noncontrolling Interests for details.

The investor should also consider whether it is probable (under ASC 450-20) that other investors will be able to bear their share of the equity method investee’s losses. If not, and the investor has provided or committed to provide additional financial support to the investee, the investor should record its share of the losses otherwise attributable to the investors that cannot bear their share of the investee’s losses. When the investee subsequently reports income, the investor that absorbed losses attributable to other investors should record the other investors’ share (in addition to its own share) of the investee’s income until it equals the excess losses previously recorded. The investors that are considered unable to bear their share of losses should nonetheless continue to record their contractual share of losses until they are contractually or legally released from their obligation to fund losses.

The examples below illustrate the evaluation of whether (1) the investor has provided or committed to provide the investee additional financial support or (2) the investor has guaranteed the investee’s obligations, thus requiring that the investor continue recording equity method losses that exceed the investor’s equity method investment carrying amount.

Example 5-23

Investor A owns 15 percent of Limited Partnership B and accounts for its investment in B under the equity method in accordance with ASC 323-30-S99-1 and ASC 970-323-25-6. Limited Partnership B has incurred, and continues to incur, losses, and A is aware that the other partners in B cannot bear their share of the losses since they lack the financial capacity to fund ongoing operations of B and their capital accounts have been reduced to zero. Because A becomes the sole source of funding to support the continuing operations of B, A should record 100 percent of B’s losses in its equity method accounting.

Example 5-24

Investors B, C, D, and E enter into an investor arrangement that does not require any of the investors to guarantee the obligations or to provide for any future funding requirements of the investee. However, a provision does exist whereby B could be required to pay C up to $25 million if certain conditions have been met. Assume that none of those conditions would require B to provide support directly or indirectly to the investee. Also assume that B’s investment in the investee is zero.

Investor B should not reduce its investment in the investee to a negative amount for its portion of losses after formation of the investee, despite its potential obligation to C. Equity method investors should not record additional equity method losses when their investment is zero and they are not required to provide further financial support to the investee, as stated in ASC 323-10-35-20. Investor B has not guaranteed the obligations of the investee and is not otherwise obligated to provide it with future financial support. Although B could be required to compensate C if certain events occur, B is not obligated to the investee itself. Therefore, B would not be required to reduce its investment below zero for additional investee losses.

Note that B would consider whether the arrangement with C requires accounting under other U.S. GAAP (e.g., as a guarantee under ASC 460).

Example 5-25

Investors B, C, D, and E each have a 25 percent ownership in Investee F and account for their investments under the equity method. Profits and losses are shared equally. Investee F has had continuing operating losses. As a result, B’s investment in F has been reduced to zero. Further, B has guaranteed F’s LOC jointly and severally with the other investors. Investor B has no collateral or other arrangements with F, the holder of the LOC, or the other investors or their related parties. While F has not yet drawn down on the LOC, it is expected to draw the full amount in the near future. Therefore, B has determined that it should recognize further losses for its investment in F under the provisions of ASC 323-10-35-20.

If the other investors in F are proved to be financially solvent and can fund their pro rata portion, it would be appropriate for B to record its proportionate share of losses in each period, up to its pro rata share of the LOC. However, if one or more of the investors demonstrates questionable financial stability, B should evaluate its risk under the agreement and record losses accordingly.

Further assume that F draws down on the LOC for its full facility of $5 million and reports a loss of $1 million. Investor B concludes that the other investors are financially solvent. Investor B should record a $250,000 loss in its financial statements for its proportionate share of losses. Investor B would continue to record its proportionate share of losses in each period, up to its 25 percent pro rata share of the outstanding amount of the LOC (i.e., $1.25 million). If B determines that it is probable that it will pay $5 million to the holder of the LOC because of the financial condition of F and the other investors, B should record a loss of $5 million.

Example 5-26

Cash Commitment to Investee

Investors A, B, C, and D each have 25 percent ownership over Investee E, and each investor accounts for its investment under the equity method. Profits and losses are shared equally. Investor A has committed to provide up to $10 million of additional financial support to E and does not receive additional ownership in E in exchange for providing such support. Investors B, C, and D have not made similar commitments.

Investee E reports recurring losses such that each investor’s equity method investment balance has been reduced to zero at the end of year 3. In year 4, E records another loss of $20 million. All investors have demonstrated that they are still financially solvent and able to fund their pro rata portion of E’s losses. Investor A determines that because it has committed to provide E with up to $10 million of additional financial support, it should record its $5 million proportionate share of E’s losses along with an offsetting liability in accordance with ASC 323-10-35-20.

On the other hand, consider a situation in which A has committed to provide E with additional financial support of up to $1 million and there are no other indications that A would provide support beyond this amount.

In this case, at the end of year 4, A determines that it should record its proportionate share of E’s losses, up to its committed financial support of $1 million, under ASC 323-10-35-20. Although A’s proportionate share of E’s losses is $5 million, A limits its recognized losses in E to A’s committed financial support by recognizing an equity method loss and a liability of $1 million. The remaining $4 million proportionate loss would be recorded in A’s memo accounts.

5.2.1 Guarantee of an Equity Method Investee’s Third-Party Debt

See Section 4.2.1 for further discussion of the accounting when a guarantee is issued by the investor in conjunction with the equity method investee’s formation or is issued after formation as required by the formation documents. As noted in that section, we generally believe that, in the absence of substantive evidence to the contrary, the value of the guarantee would be included in the initial measurement of the equity method investment (i.e., the debit entry would be recorded to the equity method investment account rather than to expense) given that it is more likely that the guarantee was issued to balance the investor’s investment in the investee.

A guarantee that is not contemplated or required by the formation documents may be issued after the equity method investee’s formation. In such a situation, if the investor does not receive any consideration from the equity method investee or the other investors for issuing the guarantee, the investor should recognize a guarantee liability initially at fair value in accordance with ASC 460-10-25-3 and 25-4 and ASC 460-10-30-2. When the investor initially recognizes a guarantee liability related to a guarantee issued after the investee’s formation, the investor should use judgment to allocate the initial fair value of the guarantee between its interest in the equity method investee and that of other investors. The investor should do the following:

Expense the portion of the debit entry related to noncontributing investors.
Record the portion of the debit entry related to the investor’s interest in the equity method investee as an increase in its investment in the equity method investee and amortize that portion over the life of the guarantee.

If a controlling financial interest holder deconsolidates a subsidiary in accordance with ASC 810-10-40-3A through 40-5 and retains an equity method investment, the investor measures the equity method investment at its fair value in accordance with ASC 323-10-30-2. If the investor issues a guarantee of the investee’s third-party debt in conjunction with the deconsolidation, we believe that the initial fair value of the guarantee liability would be accounted for as part of the gain or loss upon deconsolidation rather than capitalized as part of the investor’s basis in the equity method investment.

5.2.2 Collateral of the Investee Held by the Investor When Equity Losses Exceed the Investor’s Investment

An investor may provide a loan to an equity method investee or guarantee a third-party loan held by the investee that is collateralized by the investee’s underlying assets. Further, the appraised value of the assets may be greater than the combined outstanding loan amount.

If the investor’s share of the investee’s cumulative losses exceeds the investor’s equity investment and loan balances, it would not be appropriate for the investor to avoid recording equity losses associated with the guarantee of the investee’s loans because the liquidation value of the collateral it holds exceeds the amount of the guarantee. In other words, the investor should not consider the liquidation value of collateral to offset the guarantee. However, it may be appropriate for the investor to consider the liquidation value of collateral when recognizing investee losses if all the following conditions are met:

The operations related to the assets that serve as collateral do not represent a large percentage of the investee’s operations, and removal of the assets would not preclude the investee’s continued operations.
The investor has the ability and intent to take possession of the collateral if it is required to honor the guarantee. That is, the investor has the ability to obtain clear title to the collateral, notwithstanding any potential claims that other third parties may have.
The investor could use the equipment in its own operations or has sufficient experience with and access to a market for assets that serve as collateral so that it can sell and realize the collateral’s value.

If the collateral is essential to the investee’s operations, the first condition would not be met. We expect that it would be rare for all these conditions to be met.

If the investee extinguishes or settles the loan guaranteed by the investor, the investor should stop recognizing excess losses from the time of extinguishment or settlement of the loan and reverse its related liability, with an adjustment to the equity method gains or losses from the investee. The investor should consider disclosing the adjustment.

5.2.3 Investee Losses if the Investor Has Other Investments in the Investee

ASC 323-10

35-23 The guidance in the following paragraph applies to situations in which both of the following conditions exist:

An investor is not required to advance additional funds to an investee.
Previous losses have reduced the common stock investment account to zero.

35-24 In the circumstances described in paragraph 323-10-35-23, the investor shall continue to report its share of equity method losses in its statement of operations to the extent of and as an adjustment to the adjusted basis of the other investments in the investee. The order in which those equity method losses should be applied to the other investments shall follow the seniority of the other investments (that is, priority in liquidation). For each period, the adjusted basis of the other investments shall be adjusted for the equity method losses, then the investor shall apply Subtopic 310-10, 320-10, 321-10, 326-20, or 326-30 to the other investments, as applicable.

35-25 The cost basis of the other investments is the original cost of those investments adjusted for the effects of write-downs, unrealized holding gains and losses on debt securities classified as trading in accordance with Subtopic 320-10 or equity securities accounted for in accordance with Subtopic 321-10 and amortization of any discount or premium on debt securities or financing receivables. The adjusted basis is the cost basis adjusted for the allowance for credit losses account recorded in accordance with Topic 326 on measurement of credit losses for an investee financing receivable and debt security and the cumulative equity method losses applied to the other investments. Equity method income subsequently recorded shall be applied to the adjusted basis of the other investments in reverse order of the application of the equity method losses (that is, equity method income is applied to the more senior investments first).

35-26 If the investor has other investments in the investee (including, but not limited to, preferred stock, debt securities, and loans to the investee) that are within the scope of Subtopic 310-10, 320-10, or 321-10, the investor should perform all of the following steps to determine the amount of equity method loss to report at the end of a period:

Apply this Subtopic to determine the maximum amount of equity method losses.
Determine whether the adjusted basis of the other investment(s) in the investee is positive, and do the following:
1. If the adjusted basis is positive, the adjusted basis of the other investments shall be adjusted for the amount of the equity method loss based on the investments’ seniority. Paragraph 320-10-35-3 explains that, for investments accounted for in accordance with Subtopic 320-10, this adjusted basis becomes the debt security’s basis from which subsequent changes in fair value are measured. Paragraph 321-10-35-5 explains that for investments accounted for in accordance with Subtopic 321-10, this adjusted basis becomes the equity security’s basis from which subsequent changes in fair value are measured.
2. If the adjusted basis reaches zero, equity method losses shall cease being reported; however, the investor shall continue to track the amount of unreported equity method losses for purposes of applying paragraph 323-10-35-20. If one of the other investments is sold at a time when its carrying value exceeds its adjusted basis, the difference between the cost basis of that other investment and its adjusted basis at the time of sale represents equity method losses that were originally applied to that other investment but effectively reversed upon its sale. Accordingly, that excess represents unreported equity method losses that shall continue to be tracked before future equity method income can be reported. Example 4 (see paragraph 323-10-55-30) illustrates the application of (b)(2).
After applying this Subtopic, apply Subtopics 310-10, 320-10, 321-10, 326-20, and 326-30 to the adjusted basis of the other investments in the investee, as applicable.
Apply appropriate generally accepted accounting principles (GAAP) to other investments that are not within the scope of Subtopic 310-10, 320-10, 321-10, 326-20, or 326-30.

Example 4 (see paragraph 323-10-55-30) illustrates the application of this guidance.

When an investor does not have a requirement or commitment to advance additional funds to an investee and losses have reduced its common stock equity method investment balance to zero, the investor should continue to record its share of equity method losses to the extent that the investor has other investments (e.g., preferred stock, loans to the investee, other securities) in the equity method investee. The SEC staff has held that all investments and advances, other than receivables, are presumed to fund the investee’s operating losses.

Equity method losses should be applied in order of seniority of the investor’s other investments, starting with the most subordinated investment to the extent that such an investment has a positive adjusted basis.

ASC 323-10-35-25 indicates that the cost basis and adjusted basis of an investor’s other investments are determined as follows:

We believe that the guidance in ASC 323-10-35-25 is meant to reflect the calculation of the adjusted basis of an investment but does not address the order in which to apply the measurement guidance.

Generally, an investor applies the following steps to its other investments when it has incurred equity method losses during a reporting period: (1) it adjusts its other investments for equity method losses to the extent that the other investments’ adjusted basis is positive and (2) adjusts the other investments further by applying other U.S. GAAP to them (e.g., ASC 310-10, ASC 320-10, ASC 321-10, and so forth). That is, for example, the investor would apply the guidance in ASC 323 first and then apply the guidance in ASC 321, which would result in recording the other equity investments at fair value in accordance with ASC 321.

Once the adjusted basis of an investor’s other investments reaches zero, the investor should stop recording equity method losses as an adjustment to those investments. If there are no other investments with a positive adjusted basis, the investor should continue to track the unreported equity method losses for subsequent periods. When an investee returns to profitability, the investor should wait until profits recover unreported equity method losses before adjusting other investments.

When an investee begins to report equity method income, the income should first be applied to the adjusted basis of the investor’s other investments starting with the most senior investment (the reverse order of the application of losses described above). Therefore, the investor would not recognize any equity method income unless or until the amount of the subsequent equity method income exceeds the cumulative unreported equity method losses.

Changing Lanes

Clarifying the Interaction Between ASC 321 and ASC 323

In May 2019, the FASB added a project9 to the EITF’s technical agenda on clarifying the interaction between ASC 321 and ASC 323. The project included an issue related to “[r]ecognizing investee losses when an investor has other equity investments in the investee.” As stated in Issue Summary 1 of EITF Issue 19-A, at its June 13, 2019, meeting, the EITF discussed the order in which an investor should apply the guidance when (1) “an investor has additional investments in the equity method investee that do not qualify for the equity method of accounting”; (2) “the investee’s equity method losses have resulted in a zero carrying amount for the investor’s equity method investment”; (3) the investor is applying the measurement alternative in ASC 321; and (4) within an accounting period, there is an observable transaction that will result in an adjustment (i.e., increase) to the carrying value of the investment under ASC 321. Issue Summary 1 of EITF Issue 19-A provides the following example:

On January 1, 20X1, an investor acquires 20 percent of Company A’s common stock and 10 percent of its preferred stock for $10,000,000 and $5,000,000, respectively. The investor’s investment in the common stock is accounted for in accordance with the equity method of accounting, and the investment in the preferred stock is accounted for as an equity security under the measurement alternative under Topic 321. In each of the quarters between January 1, 20X1 and December 31, 20X3, Company A reports net losses. Because the investor records its share of Company A’s losses, the cost basis in both investments is reduced to zero. As of December 31, 20X3, the investor has accumulated approximately $50,000,000 of unrecognized equity method losses in a memo account.

On March 31, 20X4, Company A completes a new round of equity financing involving new investors. The investor determines that the new round of equity financing constitutes an orderly transaction with an observable price that requires the investor to remeasure its investment in the preferred stock to its fair value of $60,000,000. Additionally, the investor’s share of the investee’s equity losses for the period ended March 31, 20X4 is $10,000,000.

Normally, an entity would apply the measurement guidance in ASC 321 after applying adjustments recognized under ASC 323. However, under the measurement alternative in ASC 321, the entity would adjust the equity security to fair value for an observable transaction that occurred during the period and may not be at the end of the reporting period. Because this observable transaction may not be at the end of the period, it calls into question the normal sequencing the entity would follow of applying the measurement guidance in ASC 321 after recognizing equity method losses for the period under ASC 323.

The EITF was able to reach consensus with respect to other issues contemplated as part of EITF Issue 19-A, which led to the FASB’s issuance of ASU 2020-01. However, the Task Force was unable to reach a consensus on the order in which Codification topics would be applied to the recognition of investee losses when an investor has other equity investments in the investee.

We believe that in the absence of authoritative guidance addressing the issue, either of the following approaches described in Issue Summary 1 of EITF Issue 19-A would be acceptable.

Approach 1 — “Accumulated equity method losses that have not been allocated to an investor’s investments in the investee (that is, accumulated investee losses in the memo account) should offset any unrealized gains resulting from remeasurement of the investment due to an observable transaction in accordance with Topic 321.” That is, the investor would apply the guidance in ASC 321 first and then apply the guidance in ASC 323.

Application of this guidance to the example above would result in a preferred stock carrying amount of $0. “The investor would apply the guidance in Topic 321 and remeasure the preferred stock to its fair value of $60,000,000. The investor would then apply the guidance in Topic 323 and adjust the basis of the preferred stock for cumulative investee losses of $60,000,000.”
Approach 2 — “Recognition of unrealized gains related to an orderly transaction in accordance with the measurement alternative in Topic 321 should be applied after the allocation of any equity method losses. As such, the carrying amount of the equity investment should reflect the most recent observable price, without offsetting any accumulated equity method losses.” That is, the investor would apply the guidance in ASC 323 first and then apply the guidance in ASC 321.

Application of this guidance to the example above would result in a preferred stock carrying amount of $60,000,000. “The investor would apply the guidance in Topic 323 and record the additional $10,000,000 of investee losses in the memo account. The investor would then apply the guidance in Topic 321 to remeasure the preferred stock to its fair value of $60,000,000.”

An entity should use one entity-wide method that is disclosed in the footnotes to the financial statements. Preparers should monitor developments in this area and consider consulting with their independent auditors or their professional accounting advisers as needed.

ASU 2019-04

In April 2019, the FASB issued ASU 2019-04, which, among other things, provided Codification improvements to ASU 2016-01, ASU 2016-13, and ASU 2017-12. Upon adoption of ASU 2019-04, an investor must first adjust its other investments for equity method losses and then may have to adjust them further on the basis of the application of other U.S. GAAP (e.g., ASC 310-10, ASC 320-10, ASC 321-10, ASC 326-20, and ASC 326-30) to those investments.

In addition to ASU 2019-04, ASU 2016-13 amends the guidance in U.S. GAAP on impairment of financial instruments.

ASU 2016-13 adds to U.S. GAAP an impairment model (known as the current expected credit loss [CECL] model) that is based on expected losses rather than incurred losses. Under the new guidance, an entity recognizes as an allowance its estimate of expected credit losses, which the FASB believes will result in more timely recognition of such losses. This ASU is also intended to reduce the complexity of U.S. GAAP by decreasing the number of credit impairment models that entities use to account for debt instruments.

5.2.3.1 Percentage Used to Determine the Amount of Equity Method Losses

ASC 323-10

35-27 The guidance in the following paragraph applies if all of the following conditions exist:

An investor owns common stock (or in-substance common stock) and other investments in an investee.
The investor has the ability to exercise significant influence over the operating and financial policies of the investee.
The investor is not required to advance additional funds to the investee.
Previous losses have reduced the common stock investment account to zero.

35-28 In the circumstances described in the preceding paragraph, the investor shall not recognize equity method losses based solely on the percentage of investee common stock held by the investor. Example 5 (see paragraph 323-10-55-48) illustrates two possible approaches for recognizing equity method losses in such circumstances.

When an investor’s common stock equity method investment has been reduced to zero and the investor has other investments in an investee, the amount of equity method loss to be recognized in each period should not be based solely on the percentage of ownership, as stated in ASC 323-10-35-28, which was initially introduced by EITF Issue 99-10. While the EITF did not reach a consensus on a single method of recognition, it acknowledged that various approaches may be acceptable and that an entity should use one entity-wide method that is disclosed in the footnotes to the financial statements. The example below from ASC 323-10-55-48 through 55-57 illustrates two potential acceptable methods of recognition (one based on the ownership level of each specific investment and the other based on the change in the investor’s claim on the investee’s book value).

ASC 323-10

Example 5: Percentage Used to Determine the Amount of Equity Method Losses

55-48 The following Cases illustrate possible approaches to recognizing equity method losses in accordance with paragraph 323-10-35-28:

Ownership level of particular investment (Case A)
Change in investor claim on investee book value (Case B).

55-49 Cases A and B share all of the following assumptions:

Investee was formed on January 1, 20X0.
Five investors each made investments in and loans to Investee on that date and there have not been any changes in those investment levels (that is, no new money, reacquisition of interests by Investee, principal payments by Investee, or dividends) during the period from January 1, 20X0, through December 31, 20X3.
Investor A owns 40 percent of the outstanding common stock of Investee; the common stock investment has been reduced to zero at the beginning of 20X1 because of previous losses.
Investor A also has invested $100 in preferred stock of Investee (50 percent of the outstanding preferred stock of Investee) and has extended $100 in loans to Investee (which represents 60 percent of all loans extended to Investee).
Investor A is not obligated to provide any additional funding to Investee. As of the beginning of 20X1, the adjusted basis of Investor’s total combined investment in Investee is $200, as follows.
Investee operating income (loss) from 20X1 through 20X3 is as follows.
Investee’s balance sheet is as follows.

Case A: Ownership Level of Particular Investment

55-50 Under this approach, Investor A would recognize equity method losses based on the ownership level of the particular investee security, loan, or advance held by the investor to which equity method losses are being applied.

55-51 In 20X1, in accordance with this Subtopic, Investor A would record the equity method loss to the adjusted basis of the preferred stock (the next most senior level of capital) after the common stock investment becomes zero (50% × $160 = $80). Investor A would record the following journal entry.

55-52 In 20X2, in accordance with this Subtopic, Investor A would record the equity method loss to the extent of the adjusted basis of the preferred stock of $20 (50% × $40 = $20) and, because the adjusted basis of the preferred stock will then be reduced to zero, record the remaining equity method loss to the adjusted basis of the loan (the next most senior level of capital) (60% × $160 [that is, $200–$40 applied to the preferred stock] = $96). Investor A would record the following journal entry.

55-53 In 20X3, in accordance with this Subtopic, Investor A would record the equity method income first to the loan until its adjusted basis is restored (60% × $160 = $96), then to the preferred stock until its adjusted basis is restored (50% × $200 = $100), and finally to the common stock (40% × $140 = $56). Investor A would record the following journal entry.

Case B: Change in Investor Claim on Investee Book Value

55-54 Under this approach, Investor A would recognize equity method losses based on the change in the investor’s claim on the investee’s book value.

55-55 With respect to 20X1, if Investee hypothetically liquidated its assets and liabilities at book value at December 31, 20X1, it would have $207 available to distribute. Investor A would receive $120 (Investor A’s 60% share of a priority claim from the loan [$100] and a priority distribution of its preferred stock investment of $20 [which is 50% of the $40 remaining to distribute after the creditors are paid]). Investor A’s claim on Investee’s book value at January 1, 20X1, was $200 (60% × $167 = $100 and 50% × $200 = $100). Therefore, during 20X1, Investor A’s claim on Investee’s book value decreased by $80 and that is the amount Investor A would recognize in 20X1 as its share of Investee’s losses. Investor A would record the following journal entry.

55-56 With respect to 20X2, if Investee hypothetically liquidated its assets and liabilities at book value at December 31, 20X2, it would have $7 available to distribute. Investor A would receive $4 (Investor A’s 60% share of a priority claim from the loan). Investor A’s claim on Investee’s book value at December 31, 20X1, was $120 (see the preceding paragraph). Therefore, during 20X2, Investor A’s claim on Investee’s book value decreased by $116 and that is the amount Investor A would recognize in 20X2 as its share of Investee’s losses. Investor A would record the following journal entry.

55-57 With respect to 20X3, if Investee hypothetically liquidated its assets and liabilities at book value at December 31, 20X3, it would have $507 available to distribute. Investor A would receive $256 (Investor A’s 60% share of a priority claim from the loan [$100], Investor A’s 50% share of a priority distribution from its preferred stock investment [$100], and 40% of the remaining cash available to distribute [$140 × 40% = $56]). Investor A’s claim on Investee’s book value at December 31, 20X2, was $4 (see above). Therefore, during 20X3, Investor A’s claim on Investee’s book value increased by $252 and that is the amount Investor A would recognize in 20X3 as its share of Investee’s earnings. Investor A would record the following journal entry.

5.2.4 Additional Investment After Suspension of Loss Recognition

ASC 323-10

35-29 If a subsequent investment in an investee does not result in the ownership interest increasing from one of significant influence to one of control and, in whole or in part, represents, in substance, the funding of prior losses, the investor should recognize previously suspended losses only up to the amount of the additional investment determined to represent the funding of prior losses (see (b)). Whether the investment represents the funding of prior losses, however, depends on the facts and circumstances. Judgment is required in determining whether prior losses are being funded and all available information should be considered in performing the related analysis. All of the following factors shall be considered; however, no one factor shall be considered presumptive or determinative:

Whether the additional investment is acquired from a third party or directly from the investee. If the additional investment is purchased from a third party and the investee does not obtain additional funds either from the investor or the third party, it is unlikely that, in the absence of other factors, prior losses are being funded.
The fair value of the consideration received in relation to the value of the consideration paid for the additional investment. For example, if the fair value of the consideration received is less than the fair value of the consideration paid, it may indicate that prior losses are being funded to the extent that there is disparity in the value of the exchange.
Whether the additional investment results in an increase in ownership percentage of the investee. If the investment is made directly with the investee, the investor shall consider the form of the investment and whether other investors are making simultaneous investments proportionate to their interests. Investments made without a corresponding increase in ownership or other interests, or a pro rata equity investment made by all existing investors, may indicate that prior losses are being funded.
The seniority of the additional investment relative to existing equity of the investee. An investment in an instrument that is subordinate to other equity of the investee may indicate that prior losses are being funded.

35-30 Upon making the additional investment, the investor should evaluate whether it has become otherwise committed to provide financial support to the investee.

In situations in which equity method losses have reduced an investor’s equity method investment balance to zero and the investor makes an additional contribution to an equity method investee for no additional ownership interest, the investor must first determine whether this additional investment provides it with a controlling financial interest in the investee. See Section 5.6 for further discussion related to accounting for changes in the level of ownership or degree of influence over an investee.

If the additional contribution does not result in a change from significant influence to control, the investor must determine whether the additional investment in the investee represents the funding of prior losses. ASC 323-10-35-29 discusses factors to consider in the determination of whether additional investments in an investee represent funding of prior losses when the investor has suspended equity method loss recognition in accordance with ASC 323-10-35-20 and ASC 323-10-35-23 through 35-26. This determination involves significant judgment, and the investor should consider all relevant facts and circumstances.

The factors in ASC 323-10-35-29 suggest that if the additional investment is determined, in substance, to be a funding of prior losses, the investor should recognize any prior suspended losses up to the amount of this investment. The investor should also evaluate whether the additional investment results in a commitment to provide financial support to the equity method investee. If the additional investment is not considered to be a funding of prior losses, the investor should account for the additional investment by using the equity method, including recording its share of equity method losses incurred after the additional investment is made. However, the investor would not recognize any prior suspended losses related to its initial investment.

Footnotes

EITF Issue No. 19-A, “Financial Instruments — Clarifying the Interactions Between Topic 321 and Topic 323.”

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.