5.4 Costs Incurred on Behalf of an Investee

5.4.1 Accounting for Costs Incurred on Behalf of an Investee in the Financial Statements of the Investor

The guidance in ASC 323-10-25-3 through 25-5, which was initially introduced by EITF Issue 00-12 (see Section 5.3), examines situations in which an additional investment made by an investor is not determined to be a funding of prior losses and considers the manner in which (i.e., capitalization or expense), and period(s) over which, the investor should account for any costs incurred on behalf of an investee. The following are two different views proposed by the EITF regarding how an investor should recognize the many types of expenditures it might incur on behalf of an investee:

View A — The investor should record the expenditures as expenses “to the extent that the investor’s claim on the investee’s book value has not been increased.” If the investor’s claim on the investee’s book value has been increased (e.g., when the cost incurred by the investor is capitalized by the investee), the investor should recognize the portion of the expenditures represented by the increase as an additional investment in the investee.
View B — The investor should recognize the expenditures as an increase in its investment in the investee. The investor would then recognize its share of the earnings or losses of the investee, inclusive of the costs incurred, on the basis of its ownership percentage in the investee. The remainder of the cost incurred (the percentage of the cost that benefits the other investors) results in an originated-basis difference between the investor’s investment balance and its underlying equity in net assets of the investee. This difference should be accounted for in a manner similar to that described in ASC 323-10-35-34, whereby the difference is attributed to specific individual assets or liabilities of the investee, and any residual excess of the cost of the investment over the proportional fair value of the investee’s assets and liabilities is treated as equity method goodwill. When attributing the basis difference to the investee’s underlying net assets, the investor should consider the relevant facts and circumstances, including the nature of the expenditures. See Sections 4.5 and 5.1.5.2, respectively, for initial measurement of and subsequent accounting for basis differences.

After the EITF considered these two alternatives, the scope of the discussion and consensus in EITF Issue 00-12 (as codified in ASC 323-10-25-3 through 25-5) was narrowed to focus only on the costs of investor stock-based compensation granted by the investor to employees of the equity method investee, and not on contributions in other forms. When investor stock-based compensation costs are incurred, the consensus of ASC 323-10-25-3 through 25-5 would be followed. That is, the contributing investor would expense the cost of investor stock-based compensation granted to employees of an equity method investee as incurred (i.e., as the contribution is recognized by the investee) to the extent that the investor’s claim on the investee’s book value has not increased (see Section 5.3).

However, for costs that do not represent investor stock-based compensation costs incurred by the contributing investor on behalf of the equity method investee for no additional ownership interest, and when no proportionate funding is provided by the other equity holders, we believe that View B would generally be appropriate, after consideration of the provisions of ASC 323-10-35-29 (see Section 5.2.4). Although the investor’s contribution may not result in an additional ownership interest for that investor, the contribution would presumably be made to enhance the investor’s investment or would result in the investee’s avoidance of costs, benefiting the investor indirectly.

Example 5-27

Investor W holds an investment in Investee M, which owns the mineral rights to an exploratory mining project. Investee M is in the development stage with no revenue or forms of debt financing and has no assets or activities other than those related to the mining project. Investor W accounts for its investment in M under the equity method. Investor W elects to fund 100 percent of M’s exploration costs incurred for the calendar year. These exploration payments are expected to cover all of M’s exploration program costs and allow M to complete its exploration phase. The exploration payments do not represent a funding of prior losses.

Although W will not receive an additional ownership in M when it funds the exploration costs, these contributions enhance W’s investment because M does not have to bear the economic burden that it would have otherwise incurred if W had not made these contributions. Given M’s capital structure, W will provide all of M’s operating financing during this exploration phase of the mining project. The viability of M, as an entity in the development stage with no revenue or forms of debt financing, depends wholly on W’s equity commitment, and thus the contributions will enhance the value of W’s investment. Therefore, in these circumstances, it is appropriate for W to recognize the exploration payments as an increase to the carrying value of its investment in M in accordance with View B. The costs attributable to the noncontributing investor(s) result in an originated-basis difference between W’s investment balance and its underlying equity in M’s net assets. This basis difference would be attributable to the underlying investee’s mineral rights property asset and would be amortized over the life of that asset.

5.4.1.1 Accounting for Costs Incurred on Behalf of, and Subsequently Reimbursed by, an Investee in the Financial Statements of the Investor

In scenarios in which the investor incurs costs on behalf of an investee that do not result in an additional ownership interest in the investee (see Section 5.4.1), the investee and investor may also enter an arrangement that obligates the investee to reimburse the investor for costs previously incurred on the investee’s behalf.

As the investee reimburses the investor for such costs, the investee’s net assets decrease. Accordingly, we believe that the investor should reflect such reimbursements as a reduction of its investment in the investee given that its claim on the investee’s net assets has decreased. We believe that, in such circumstances, the investor should “unwind” the accounting described in View B (see Section 5.4.1) with respect to costs that do not represent investor stock-based compensation costs incurred on behalf of an investee for which the investor does not receive an additional ownership interest in the investee.

5.4.2 Accounting for Costs Incurred on Behalf of an Investee in the Financial Statements of the Investee

When an investor incurs costs related to an equity method investment, the investor should use judgment to determine whether the costs are incurred on behalf of the investee and therefore should be reflected in the investee’s financial statements. SAB Topic 1.B states, in part, that “[i]n general, the staff believes that the historical income statements of a registrant should reflect all of its costs of doing business. Therefore, in specific situations, the staff has required the subsidiary to revise its financial statements to include certain expenses incurred by the parent on its behalf.” In addition, SAB Topic 5.T discusses the concept of reflecting costs incurred by a shareholder on behalf of a company in the company’s financial statements. SAB Topic 5.T states, in part, that a transaction in which “a principal stockholder pays an expense for the company, unless the stockholder’s action is caused by a relationship or obligation completely unrelated to his position as a stockholder or such action clearly does not benefit the company” should be reflected as an expense in the company’s financial statements, with a corresponding credit to APIC. We believe that the guidance in SAB Topics 1.B (by analogy) and 5.T applies to equity method investees. Therefore, we believe that costs incurred by an investor on behalf of an investee should be recorded in the financial statements of the investee as an expense (or capitalized if permitted under other U.S. GAAP), with a corresponding credit to APIC.

In addition, even though the guidance in SAB Topics 1.B and 5.T applies to public companies, we believe that private companies should also apply this guidance when evaluating the recognition of costs incurred by an investor on behalf of an investee.

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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.