5.6 Change in Level of Ownership or Degree of Influence

An investor’s ownership and degree of influence may change as a result of a variety of transactions, including, but not limited to, the following:

The investor directly acquires or disposes of an investment.
The investee carries out a stock repurchase program, resulting in an increase in the investor’s relative ownership percentage (e.g., the investor does not sell any shares back to the investee or sells fewer than do other investors). Conversely, the investee sells additional shares and dilutes the investor’s relative ownership percentage (e.g., the investor does not purchase any shares from the investee).
The investee emerges from bankruptcy. The investor accounted for its investment under ASC 321 at fair value (unless the measurement alternative was elected)11 during the bankruptcy because it was unable to exercise significant influence over the investee. However, upon emergence, the investor may be able to exercise significant influence again.
The investor’s representation on the investee’s board of directors increases without a corresponding increase in the investor’s investment (e.g., a board member resigns and is not replaced, thereby increasing the investor’s relative representation, or alternatively, the investor is given or gains another seat on the board for no consideration). Conversely, an investor’s representation on the investee’s board of directors decreases without a corresponding decrease in the investor’s investment.

The above changes in the investor’s level of influence will result in the following accounting changes, which are further discussed in this section:

Increase in influence over an equity method investment results in control over the investment (equity method to consolidation); see the next section.
Increase in influence over an investment accounted for in accordance with ASC 321 results in significant influence over the investment (ASC 321 to equity method); see Section 5.6.2.
Increase in influence over an equity method investment results in the continued application of the equity method of accounting (significant influence retained); see Section 5.6.3.
Decrease in influence over an equity method investment results in the continued application of the equity method of accounting (significant influence retained); see Section 5.6.4.
Decrease in influence over an equity method investment results in ownership of an investment accounted for in accordance with ASC 321 (equity method to ASC 321); see Section 5.6.5.
Decrease in the level of ownership interest results in loss of control over the investee (consolidation to equity method); see Section 5.6.7.

5.6.1 Increase in Level of Ownership or Degree of Influence — Control Initially Obtained (From Equity Method to Consolidation Accounting)

If an investor obtains a controlling financial interest in accordance with ASC 810, it should consolidate the investee and stop using the equity method of accounting. The investor should not retrospectively adjust the financial statements to consolidate the investee during the period in which it only had an equity method investment and did not control the investee. To determine the applicable measurement and recognition guidance, the investor should consider whether the investee and investor are under common control as defined in ASC 805-50 (see Appendix B of Deloitte’s Roadmap Business Combinations for more information).

If the investee and investor are not under common control, the investor should consider whether the investee is:

A business as defined in ASC 805-10 (see Deloitte’s Roadmap Business Combinations). In such case, the investor should remeasure its equity interest to fair value as of the acquisition date and recognize any gain or loss from the remeasurement of the previously held equity method investment in earnings. Also, the investor should reclassify the AOCI balance related to the investee and include it in the computation of gain or loss.
A VIE as defined in ASC 810-10 that is not a business. In such case, the VIE should consider the recognition and measurement guidance in ASC 810-10-30-3 and 30-4 (see Appendix C of Deloitte’s Consolidation Roadmap). The primary beneficiary of the VIE should not recognize goodwill and should measure and recognize the assets and liabilities of the VIE in accordance with ASC 805-20-25 and ASC 805-20-30. Also, no gain or loss should be recognized on assets and liabilities that were transferred to the VIE on, after, or shortly before the date the investor became the primary beneficiary of the VIE. The gain or loss should be measured as the difference between (1) the sum of the fair value of the consideration paid, the fair value of any noncontrolling interests, and the reported amount of any previously held interests and (2) the net amount of the VIE’s identifiable assets and liabilities recognized and measured in accordance with ASC 805.

If the investee and investor are under common control, the investor does not remeasure its previously held interests in the investee. Instead, it should measure the newly acquired assets and liabilities at the common-control parent’s historical carrying amounts regardless of whether pushdown accounting was previously applied. The investor should recognize any difference between the consideration paid and the net assets recognized in equity.

If the investee is neither a business nor a VIE, the investor should account for the transaction in which it obtains control as an asset acquisition and consider the guidance in Appendix C of Deloitte’s Roadmap Business Combinations. There are two alternatives available to an investor for determining the cost of assets acquired. Under the first alternative, the investor includes both the carrying value of its preexisting ownership interests and the cost of additional ownership interest as part of the total cost of the assets acquired, which follows the cost accumulation model. Under the second alternative, the investor may analogize to the guidance on business combination in ASC 805-30-30-1 and include the fair value of any previously held interests (after recognizing a gain or loss for the difference between the interest’s fair value and its carrying value), consideration paid, and transaction costs incurred as the total cost of the assets acquired.

5.6.2 Increase in Level of Ownership or Degree of Influence — Significant Influence Initially Obtained (ASC 321 to Equity Method)

ASC 323-10

15-12 An investment in common stock of an investee that was previously accounted for on other than the equity method may become qualified for use of the equity method in accordance with paragraph 323-10-15-3 by an increase in the level of ownership described in that paragraph (that is, acquisition of additional voting stock by the investor, acquisition or retirement of voting stock by the investee, or other transactions). See paragraph 323-10-35-33 for guidance on all changes in an investor’s level of ownership or degree of influence.

35-33 Paragraph 323-10-15-12 explains that an investment in common stock of an investee that was previously accounted for on other than the equity method may become qualified for use of the equity method by an increase in the level of ownership described in paragraph 323-10-15-3 (that is, acquisition of additional voting stock by the investor, acquisition or retirement of voting stock by the investee, or other transactions). If an investment qualifies for use of the equity method (that is, falls within the scope of this Subtopic), the investor shall add the cost of acquiring the additional interest in the investee (if any) to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. The current basis of the investor’s previously held interest in the investee shall be remeasured in accordance with paragraph 321-10-35-1 or 321-10-35-2, as applicable, immediately before adopting the equity method of accounting. For purposes of applying paragraph 321-10-35-2 to the investor’s previously held interest, if the investor identifies observable price changes in orderly transactions for an identical or a similar investment of the same issuer that results in it applying Topic 323, the entity shall remeasure its previously held interest at fair value immediately before applying Topic 323.

35-34 The carrying amount of an investment in common stock of an investee that qualifies for the equity method of accounting as described in paragraph 323-10-15-12 may differ from the underlying equity in net assets of the investee. The difference shall affect the determination of the amount of the investor’s share of earnings or losses of an investee as if the investee were a consolidated subsidiary. However, if the investor is unable to relate the difference to specific accounts of the investee, the difference shall be recognized as goodwill and not be amortized in accordance with Topic 350.

When an investor obtains an additional interest that provides it with significant influence, it must apply the equity method of accounting. This is the case regardless of whether the transaction that leads to significant influence is undertaken by the investor (e.g., a purchase of additional shares) or the investee (e.g., a change in the structure of the board of directors that provides the investor with increased relative influence).

For investments in equity securities that do not require consolidation or application of the equity method, an investor will recognize them at fair value (unless the measurement alternative is elected).12

The guidance requires the equity method to be applied prospectively from the date an investor obtains significant influence. When an investment qualifies for the equity method (as a result of an increase in the level of ownership interest or degree of influence), the cost of acquiring the additional interest in an investee would be added to the current basis of the investor’s previously held interest, and the equity method would be applied subsequently from the date on which the investor obtains the ability to exercise significant influence over the investee.

An entity that applies the measurement alternative in ASC 321 should consider observable transactions that require it to remeasure its equity investment in accordance with that guidance before it applies ASC 323. Therefore, immediately before applying the equity method of accounting, an investor would remeasure its original investment on the basis of the valuation implied by the additional investment in accordance with ASC 321-10-35-1 or 35-2, as applicable. In other instances, qualification for the equity method of accounting can occur without an observable price change (e.g., an increase in the level of influence without an acquisition of an additional interest). If the transaction is not an observable transaction, the investor should add the cost of the new investment to the carrying amount of its existing interest, which would become the initial measurement of the equity method investment in the investee. Under either scenario, the investor must analyze any remaining basis differences after applying the equity method, if applicable.

Example 5-33

Investor A acquires a 5 percent interest in Investee B at the beginning of the fiscal year for $5 million and then acquires an additional 20 percent interest two years later for $24 million, at which time the fair value of the original 5 percent interest is $6 million. The $6 million would therefore be added to the $24 million to represent a $30 million equity method investment. Investor A would also undertake a purchase price allocation to determine any basis difference as of the date significant influence is obtained.

If the investor’s claim to the investee’s carrying value is more than the total cost basis after the addition of the cost of acquiring the additional interest, a negative basis difference will exist. Because the investor records the investments at fair value under ASC 321 before applying the equity method if there is an observable price change, this would generally be limited to instances in which the investor elects the measurement alternative and qualifies for the equity method without an observable price change. In these cases, the guidance in ASC 323 is unclear on how the investor should account for the negative basis difference related to the original investment. We do not believe that it would be acceptable to recognize the negative basis difference immediately in earnings. That is, we do not believe that this circumstance (i.e., an increase in value since the original investment) is akin to a bargain purchase gain as discussed in Section 4.5.1. Rather, the investor should account for the negative basis difference in a manner similar to the amortization or accretion of any other negative basis difference (see Section 5.1.5.2). In some situations, it may be appropriate to defer the recognition of negative basis differences until the investment’s disposal.

5.6.2.1 Investee Bankruptcy

Other transactions, such as the bankruptcy of an investee and its subsequent emergence from bankruptcy, also may result in the discontinuation of the equity method of accounting and its subsequent reinstatement upon the investee’s emergence from bankruptcy.

Example 5-34

Investor A owns a 50 percent interest in Investee B, a joint venture, and uses the equity method to account for its interest. An unrelated company, Investor C, owns the remaining 50 percent interest in B. In 20X7, B voluntarily files for Chapter 11 bankruptcy protection as a result of litigation.

Other than the significant exposure to loss that B could face through adverse findings associated with the litigation, B generates positive earnings and cash flows. However, no distributions are made to equity investors during the bankruptcy proceedings. Investor A is not the guarantor of any obligations of B, nor is A otherwise committed to provide financial support to B. However, as a result of the Chapter 11 filing, A concluded in 20X7 that there was substantial doubt about whether its investment in B would be recovered. Therefore, A wrote off its entire investment in B in accordance with ASC 323-10-35-32.

Investor A concluded that it lost significant influence over B during the bankruptcy proceedings. Therefore, A derecognized the equity method investment, which was fully impaired, and recognized the investment at fair value in accordance with ASC 321 (see Section 5.6.5 for further discussion of the loss of significant influence). The fair value was zero because of the impairment recognized. Investee B is expected to emerge from bankruptcy in 20X9 with a positive equity balance and no change in its ownership structure (i.e., A and C will each continue to own 50 percent of B).

Investor A began to account for its investment in B at fair value during the bankruptcy period because it could no longer exercise significant influence over B. As a result, B’s emergence from bankruptcy is a significant transaction that affects both the cost basis of the investment and the accounting method for the investment; therefore, the emergence from bankruptcy, although not an equity event, is included within the scope of ASC 323-10-35-33 (i.e., an “other transaction”). Accordingly, when B emerges from bankruptcy and A begins applying the equity method of accounting, A should account for any difference between its investment and its share of equity in B’s net assets in accordance with ASC 323-10-35-34, which requires that this difference be assigned and subsequently accounted for in the same manner as a business combination (i.e., basis differences). Assume that A’s share of B’s underlying net assets at emergence is $50 million and A’s share of B’s earnings during the bankruptcy proceedings is $10 million.

In accordance with ASC 323-10-35-33, A would apply the equity method of accounting prospectively. Therefore, the investment balance would be zero at emergence (because the investment was fully impaired and accounted for at fair value throughout the bankruptcy proceedings). Since the investment balance would be zero, A would have a $50 million negative basis difference.

5.6.3 Increase in Level of Ownership or Degree of Influence — Significant Influence Retained

When an investor increases its level of ownership and the equity method of accounting is applicable both before and after the transaction, the investor would account for the acquisition of the additional interest in a manner consistent with that used to account for an initial investment in an equity method investee. The equity method of accounting requires the use of a cost accumulation model, whereby the purchase price is recognized as the initial investment. To the extent that the purchase price differs from the share of the investee’s underlying net assets, the investor must account for any new basis differences accordingly (see Sections 4.5 and 5.1.5.2 for the initial and subsequent measurement, respectively, of basis differences). Since investments accounted for under the equity method are not subject to fair value measurement, the investor may not remeasure the existing equity method investment.

Example 5-35

At the beginning of year 1, Investor A purchases a 25 percent interest in Investee B and accounts for its investment under the equity method of accounting. The purchase price of the investment is $900 million, which includes $100 million of positive basis differences related to fixed assets (with an average useful life of 10 years). In year 1, B earns $200 million in profit. Therefore, A recognizes $40 million in earnings ($50 million share of net income partially offset by a $10 million amortization of the fixed asset basis difference). At the end of year 1, A’s carrying value of the investment is $940 million, composed of an $850 million share of B’s underlying net assets and a $90 million unamortized basis difference related to fixed assets.

At the beginning of year 2, A purchases an additional 5 percent stake in B from a third party for $200 million. Assume that A’s share of B’s underlying net assets (related only to the incremental 5 percent interest) is $170 million. Investor A would record the incremental $200 million purchase price, bringing its aggregate investment to $1.14 billion, which consists of $1.02 billion of A’s share of B’s underlying net assets ($850 million in existing investment + $170 million in incremental investment) and $120 million in basis differences ($90 million in existing investment + $30 million in incremental investment). On the basis of the purchase price paid for the incremental 5 percent interest ($200 million), A’s existing 25 percent interest is worth $1 billion, or ($200 million ÷ 5%) × 25%. However, A may not adjust the existing interest to fair value since the equity method of accounting requires a cost accumulation approach.

5.6.4 Decrease in Level of Ownership or Degree of Influence — Significant Influence Retained

ASC 323-10

35-35 Sales of stock of an investee by an investor shall be accounted for as gains or losses equal to the difference at the time of sale between selling price and carrying amount of the stock sold.

40-1 An equity method investor shall account for a share issuance by an investee as if the investor had sold a proportionate share of its investment. Any gain or loss to the investor resulting from an investee’s share issuance shall be recognized in earnings.

Since equity method investments other than in-substance nonfinancial assets are considered to be financial assets, an investor should first consider the requirements of ASC 860 (see Section 3.1 of Deloitte’s Roadmap Transfers and Servicing of Financial Assets) to determine whether the transfer of financial assets should be considered as a sale before derecognizing the partial investment and recognizing a gain or loss.

An investor’s ownership of or influence over an investee may decline as a result of its own action or the investee’s actions. For example, direct sales of interests by the investor will result in a decline in ownership or influence.13 Similarly, sales of additional shares by the investee will dilute the investor’s influence and ownership if the investor does not purchase additional shares equal to its proportionate ownership interest immediately preceding the additional sale. In either case, a gain or loss should be recognized on the basis of the deemed selling price. When calculating the gain or loss, the investor would include basis differences, if any, which would proportionately reduce its equity method basis differences to reflect the sale or dilution and proportionate reduction in ownership.

Example 5-36

Investor Sells Shares to a Third Party

Investor A holds a 40 percent interest in Investee B. Investor A sells a 5 percent stake in B to a third party for $120 million. Investor A’s stake in B does not represent an in-substance nonfinancial asset, and the transfer meets the definition of a sale in ASC 860. Immediately before the sale, the carrying value of A’s 40 percent interest in B was $800 million, including a $100 million positive basis difference. Investor A would derecognize a proportionate share of the carrying value, including the basis difference, or $100 million, or (5% ÷ 40%) × $800 million. The difference between the cash proceeds (i.e., $120 million) and the carrying value derecognized (i.e., $100 million) represents a gain on the disposal transaction (i.e., $20 million).

Example 5-37

Investee Sells Additional Shares to a Third Party

Investor X holds 15 shares of Investee Y, which represents a 37.5 percent ownership interest. Investee Y issues an additional 10 shares to a third party for $650,000. Immediately before the issuance, Y’s net asset balance was $1.5 million. The carrying value of X’s 37.5 percent interest in Y was $600,000, including a $37,500 positive basis difference. The calculation of X’s dilution, share of proceeds, and investment balance after share issuance is shown in the chart below.

Investee Y’s issuance of shares diluted X’s ownership interest from 37.5 percent to 30 percent, resulting in X’s having effectively disposed of 20 percent, or 1 − (30% ÷ 37.5%), of its interest. Investor X’s investment in Y was $600,000 before the transaction, which includes a $37,500 positive basis difference. Therefore, X must derecognize $120,000 of its investment because of dilution, which would include a proportional reduction of the basis difference. However, X would also share in the increase of Y’s net assets (i.e., the proceeds received from the sale of shares by Y), resulting in an increase in the investment of $195,000.

The net effect of the transaction would be recorded as follows:

5.6.5 Decrease in Level of Ownership or Degree of Influence — Significant Influence Lost (Equity Method to ASC 321)14

ASC 323-10

35-36 An investment in voting stock of an investee may fall below the level of ownership described in paragraph 323-10-15-3 from sale of a portion of an investment by the investor, sale of additional stock by an investee, or other transactions and the investor may thereby lose the ability to influence policy, as described in that paragraph. An investor shall discontinue accruing its share of the earnings or losses of the investee for an investment that no longer qualifies for the equity method. The earnings or losses that relate to the stock retained by the investor and that were previously accrued shall remain as a part of the carrying amount of the investment. The investment account shall not be adjusted retroactively under the conditions described in this paragraph. Upon the discontinuance of the equity method, an investor shall remeasure the retained investment in accordance with paragraph 321-10-35-1 or 321-10-35-2, as applicable. For purposes of applying paragraph 321-10-35-2 to the investor’s retained investment, if the investor identifies observable price changes in orderly transactions for the identical or a similar investment of the same issuer that results in it discontinuing the equity method, the entity shall remeasure its retained investment at fair value immediately after discontinuing the equity method. Topic 321 also addresses the subsequent accounting for investments in equity securities that are not consolidated or accounted for under the equity method.

ASC 321-10

30-1 If an equity security no longer qualifies to be accounted for under the equity method (for example, due to a decrease in the level of ownership), the security’s initial basis for which subsequent changes in fair value are measured shall be the previous carrying amount of the investment. Paragraph 323-10-35-36 states that the earnings or losses that relate to the stock retained by the investor and that were previously accrued shall remain as a part of the carrying amount of the investment and that the investment account shall not be adjusted retroactively. Upon discontinuance of the equity method, an entity shall remeasure the equity security in accordance with paragraph 321-10-35-1 or 321-10-35-2, as applicable. For purposes of applying paragraph 321-10-35-2 to the investor’s retained investment, if the investor identifies observable price changes in orderly transactions for the identical or a similar investment of the same issuer that results in it discontinuing the equity method, the entity shall remeasure its retained investment at fair value immediately after it no longer applies the guidance in Topic 323.

35-1 Except as provided in paragraph 321-10-35-2, investments in equity securities shall be measured subsequently at fair value in the statement of financial position. Unrealized holding gains and losses for equity securities shall be included in earnings.

35-2 An entity may elect to measure an equity security without a readily determinable fair value that does not qualify for the practical expedient to estimate fair value in accordance with paragraph 820-10-35-59 at its cost minus impairment, if any. If an entity identifies observable price changes in orderly transactions for the identical or a similar investment of the same issuer, it shall measure the equity security at fair value as of the date that the observable transaction occurred. An election to measure an equity security in accordance with this paragraph shall be made for each investment separately. Once an entity elects to measure an equity security in accordance with this paragraph, the entity shall continue to apply the measurement guidance in this paragraph until the investment does not qualify to be measured in accordance with this paragraph (for example, if the investment has a readily determinable fair value or becomes eligible for the practical expedient to estimate fair value in accordance with paragraph 820-10-35-59). The entity shall reassess at each reporting period whether the equity investment without a readily determinable fair value qualifies to be measured in accordance with this paragraph. If an entity measures an equity security in accordance with this paragraph (and the security continues to qualify for measurement in accordance with this paragraph), the entity may subsequently elect to measure the equity security at fair value. If an entity subsequently elects to measure an equity security at fair value, the entity shall measure all identical or similar investments of the same issuer, including future purchases of identical or similar investments of the same issuer, at fair value. The election to measure those securities at fair value shall be irrevocable. Any resulting gains or losses on the securities for which that election is made shall be recorded in earnings at the time of the election.

An investor can lose significant influence in various circumstances, including a drop in ownership interest below a certain threshold or a loss in the degree of influence over an investee. In all instances, the investor may no longer apply the equity method of accounting as of the date on which the threshold for applying the equity method no longer exists. That is, the investor must no longer recognize its share of earnings or losses prospectively from that date forward. However, the investor is precluded from reversing any previously recognized earnings or losses; instead, the carrying amount of any remaining investment becomes the new cost basis for the retained interest.

In a manner similar to that discussed in Section 5.6.4, an investor should first consider the guidance in ASC 860 to determine whether the sale or partial sale of its investment represents a true sale under that guidance.

If the investor fully sells its ownership interest, any gain or loss is measured by comparing the carrying amount of the equity method investment with the proceeds from the sale. If the investor retains an interest, any gain or loss is calculated by deducting the carrying value of the portion of the investment disposed from the transaction’s proceeds, which may include either amounts received directly by the investor or the investor’s proportionate share of the increase in the investee’s equity.

If the investor does not fully sell its ownership interest and the retained interest is accounted for at fair value in accordance with ASC 321, subsequent changes in the fair value of the investment after the equity method is discontinued are recognized in earnings. Although the previous carrying amount of the equity method investment becomes the cost basis under ASC 321, the fair value measurement objective will frequently result in the remeasurement of the entire retained interest to fair value through earnings. See Example 5-38 for an illustration of the accounting.

Further, as discussed in Section 5.6.2, an entity that applies the measurement alternative under ASC 321 should consider observable transactions that require it to discontinue application of the equity method upon discontinuing the application of the guidance in ASC 323.

Example 5-38

Investor Sells Shares to a Third Party

Investor X holds 10,000 shares (a 25 percent interest) in Investee Y and sells 4,000 shares to a third party for $250 million. The sale results in X’s ceasing to have significant influence. Investor X must discontinue the application of the equity method of accounting, recognize a gain or loss for the interest disposed of, and account for the remaining interest. Assume the following:

The difference between the carrying value of $240 million derecognized and the cash proceeds of $250 million represents a gain on the disposal transaction of $10 million. The initial carrying value of the retained interest would be $360 million.

The retained interest would be accounted for in accordance with ASC 321. If the retained interest has a readily determinable fair value, X would immediately adjust the carrying value of the retained interest to fair value, with any gain or loss recognized in earnings. If the retained interest does not have a readily determinable fair value and X elects the measurement alternative,15 the sale of shares to a third party would be likely to provide sufficient observable evidence of the fair value of the retained interest, resulting in a gain recognized in earnings to adjust the initial carrying value to the fair value implied by the transaction.

Example 5-39

Investee Sells Additional Shares

Investor X holds 10,000 shares (a 25 percent interest) in Investee Y. Investee Y issues 15,000 additional shares to a third party for $950 million, which causes X to lose significant influence. Investor X must discontinue the application of the equity method of accounting, recognize a gain or loss for the deemed sale of a portion of its interest, and account for the remaining interest. Assume the following:

Investor X will record a gain of $9.03 million, equal to the difference between (1) the deemed proceeds from the issuance of $172.71 million ($950 million × 18.18%) and (2) the carrying value of X’s net investment sold of $163.68 million ($600 million × 27.28%). The initial carrying value of the retained interest would be $609.03 million.

The retained interest would be accounted for in accordance with ASC 321. If the retained interest has a readily determinable fair value, X would immediately adjust the carrying value of the retained interest to fair value, with any gain or loss recognized in earnings. If the retained interest does not have a readily determinable fair value and X elects the measurement alternative,16 the sale of shares to a third party would be likely to provide sufficient observable evidence of the fair value of the retained interest, resulting in a gain recognized in earnings to adjust the initial carrying value to the fair value implied by the transaction.

5.6.5.1 OCI Upon Discontinuation of the Equity Method of Accounting

ASC 323-10

35-37 Paragraph 323-10-35-39 provides guidance on how an investor shall account for its proportionate share of an investee’s equity adjustments for other comprehensive income in all of the following circumstances:

A loss of significant influence
A loss of control that results in accounting for the investment in accordance with Topic 321
Discontinuation of the equity method for an investment in a limited partnership because the conditions in paragraph 970-323-25-6 are met for accounting for the investment in accordance with Topic 321.

35-38 Paragraph 323-10-35-39 does not provide guidance for entities that historically have not recorded their proportionate share of an investee’s equity adjustments for other comprehensive income. That paragraph does not provide guidance on the measurement and recognition of a gain or loss on the sale of all or a portion of the underlying investment.

35-39 In the circumstances described in paragraph 323-10-35-37, an investor’s proportionate share of an investee’s equity adjustments for other comprehensive income shall be offset against the carrying value of the investment at the time significant influence is lost. To the extent that the offset results in a carrying value of the investment that is less than zero, an investor shall both:

Reduce the carrying value of the investment to zero
Record the remaining balance in income.

When an investor disposes of its entire interest in an investee, accounting for AOCI is straightforward. Upon disposition, the investor’s share of the investee’s AOCI should be reclassified and recognized in income by the investor. For partial disposals, a similar concept applies: the investor would determine the proportion of its investment that has been disposed and reclassify and recognize in income a proportional amount of AOCI. However, upon transition from the equity method of accounting, the investor must also adjust the AOCI related to the retained investment. Specifically, the investor’s share of AOCI related to the retained investment must be reclassified as an offset to the carrying value of the retained investment. To the extent that this reclassification reduces the carrying amount to zero, any excess would be recognized in income. To the extent that the reclassification increases the carrying amount (i.e., a loss is reclassified from AOCI), the investor should consider whether an impairment indicator exists.

Example 5-40

Investor Sells Shares to a Third Party

Investor X holds a 25 percent interest in Investee Y that is accounted for under the equity method of accounting. Investor X sells a 10 percent interest in Y to a third party for $250 million, which results in X’s investment’s no longer qualifying for the equity method. In addition to the facts and entries made in Example 5-38, assume that X has recognized a $50 million gain in AOCI related to its investment in Y. Since X has disposed of 40 percent (10% ÷ 25%) of its interest, $20 million of the gain in AOCI will be recognized in income upon the discontinuance of the equity method of accounting. The remaining $30 million of gain in AOCI will be reclassified against the carrying value of the retained interest ($360 million), resulting in a carrying amount of $330 million.

Example 5-41

Investor Sells Shares to a Third Party

Assume the same facts as in the example above, except that the amount of the gain deferred in AOCI is $700 million. Since Investor X has disposed of 40 percent of its interest, $280 million of the gain in AOCI will be recognized in income upon loss of significant influence. The remaining $420 million of gain in AOCI will be reclassified against the carrying value of the retained interest ($360 million), resulting in a carrying amount of nil and an additional gain of $80 million.

5.6.6 Decrease in Level of Ownership or Degree of Influence — Full Disposal of Equity Method Investment

Transfers of equity method investments are within the scope of ASC 860 unless those transfers represent in-substance nonfinancial assets.

Accordingly, for equity method investments that do not meet the definition of in-substance nonfinancial assets, an investor applies ASC 860 when accounting for the derecognition of its equity method investment. See Deloitte’s Roadmap Transfers and Servicing of Financial Assets for more information.

For equity method investments that do meet the definition of in-substance nonfinancial assets, the investor should apply ASC 610-20 when accounting for the derecognition of its equity method investment. See Deloitte’s Roadmap Revenue Recognition for additional guidance.

5.6.7 Decrease in Level of Ownership Interest Results in Loss of Control Over the Investee (Consolidation to Equity Method)

Upon a decrease in the ownership interest of a consolidated subsidiary, an investor should perform an assessment under ASC 810-10 to determine whether it has retained a controlling financial interest in the subsidiary. If the investor loses a controlling financial interest over the former subsidiary but retains a noncontrolling investment in common stock or in-substance common stock that gives it significant influence over that investee, the investor is required to apply the equity method of accounting to its retained interest.

If the parent ceases to have a controlling financial interest in a subsidiary but still retains an investment that will be accounted for under the equity method in accordance with ASC 323-10, the parent should deconsolidate the subsidiary and recognize a gain or loss in accordance with ASC 810-10-40-5. As of the date the loss of control occurs, the former parent remeasures, at fair value, its retained investment and includes any resulting adjustments as part of the gain or loss recognized upon deconsolidation. The fair value of the retained investment represents the investor’s cost basis in the investee’s net assets and should be used in assessing basis differences as described in Section 4.5. The parent must apply the equity method of accounting prospectively from the date control over the subsidiary is relinquished and should not revise its prior-period presentation to reflect deconsolidation of the subsidiary and application of the equity method of accounting.

When an entity loses a controlling financial interest in a subsidiary that does not represent a business in a transaction that, in substance, is addressed by other GAAP, the entity must apply such other GAAP (see ASC 810-10-40-3A(c)). For instance, upon the loss of a controlling financial interest in a subsidiary that does not represent a business in a transaction that, in substance, represents the transfer of nonfinancial or in-substance nonfinancial assets (or both) to a noncustomer, a reporting entity applies ASC 610-20 to determine any gain or loss on the derecognition of such assets. See Section 17.2.1 of Deloitte’s Roadmap Revenue Recognition for a discussion of in-substance nonfinancial assets that are within the scope of ASC 610-20 and Appendix F of Deloitte’s Consolidation Roadmap for more information.

5.6.8 Other Considerations

5.6.8.1 Dissolution

Upon dissolution of an investee, the investor should determine whether the net assets received from the investee as part of the dissolution meet the definition of a business under ASC 805-10 or whether the investor obtains a controlling financial interest over a VIE as defined in ASC 810. In such cases, the investor should account for the net assets obtained by using acquisition accounting in accordance with ASC 805 (see Deloitte’s Roadmap Business Combinations). At the time of dissolution, the investor should recognize the difference between the carrying value and fair value of the equity method investment as a gain or loss in the income statement since the fair value of the investor’s equity method investment at dissolution is deemed to be the consideration transferred. If the net assets received do not meet the definition of a business in accordance with ASC 805 or the investor does not obtain a controlling financial interest over the VIE, the transaction may be within the scope of the asset acquisition guidance under ASC 805-50, the guidance on nonmonetary transactions under ASC 845, the guidance on transfers of financial assets under ASC 860, or other U.S. GAAP, depending on the nature of the net assets transferred and the transaction.

5.6.8.2 Spin-Off Transactions

The investor’s accounting for an investee spin-off transaction depends on whether the distribution of shares by the investee is completed on a pro rata or non–pro rata basis as follows:

Pro rata distribution — The investor receiving the distribution should allocate the previous investment between the spinnor and shares received in the spinoff (i.e., the investor accounts for the distribution as a deemed distribution to the shareholders at the carrying amount of the investment).
Non–pro rata distribution — The investor recognizes a gain or loss from the transaction in the income statement. The gain or loss should equal the difference between the fair value of the shares received and the investor’s carrying amount of the proportionate share in the investee that was sold, including its share of unamortized basis differences, if any.

5.6.8.3 Common-Control Contributions

In a common-control transaction, an investee receives assets from its parent or an associate in exchange for additional shares, resulting in the investee’s recognizing the assets at the parent’s carrying basis. However, a third-party investor accounting for its ownership interest under the equity method (if there is one) is required to determine the dilution gain or loss by using the fair values of (1) the assets contributed and (2) additional interests issued to the parent company. The third-party investor should track and adjust any basis differences by using its memo accounts.

Footnotes

See ASC 321-10-35-2.

See footnote 11.

Accounting for the sale of an equity method investment may fall within the scope of ASC 860. The guidance provided herein discusses the impact on the application of the equity method of accounting; however, financial statement preparers should also consider the requirements of ASC 860 when determining the appropriate accounting treatment for the sale transaction.

See footnote 11.

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.