5.5 Decrease in Investment Value and Impairment

ASC 323-10

35-31 A series of operating losses of an investee or other factors may indicate that a decrease in value of the investment has occurred that is other than temporary and that shall be recognized even though the decrease in value is in excess of what would otherwise be recognized by application of the equity method.

35-32 A loss in value of an investment that is other than a temporary decline shall be recognized. Evidence of a loss in value might include, but would not necessarily be limited to, absence of an ability to recover the carrying amount of the investment or inability of the investee to sustain an earnings capacity that would justify the carrying amount of the investment. A current fair value of an investment that is less than its carrying amount may indicate a loss in value of the investment. However, a decline in the quoted market price below the carrying amount or the existence of operating losses is not necessarily indicative of a loss in value that is other than temporary. All are factors that shall be evaluated.

35-32A An equity method investor shall not separately test an investee’s underlying asset(s) for impairment. However, an equity investor shall recognize its share of any impairment charge recorded by an investee in accordance with the guidance in paragraphs 323-10-35-13 and 323-10-45-1 and consider the effect, if any, of the impairment on the investor’s basis difference in the assets giving rise to the investee’s impairment charge.

ASC 970-323

35-12 A loss in value of an investment other than a temporary decline shall be recognized. Such a loss in value may be indicated, for example, by a decision by other investors to cease providing support or reduce their financial commitment to the venture.

35-13 If a transaction with a real estate venture confirms that there has been a loss in the value of the asset sold that is other than temporary and that has not been recognized previously, the loss shall be recognized on the books of the transferor.

An investor must determine whether its equity method investment is impaired when certain indications are present even if an investee has not recognized impairments of its assets. In addition, an equity method investment may be impaired in an amount greater than impairments recognized by the investee. Although a current fair value below the recorded investment is an indicator of impairment, the investor should recognize an impairment only if the loss in value is deemed to be an OTTI.10 If an impairment of an equity method investment is determined to be other than temporary, the investor must record an impairment charge sufficient to reduce the investment’s carrying value to its fair value, which results in a new cost basis. This new cost basis cannot subsequently be written up to a higher value as a result of increases in fair value. The investor should apply the equity method of accounting to the new cost basis in its investment by recording its share of subsequent income or loss of the investee in a manner consistent with the accounting method used before the OTTI (see Section 5.1).

The investor should not test the investee’s underlying assets for impairment; rather, the investor should test the equity method investment for impairment as its own unit of account. Also, ASC 323-10-35-32A requires the investor to “recognize its share of any impairment charge recorded by an investee in accordance with the guidance in paragraphs 323-10-35-13 and 323-10-45-1 and consider the effect, if any, of the impairment on the investor’s basis difference in the assets giving rise to the investee’s impairment charge.” However, the investor must nonetheless ensure that the amounts recognized comply with U.S. GAAP. Therefore, the investor should consider if impairment indicators exist at the investee level that were not recognized but should have been in accordance with U.S. GAAP.

5.5.1 Identifying Impairments

ASC 323-10-35-31 and 35-32 provide certain factors that may be indicative of an impairment, including:

“A series of operating losses of an investee.”
The “absence of an ability to recover the carrying amount of the investment.”
The “inability of the investee to sustain an earnings capacity.”
“A current fair value of an investment that is less than its carrying amount.”

In addition to these factors, the SEC issued SAB Topic 5.M, which provided three indicators of OTTI on investments in AFS equity securities. As a result of the issuance (and the adoption) of ASU 2016-01, SAB Topic 5.M was removed from the Codification. Although that guidance specifically related to AFS equity securities, we believe that the indicators of an OTTI contained therein continue to be helpful when an investor is evaluating whether an OTTI of any equity method investment exists. The indicators in SAB Topic 5.M were as follows:

The length of the time and the extent to which the market value has been less than cost;
The financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer such as changes in technology that may impair the earnings potential of the investment or the discontinuance of a segment of the business that may affect the future earnings potential; or
The intent and ability of the holder to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in market value.

SEC Accounting and Auditing Enforcement Release Nos. 309, 316, 370, and 422 provide additional factors to evaluate in the determination of an OTTI, including the following:

The condition and trend of the economic cycle.
The issuer’s financial performance and projections.
Trends in the general market.
The issuer’s capital strength.
The issuer’s dividend payment record.
Whether other adverse conditions at the investee level are further indicators of an other-than-temporary diminution in value, including:
- Known liquidity crisis.
- Bankruptcy proceedings.
- Going-concern commentary in the auditor’s report on the investee’s most recent financial statements.

Any impairment analysis will require a careful consideration of all the facts and circumstances, with no individual factor being determinative. Note, however, that when an equity method investment has a readily determinable value, it is more difficult to overcome the indication of impairment (e.g., by performing an internal discounted cash flow analysis that contradicts the market value).

An investor is required to test certain long-lived assets for recoverability by using undiscounted cash flows as a first step in determining whether an impairment loss should be recognized under ASC 360-10; however, equity method investments are outside the scope of ASC 360-10. At the 2002 AICPA Conference on Current SEC Developments, the SEC staff indicated that it would object to the use of an undiscounted cash flow analysis under ASC 360-10 for the determination of whether an equity method investment is impaired. In addition, at the March 17–18, 2004, EITF meeting, during deliberations of EITF Issue 03-1, the SEC observer stated that registrants “should continue to rigorously assess equity method investments for impairment” and that the “SEC staff will continue to object to inappropriate impairment analyses for such investments, for example a Statement 144 [codified in ASC 360] undiscounted cash flow approach.” Thus, it would not be appropriate to conclude that an impairment of an equity method investment does not exist simply because the investment’s undiscounted cash flows exceed its carrying amount. An investor should consider all factors, as well as the severity and duration of the equity method investment’s decline in value, when determining whether an impairment is other than temporary. However, if the equity method investment’s undiscounted cash flows are less than its carrying amount, this is a strong indicator of an impairment.

The table below outlines factors that may indicate that an equity method investment’s decline in value is an OTTI as well as those that may indicate that it is not an OTTI.

Indicator	OTTI	Not an OTTI
Length of time that the fair value is below the investor’s carrying value	Prolonged period	Short period, generally measured in months rather than in years
Current expected performance relative to expected performance when the investor initially invested in the investee	Current expected performance is significantly worse than anticipated when the investor initially invested in the investee	Current expected performance is consistent with the level anticipated when the investor initially invested in the investee
Performance relative to peers	The investee is performing significantly worse than peer companies	The investee is performing in a manner that is commensurate with peer companies
Industry performance relative to economy	The investee’s industry is declining and significantly lags the performance of the economy as a whole	The investee’s industry is performing in a manner that is consistent with the general economy as a whole
Credit rating	The investee’s credit rating has been downgraded	No significant change in the investee’s credit rating has occurred
Regulatory action	Adverse regulatory action is expected to substantially reduce the investee’s product demand or profitability	No significant adverse regulatory actions against the investee have occurred
Loss of principal customers or suppliers	The investee has lost significant customers or suppliers with no immediate prospects for replacement	The investee has maintained significant customers and suppliers or has identified replacements for those expected to be lost
Discounted cash flows	The investee’s discounted cash flows are below the investor’s carrying amount	The investee’s discounted cash flows are greater than the investor’s carrying amount
Undiscounted cash flows	The investee’s undiscounted cash flows are below the investor’s carrying amount	The evaluation of the investee’s undiscounted cash flows would not be determinative of whether an OTTI exists

5.5.2 Measuring Impairment

ASC 323 requires an investor to measure impairment (if it is determined to be other than temporary) by comparing the carrying value of the investment with its fair value. The investor is prohibited from testing an equity method investee’s underlying assets for impairment; instead, the investor must test the total equity method investment for impairment, including any goodwill recognized on the date of initial investment (i.e., equity method goodwill recognized is not separately tested for impairment in accordance with ASC 350 but included as part of the total equity method investment subject to impairment testing under ASC 323).

If an investor uses a cash flow analysis to determine the fair value of an equity method investment, it must discount the cash flows to arrive at a measure of the investment’s fair value. A discounted cash flow analysis is similar to the present value techniques described in ASC 820-10-55-5(c) and (d) and incorporates the time value of money and risk premiums that market participants would take into account when pricing the asset. The time value of money generally cannot be incorporated into an estimate of future cash flows but must be incorporated into the discount rate used to measure fair value under the discounted cash flow method. Certain risk factors are also usually included in the discount rate. However, it is inappropriate for an investor to use an undiscounted cash flow approach since such a valuation method would not take into account the considerations described above and would not result in a correct measurement of the “loss in value” of an equity method investment.

Depending on the facts and circumstances, there may be other acceptable ways to determine the fair value of an equity method investment for impairment, such as the market approach or other income approach methods described in ASC 820 (e.g., a discount rate adjustment technique or probability-weighted techniques). However, if the investment has a readily determinable fair value, it would be inappropriate for the investor to modify the amount of impairment measured by using the readily determinable fair value by substituting another valuation technique (e.g., discounted cash flows).

5.5.2.1 Consideration of Basis Differences After Recognizing an Impairment

As discussed in Section 5.5, equity method investments are tested for impairment as a single unit of account (i.e., the investment rather than individual assets or basis differences). However, the recognition of an impairment charge will often affect existing basis differences or give rise to new ones. For example, if an investor has a positive basis difference allocated to various assets and equity method goodwill greater than an impairment, the impairment will be likely to reduce the existing positive basis differences and affect their subsequent amortization. ASC 323 does not provide guidance on how the impact of an impairment charge should be allocated to basis differences. Therefore, an investor should select an accounting policy to allocate impairment charges to basis differences and apply it consistently. As illustrated in the example below, it would be appropriate to allocate on the basis of the fair value at the time of impairment. While there may be other acceptable allocation methods, we believe that the allocation method applied should be reasonable on the basis of the facts and circumstances and the nature of the impairment.

Example 5-28

As of December 31, 20X1, Investor X has a 40 percent interest in Investee Z with a carrying value of $2.376 million, which consists of the following:

Share of underlying net assets: $1.8 million.
Basis differences: $576,000.
- Fixed assets: $380,000.
- Intangible assets: $116,000.
- Goodwill: $80,000.

Investor X concludes that the fair value of its investment in Z is $1.84 million, and the decline in value is other than temporary. Investor X would record a $536,000 impairment charge and allocate it on the basis of the fair value of Z’s underlying assets as follows:

After comparing the new basis differences with the carrying value immediately before the impairment, X would allocate the impairment to the existing basis differences as follows:

Conversely, if an investor does not have any positive basis differences or the impairment exceeds the existing basis differences, the recognition of an impairment charge will result in the creation of a negative basis difference. The write-down may affect the amortization of basis differences. Subsequent increases in the investment’s value as a result of increases in fair value not related to the amortizable basis differences would not be recognized until realized (i.e., disposal of the investment). See Section 5.5 for details related to recording an OTTI.

Example 5-29

Assume the same facts as in the example above, except that as of December 31, 20X1, Investor X concludes that the fair value of its investment in Investee Z is $1.76 million, and the decline in value is other than temporary. Investor X would record a $616,000 impairment charge and allocate it on the basis of the fair value of Z’s underlying assets as follows:

After comparing the new basis differences with the carrying value immediately before the impairment, X would allocate the impairment to the existing basis differences as follows:

Because the basis difference attributable to fixed assets was $380,000 immediately before the recognition of the impairment, the recognition created a $40,000 negative basis difference. This difference will be amortized over the remaining useful life of the underlying fixed assets.

5.5.2.2 Consideration of Cumulative Translation Adjustment in an Impairment Analysis

An equity method investment may generate cumulative translation adjustment (CTA) balances given that the investee may be a foreign operation or hold interests in foreign operations. ASC 830 provides specific guidance regarding how CTA balances should be assessed during an impairment review. ASC 830-30-45-13 states, in part, that “[a]n entity that has committed to a plan that will cause the cumulative translation adjustment for an equity method investment or a consolidated investment in a foreign entity to be reclassified to earnings shall include the cumulative translation adjustment as part of the carrying amount of the investment when evaluating that investment for impairment.” However, ASC 830-30-45-14 states, in part, that “no basis exists to include the cumulative translation adjustment in an impairment assessment if that assessment does not contemplate a planned sale or liquidation that will cause reclassification of some amount of the cumulative translation adjustment.” Therefore, a CTA balance should be considered in an impairment analysis only when the investment’s recoverability is predicated on a plan to dispose of the investment. For further discussion of impairment considerations related to a CTA, see Section 5.5 of Deloitte’s Roadmap Foreign Currency Matters.

Example 5-30

Investor A determines that there are indicators of impairment for Investee B. Investor A’s investment in B has a carrying value of $60 million and a CTA debit balance of $10 million. Investor A has no plan to sell its investment in B or any other transaction that would cause reclassification of the CTA. Therefore, A would consider only the carrying value of $60 million when testing its investment in B for impairment.

Example 5-31

Assume the same facts as in Example 5-30, except that Investor A has committed to a plan to sell its investment in Investee B within one year. Investor A would consider the carrying value of $60 million and the CTA debit balance of $10 million (i.e., the total carrying value of $70 million must be compared with the fair value) when testing its investment in B for impairment. However, the $10 million debit balance recorded in CTA would not be released into earnings until the sale of B occurs and the conditions under ASC 830-30 are met.

ASC 830-30 does not include guidance on how an investor should determine whether it has committed to a plan to dispose of its investment. By analogy, we believe that if the equity method investment meets the held-for-sale criteria in ASC 360-10-45-9 through 45-11, the investor would consider the related CTA balance when comparing the carrying value with the fair value of the equity method investment.

5.5.2.3 Consideration of Nonrecourse Debt

The existence of nonrecourse debt or other similar financing structures does not affect the amount of impairment recognized. If an investor considered nonrecourse financing in determining an impairment charge of an equity method investment, the investor would, in substance, be accounting for the effects of a debt extinguishment before the threshold in ASC 405-20-40-1 was reached.

Example 5-32

Investor A and Investor B each contribute $6 million of cash in Investee C (a real estate project), which is financed, in part, by $10 million of nonrecourse financing. Assume that C has break-even operations after the original contribution. If A’s and B’s investment in C is determined to be other-than-temporarily impaired to such a degree that its value is reduced from $12 million to $8 million, A and B must write their investment down beyond the $10 million nonrecourse financing amount to $4 million each. The existence of nonrecourse debt is not justification for limiting the impairment charge. If A and B were to write their investment down to only $5 million each, they effectively would be recognizing a $2 million gain on a debt extinguishment that has not yet occurred, which is prohibited by ASC 405-20-40-1.

5.5.3 Impairment of Investee Goodwill

ASC 350-20-35-48 requires a goodwill impairment loss recognized at a subsidiary level to be recognized in the consolidated financial statements only if the goodwill of the reporting unit in which the subsidiary resides is also impaired. However, whether an impairment is ultimately recognized in the consolidated financial statements of the subsidiary’s parent does not affect whether an impairment is recognized by an equity method investor. Thus, if an equity method investee recognizes a goodwill impairment charge in its separate financial statements, the investor should recognize its share of the impairment in its financial statements in the same manner in which it recognizes other earnings of the investee.

5.5.4 Events During a Lag Period — Impact on Impairment Evaluation

Investors are permitted in certain instances to record their share of earnings or losses in an investee on a lag (as long as the intervening period is no more than three months); see Section 5.1.4. However, an investor should consider testing an equity method investment for impairment up until its balance sheet date because the guidance on reporting on the lag is limited to the “earnings or losses” of the investee and does not address reporting an impairment on a lag. Generally, the investor should evaluate its equity method investments as of its balance sheet date to determine whether an OTTI exists. If an OTTI exists on the balance sheet date, the measurement of the impairment should be determined as of the balance sheet date and not as of the reporting date for the lag. For example, if an investor reports its share of an investee’s earnings and losses on a three-month reporting lag, and the investor determines as of its quarter ended June 30 that its investment in the investee has an OTTI, the investor should measure an impairment by using the fair value of its investment as of June 30, not the fair value of its investment as of March 31.

If significant events occur during the period between the financial statements used to record an equity method investment and the balance sheet date, questions may be raised about whether an OTTI exists. The investor should apply the guidance in ASC 810-10-45-12 to account for transactions or events in the intervening period. It states, in part:

[R]ecognition should be given by disclosure or otherwise to the effect of intervening events that materially affect the financial position or results of operations.

Thus, investors should carefully evaluate whether material intervening events are disclosed in the notes to the financial statements or recognized in the statements themselves as an adjustment to the investment. The following events in the intervening period may require further considerations in the context of impairment evaluation:

Loss or bankruptcy of a significant customer or supplier.
Adverse credit event (e.g., downgraded rating, default on lending agreements).
Impairment of investee assets (e.g., property destroyed by fire and no insurance proceeds expected).

Additional factors may also require further consideration.

An investor may hold investments that qualify for specialized industry accounting under ASC 946. Under this guidance, investments are measured at fair value, and changes in fair value are recognized in current-period earnings. An investor holding equity method investments in entities applying accounting under ASC 946 would record its equity method earnings and losses on the basis of amounts reported by an investee, including the investor’s proportionate share of the change in fair value of the investee’s assets.

Typically, changes in the fair value of the investee’s assets arising from events occurring after the date of the investee’s most recent available financial statements should not be considered an OTTI of the investor’s equity method investment. An OTTI is the difference between the equity method investment’s carrying value and its fair value. In the absence of a reporting time lag, a difference would not exist as of the investor’s balance sheet date for the effects of fair value changes because the investee’s accounting under ASC 946 (i.e., fair value) is retained in the investor’s application of the equity method of accounting. That is, there is no impairment charge, since the carrying value and fair value would be the same.

However, if the investee and the investor have different reporting dates, the fair value reported in the investee’s most recent available financial statements may not be indicative of the fair value as of the investor’s balance sheet date. Therefore, the investor would need to evaluate the OTTI indicators to determine whether an impairment should be recognized.

Footnotes

OTTI classification does not mean that the impairment is permanent.

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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.