6.2 Presentation
6.2.1 Balance Sheet
ASC 323-10
45-1 Under the equity method, an investment in common stock shall be shown in the balance sheet of an investor as a single amount. . . .
SEC Rules, Regulations, and
Interpretations
Regulation S-X, Rule
5-02, Balance Sheets
The purpose of this rule is to indicate
the various line items and certain additional
disclosures which, if applicable, and except as
otherwise permitted by the Commission, should appear on
the face of the balance sheets or related notes filed
for the persons to whom this article pertains (see §
210.4-01(a)).
Regulation S-X, Rule
5-02(12)
Other investments. The accounting
and disclosure requirements for non-current marketable
equity securities are specified by generally accepted
accounting principles. With respect to other security
investments and any other investment, state,
parenthetically or otherwise, the basis of determining
the aggregate amounts shown in the balance sheet, along
with the alternate of the aggregate cost or aggregate
market value at the balance sheet date.
An entity should classify equity method investments as a single amount on its
balance sheet, including the impact of any basis differences and equity investee
impairments recorded by the investor, unless an investment qualifies for
proportionate consolidation (see Section 2.4.3). While multiple equity
method investments should be aggregated into a single line item, it is generally
not appropriate for an entity to combine its equity method investments with
other interests (e.g., such as loans or investments in debt securities) in the
same equity method investee for balance sheet presentation purposes.
In circumstances in which an investor has committed to fund an equity method
investee’s losses, the application of the equity method of accounting may result
in a negative investment balance. In such instances, the entity would recognize
the liability as a single amount in a manner consistent with the recognition of
equity method investment assets. However, the entity should not offset an
investment in an asset position with an investment in a liability position given
that separate investments would not meet the offset criteria outlined in ASC
210-20.
6.2.1.1 SEC Registrants
Regulation S-X, Rule 5-02(12), indicates that the investor should disclose a
separate line item for “[o]ther investments.” Regulation S-X, Rule 4-02,
provides that “[i]f the amount which would otherwise be required to be shown
with respect to any item is not material, it need not be separately set
forth. The combination of insignificant amounts is permitted.” Therefore,
SEC registrants would generally present equity method investments within a
separate investment line item. If this line item includes other investments
that do not reflect the equity method of accounting (because equity method
investments are not material), disclosure of the composition of the line
item in the footnotes may be necessary. Further, the investment balance may
be included in another line item such as “Other Assets” subject to the
materiality consideration outlined in Regulation S-X, Rule 4-02.
6.2.1.2 Other Entities
Entities other than SEC registrants may consider the guidance in Regulation S-X,
Rule 5-02(12), by analogy.
6.2.2 Income Statement
ASC 323-10
45-1 Under the equity method, an investment in common stock shall be shown in the balance sheet of an investor as a single amount. Likewise, an investor’s share of earnings or losses from its investment shall be shown in its income statement as a single amount.
45-2 The investor’s share of accounting changes reported in the financial statements of the investee shall be classified separately.
SEC Rules, Regulations, and
Interpretations
Regulation S-X, Rule
5-03, Statements of Comprehensive Income
(a) The purpose of this rule is to
indicate the various line items which, if applicable,
and except as otherwise permitted by the Commission,
should appear on the face of the statements of
comprehensive income filed for the persons to whom this
article pertains (see § 210.4-01(a)).
Unless an investment qualifies for proportionate consolidation, as discussed in
Section 2.4.3,
an entity should classify equity method investment income or loss as a single
amount in its income statement, including the impact of any basis differences.
In addition, any investor-level impairment would generally be included in the
same line item as equity method income or loss. Multiple investments may be
aggregated into a single line item. However, when income or loss from multiple
investments is aggregated into one line item, it may be necessary to provide
additional disclosures for material investments included in the aggregated
total, as further discussed in Sections 6.3 and 6.4. While this presentation is relatively
simple, the location of this line item in the income statement may vary
depending on facts and circumstances.
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SEC registrants — Regulation S-X, Rule 5-03(b)(12),1 indicates that the investor’s equity in earnings of an unconsolidated subsidiary or “50 percent or less owned [persons]” (i.e., an equity method investee) should be shown after the investor’s income tax provision and before income or loss from continuing operations. However, Rule 5-03(b)(12) also states that “[i]f justified by the circumstances, this item may be presented in a different position and a different manner.” As a result, questions often arise over the appropriate presentation of equity method earnings.
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Classification within revenues — The SEC staff has publicly stated that it is never appropriate to classify earnings of an equity method investee within any revenue amount or revenue caption of the investor.
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Classification as a component of income from operations — The staff does not object to classification of equity in earnings of an equity method investee as a component of income from operations (i.e., before nonoperating income and expenses) if the equity method investee’s operations are “integral” to the investor’s business. In this context, the staff’s definition of integral indicates more than the fact that the investor and investee operate in the same line of business (see the highlights of the March 2003 AICPA SEC Regulations Committee joint meeting with the SEC staff). The registrant should consider the following questions when determining whether the investee is integral to the investor’s business:
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Are intercompany transactions between the investor and the investee significant?
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Is the investee a vital part of the investor’s procurement, production, or distribution functions?
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Is the registrant’s management of the investee (e.g., through a management contract that does not provide control) similar to its management of its consolidated subsidiaries?
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Are the investee’s operations an extension of the investor’s operations, providing additional capacity or critical functions?
If an equity method investee’s earnings are classified within income from operations, such amounts, if material, should be shown as a separate line item within operations and should be clearly disclosed as the investor’s share of equity earnings. -
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Classification as a component of nonoperating income or a similar pretax item — The SEC staff has not provided guidance on the appropriate justification for classification of equity method earnings as other pretax income. Therefore, the staff may challenge registrants that have classified equity method earnings as a component of other income or a similar pretax item. These registrants may be able to use the Regulation S-X, Rule 5-03(b)(12), exception or materiality to justify their classification.Some registrants have proposed that equity method earnings from pass-through entities such as LLCs and partnerships, when material, may be shown as a separate line item in nonoperating income (pretax) through use of the Regulation S-X, Rule 5-03(b)(12), exception. They argue that classification of these amounts after income tax expense distorts the investor’s effective income tax rate since income taxes on the investor’s share of the equity method investee’s earnings must appear in the investor’s income tax provision and must not be shown net of equity method earnings. However, the SEC staff has neither accepted nor objected to classification of equity method earnings as a nonoperating (pretax) item solely on the basis of this potential distortion. Therefore, registrants classifying equity method earnings on this basis should be prepared to provide additional support for their position and consider further consultation with their advisers.
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Other entities — Entities other than SEC registrants may consider the guidance in Regulation S-X, Rule 5-03(b)(12), by analogy but would not be required to do so.
6.2.2.1 Tax Effects
An investee’s income tax expense (benefit) is included as part of an investor’s
share of equity method earnings. However, the tax consequences of the
investor’s equity in earnings and basis differences attributable to its
investment in the investee should be recognized within the investor’s income
tax provision and not as part of the investor’s equity in the investee’s
earnings. In the event that equity in earnings of the investee is presented
below the income tax expense, presentation of the tax effects can be
reflected within this amount.
In a manner similar to business combinations, basis differences may give rise to deferred tax effects (additional inside basis differences — see Section 4.5). To accurately account for its equity method investment, an investor would consider these inside basis differences in addition to any outside basis difference in its investment. Since equity method investments are presented as a single consolidated amount, tax effects attributable to the investor basis differences become a component of this single consolidated amount and are not presented separately in the investor’s financial statements as individual current assets and liabilities or DTAs and DTLs. In addition, to accurately measure those tax assets and liabilities, the investor should use ASC 740 to analyze the investee’s uncertain tax positions. The investor’s share of investee income or loss may ultimately need to be adjusted for investor basis differences, including those for income taxes.
For further information on income taxes, see Deloitte’s Roadmap Income
Taxes.
6.2.2.2 Disposal Transactions
ASC 205-20
45-1B A disposal of a component of an entity or a group of components of an entity shall be reported in discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results when any of the following occurs:
- The component of an entity or group of components of an entity meets the criteria in paragraph 205-20-45-1E to be classified as held for sale.
- The component of an entity or group of components of an entity is disposed of by sale.
- The component of an entity or group of components of an entity is disposed of other than by sale in accordance with paragraph 360-10-45-15 (for example, by abandonment or in a distribution to owners in a spinoff).
45-1C Examples of a strategic shift that has (or will have) a major effect on an entity’s operations and financial results could include a disposal of a major geographical area, a major line of business, a major equity method investment, or other major parts of an entity (see paragraphs 205-20-55-83 through 55-101 for Examples).
If an equity method investee reports discontinued operations, the amounts are nonetheless included in the line item in which the investor reports equity method investment earnings, even though this line item may be included in income from continuing operations. The investor should not report the equity method investee’s discontinued operations as such unless the entire equity method investment earnings amount is presented in discontinued operations as discussed below.
ASU
2014-08 modified the scope of ASC 205-20 to explicitly
include the disposal of equity method investments (for further information
on discontinued operations reporting, see Section 1.3 of Deloitte’s Roadmap
Impairments and
Disposals of Long-Lived Assets and Discontinued
Operations). However, the ASU did not expand the scope of
ASC 360-10; therefore, an equity method investment that does not qualify as
a discontinued operation under ASC 205-20 cannot be reported, and accounted
for, as held for sale. Because the measurement guidance in ASC 360-10 (i.e.,
on impairment considerations) does not pertain to equity method investments,
an entity would continue to apply the measurement guidance in ASC 323. See
Section 5.5
for a discussion of OTTIs.
If an equity method investment qualifies for discontinued operations reporting, an entity must reclassify
the equity method income or loss to income from discontinued operations for all periods presented.
Further, the entity must present the equity method investment as assets held for sale on the balance
sheet for all periods presented and must disclose the information required by ASC 205-20-50.
For disposal transactions that do not qualify for discontinued operations reporting, a gain or loss on
disposal would generally be classified either (1) in the same line item as equity method earnings or
(2) as a separate line item in nonoperating income, gross of tax, before the income tax provision. This
classification would be applicable when an entity disposes of its interest in an equity method investment
or when an investor’s ownership interest in an investee is diluted (i.e., an investee issues additional
equity interests and the investor does not maintain its proportionate ownership interest in the investee).
An investor should disclose its presentation policy.
6.2.3 Other Comprehensive Income
ASC 323-10
45-3 An
investor may combine its proportionate share of investee
other comprehensive income amounts with its own other
comprehensive income components and present the
aggregate of those amounts in the statement in which
other comprehensive income is presented.
An investor must report its proportionate share
of an equity method investee’s OCI, which may include, among other things,
foreign currency translation adjustments, actuarial gains or losses, and gains
and losses on AFS securities. The investor has the option to present a separate
section within its statement of OCI to separately report its own comprehensive
income line items and those of its equity method investee. This option further
requires that the investor include additional disclosure of amounts recognized
before reclassifications and amounts reclassified to earnings in a manner
consistent with ASC 220, as depicted below.
Alternatively, the investor has the option to
combine its share of the investee’s OCI with its own, which results in a
presentation that does not separately identify amounts related to OCI for either
the investor or the investee, as shown below.
6.2.4 Cash Flows
An equity method investor will reflect equity method investment activity only if
it results in cash transfers, such as incremental investments, receipt of
dividends, or other similar transactions. Capital transactions, such as an
initial investment or incremental investment, would generally be recognized as
investing activities. However, the classification in the statement of cash flows
for cash received from equity method investees depends on the company’s policy
for recording such receipts.
An entity must make an accounting policy election to classify distributions received from equity method investees under either of the following methods:
- Cumulative-earnings approach — Under this approach, distributions are presumed to be returns on investment and classified as operating cash inflows. However, if the cumulative distributions received, less distributions received in prior periods that were determined to be returns of investment, exceed the entity’s cumulative equity in earnings, such excess is a return of capital and should be classified as cash inflows from investing activities.
- Nature of the distribution approach — Under this approach, each distribution is evaluated on the basis of the source of the payment and classified as either operating cash inflows or investing cash inflows. If an entity that generally applies this approach does not have enough information to determine the appropriate classification (i.e., the source of the distribution), the entity must apply the cumulative-earnings approach and report a change in accounting principle on a retrospective basis. The entity is required to disclose that a change in accounting principle has occurred as a result of the lack of available information as well as the information required under ASC 250-10-50-1 and 50-2, as applicable.
See Section 6.1.2
of Deloitte’s Roadmap Statement of Cash Flows for further discussion about
the cash flow considerations related to equity method investments.
6.2.5 Earnings per Share
ASC 323-10
60-1 For
guidance on the computation of consolidated earnings per
share (EPS) if equity method investees or corporate
joint ventures have issued options, warrants, and
convertible securities, see paragraph 260-10-55-20.
ASC 260-10
55-20 The effect on consolidated EPS of options, warrants, and convertible securities issued by a subsidiary
depends on whether the securities issued by the subsidiary enable their holders to obtain common stock
of the subsidiary or common stock of the parent entity. The following general guidelines shall be used for
computing consolidated diluted EPS by entities with subsidiaries that have issued common stock or potential
common shares to parties other than the parent entity
- Securities issued by a subsidiary that enable their holders to obtain the subsidiary’s common stock shall be included in computing the subsidiary’s EPS data. Those per-share earnings of the subsidiary shall then be included in the consolidated EPS computations based on the consolidated group’s holding of the subsidiary’s securities. Example 7 (see paragraph 260-10-55-64) illustrates that provision.
- Securities of a subsidiary that are convertible into its parent entity’s common stock shall be considered among the potential common shares of the parent entity for the purpose of computing consolidated diluted EPS. Likewise, a subsidiary’s options or warrants to purchase common stock of the parent entity shall be considered among the potential common shares of the parent entity in computing consolidated diluted EPS. Example 7 (see paragraph 260-10-55-64) illustrates that provision.
55-21 The preceding
provisions also apply to investments in common stock of
corporate joint ventures and investee companies
accounted for under the equity method.
55-22 The if-converted method shall be used in determining the EPS impact of securities issued by a parent entity that are convertible into common stock of a subsidiary or an investee entity accounted for under the equity method. That is, the securities shall be assumed to be converted and the numerator (income available to common stockholders) adjusted as necessary in accordance with the provisions in paragraph 260-10-45-40(a) through (b). In addition to those adjustments, the numerator shall be adjusted appropriately for any change in the income recorded by the parent (such as dividend income or equity method income) due to the increase in the number of common shares of the subsidiary or equity method investee outstanding as a result of the assumed conversion. The denominator of the diluted EPS computation would not be affected because the number of shares of parent entity common stock outstanding would not change upon assumed conversion.
While the guidance above refers to a “subsidiary,” it is equally applicable to equity method investments. Therefore, an equity method investor must evaluate the terms of any securities issued by its equity method investees to determine whether the securities are convertible into shares of either the investee or the investor.
Although the guidance generally does not affect basic EPS, it may affect diluted
EPS. If the securities issued are convertible into common stock of the equity
method investor, they would be treated as securities of the equity method
investor, and the treasury stock or if-converted method would be used to
calculate the dilutive impact. If the securities issued are convertible into
common stock of the equity method investee, they would be considered in the
determination of the equity method investee’s diluted EPS as illustrated in the
example below.
Example 6-1
Entity A holds a 40 percent interest in the common stock of Entity B that it
accounts for under the equity method. Entity A reported
net income of $100,000 (before consideration of its
equity in the earnings of B) and has outstanding common
stock of 5,000 shares. Entity A has not issued any other
securities. Entity B has issued 1,000 shares of common
stock and warrants exercisable to purchase up to 50
shares of its common stock at $5 each. Entity B reported
net income of $3,000. The average market price for B’s
common stock was $10. Earnings are allocated pro rata on
the basis of ownership.
Entity B’s basic EPS would be $3 ($3,000 net income ÷ 1,000 shares). Entity B’s
diluted EPS would be $2.93 ($3,000 net income ÷ 1,025
shares).2
Entity A would then determine its diluted EPS of the investee by adding its
earnings from the 40 percent interest in B of $1,1723 to its net income of $100,000, yielding a
numerator of $101,172 and diluted EPS of $20.23
($101,172 ÷ A’s 5,000 common shares).
Since the warrants are exercisable into B’s shares, the denominator for B must be adjusted. However, since there were no instruments that would affect A’s common shares, the denominator for A’s diluted EPS calculation does not require adjustment.
Footnotes
1
Regulation S-X, Article 5, applies to
financial statements filed for all entities except (1)
registered investment companies; (2) employee stock
purchase, savings, and similar plans; (3) insurance
companies; (4) bank holding companies and banks; and (5)
brokers and dealers when filing Form X-17A-5.
2
Calculated as 1,000 Entity B
common shares + {[($10 average share price − $5
warrant conversion price) ÷ $10 average share
price] × 50 common shares acquired upon conversion
of warrant}.
3
Calculated as Entity B’s diluted
EPS of $2.93 × Entity A’s 400-share interest in
B.