Deloitte's Roadmap: Equity Method Investments and Joint Ventures

Preface

On the Radar

Contacts

Chapter 1 — Overview

ASC 323-10

05-4 Investments held in stock of entities other than subsidiaries, namely corporate joint ventures and other noncontrolled entities usually are accounted for in accordance with either the recognition and measurement guidance in Subtopic 321-10 or the equity method. This Subtopic provides guidance on application of the equity method. The equity method is an appropriate means of recognizing increases or decreases measured by generally accepted accounting principles (GAAP) in the economic resources underlying the investments. Furthermore, the equity method of accounting closely meets the objectives of accrual accounting because the investor recognizes its share of the earnings and losses of the investee in the periods in which they are reflected in the accounts of the investee. The equity method also best enables investors in corporate joint ventures to reflect the underlying nature of their investment in those ventures.

05-5 The equity method tends to be most appropriate if an investment enables the investor to influence the operating or financial decisions of the investee. The investor then has a degree of responsibility for the return on its investment, and it is appropriate to include in the results of operations of the investor its share of the earnings or losses of the investee. Influence tends to be more effective as the investor’s percent of ownership in the voting stock of the investee increases. Investments of relatively small percentages of voting stock of an investee tend to be passive in nature and enable the investor to have little or no influence on the operations of the investee.

05-6 In addition to the joint venture guidance included in this Topic, the accounting and reporting for real estate joint ventures is addressed in Subtopic 970-323.

When determining the appropriate accounting for its ownership interest in an investee,1 the investor2 must consider the form and substance of the investment as well as the legal form of the investee. If the investor does not control the investee and is not required to consolidate it (see Deloitte’s Roadmap Consolidation — Identifying a Controlling Financial Interest (“Consolidation Roadmap”) for further information regarding considerations on whether consolidation is required), the investor determines whether it should account for such an investment under the equity method of accounting. If the investment does not meet the criteria for the use of the equity method of accounting, it should be recorded at fair value in accordance with ASC 321 unless the measurement alternative is elected3 or in accordance with ASC 320 in instances in which the investment represents a debt security.

Generally, the equity method of accounting should be applied when the investor has the ability to exercise significant influence over the operating and financial decisions of the investee. The ability to exercise significant influence over the investee is mainly driven by the investor’s ownership interest in the investee (see Section 3.2); however, to have significant influence, the investor must have an investment in common stock or in-substance common stock4 (see Section 2.5). There are also other factors that may indicate that the investor has the ability to exercise significant influence, such as board representation, participation in policy-making processes, veto rights, material intra-entity transactions, interchange of managerial personnel, technological dependency, and others (see Section 3.3). Therefore, when determining whether it has an ability to exercise significant influence over the investee, the investor must consider all relationships and interests (voting and nonvoting) that involve the investee.

In addition, the legal form of an investee is important in the determination of whether the equity method of accounting is appropriate. Although ASC 323-10 provides guidance on investments in the common stock of corporations (including corporate joint ventures), many of the provisions in ASC 323-10 also apply to investments in noncorporate entities, such as partnerships, limited liability companies (LLCs), and unincorporated joint ventures (see Section 2.2). For example, investments in partnerships and certain LLCs that maintain specific ownership accounts for each investor have unique rules that can result in an investor’s application of the equity method of accounting with as little as 3 percent to 5 percent of the ownership interest in the investee, as further discussed in Chapter 2.

The decision tree below illustrates the relevant questions to be considered in the determination of whether the investment should be accounted for under the equity method of accounting.

The presentation of equity method investments is often referred to as a “one-line consolidation.” The equity method investment is initially recorded at cost; however, the investor must account for the differences between the cost of an investment and the underlying equity in the net assets of the investee (i.e., basis differences) as if the investee was a consolidated subsidiary (see Chapter 4). Subsequently, the carrying amount of the equity method investment is adjusted to recognize the investor’s proportionate share of the investee’s earnings or losses or changes in capital (see Chapter 5), generally in the periods in which they are reflected in the accounts of the investee.

ASC 323-10 also outlines additional disclosure requirements that must be considered (see Chapter 6).

ASC 323-740 includes guidance on the application of the proportionate amortization method, which can be applied to tax equity investments meeting certain criteria (see Appendix C and Appendix D).

Some investors are affected by both U.S. GAAP and IFRS® Accounting Standards. Significant differences between the guidance in ASC 323-10 and the equivalent guidance under IFRS Accounting Standards are discussed in Appendix B.

Appendix A of this Roadmap includes defined terms from the glossaries of ASC 323-10, ASC 970-323, and ASC 974-323.

Connecting the Dots

Throughout this Roadmap, “joint ventures” refers to “corporate joint ventures,” as defined by ASC 323-10-20. The investors (i.e., venturers) in a joint venture typically apply the equity method of accounting to their investment. Although the provisions for the equity method are usually the same for joint ventures as for any other legal entity, there are some unique accounting considerations for the venturers and the joint venture itself. We address the distinctive characteristics of joint ventures in Chapter 7 and the related accounting by the joint venture and the venturers in Chapters 8, 9, and 10, respectively.

The table below summarizes some of the possible outcomes illustrated in the above decision tree.

Consolidation (ASC 810)	Equity Method5 (ASC 323)	Fair Value (ASC 321)
Applies to financial interests that provide the holder with a controlling financial interest in the investee. Requires consolidation of the investee. See Deloitte’s Consolidation Roadmap.	Applies to investments in common stock or in-substance common stock of an investee in which: The investee is a corporation. The investor does not have a controlling financial interest in the investee. The investor has significant influence over the investee. The investor does not elect the fair value option for its investment.	Applies to investments in equity securities that do not give the investor a controlling financial interest in the investee or significant influence over the investee. Changes in fair value are recognized through earnings.

Footnotes

Throughout this Roadmap, “investee” refers to the entity that issued the equity instrument that is being analyzed for potential accounting under the equity method of accounting.

Throughout this Roadmap, “investor” refers to the party applying or determining whether it should apply the equity method of accounting to its investment.

Under ASC 321, entities may elect a practicability exception to fair value measurement if (1) they do not qualify for the practical expedient in ASC 820-10-35-59 and (2) the equity security does not have a readily determinable fair value. Specifically, ASC 321-10-35-2 states, in part, that an entity may “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.”

Unless stated otherwise, throughout this Roadmap, references to common stock include in-substance common stock.

An investment in a partnership or LLC that maintains specific ownership accounts may also be subject to the equity method of accounting. Generally, ownership of greater than 3 percent to 5 percent in a limited partnership triggers equity method accounting.

Chapter 2 — Scope and Scope Exceptions

2.1 Overview

ASC 323-10

15-2 The guidance in the Investments — Equity Method and Joint Ventures Topic applies to all entities.

15-3 The guidance in the Investments — Equity Method and Joint Ventures Topic applies to investments in common stock or in-substance common stock (or both common stock and in-substance common stock), including investments in common stock of corporate joint ventures (see paragraphs 323-10-15-13 through 15-19 for guidance on identifying in-substance common stock). Subsequent references in this Subtopic to common stock refer to both common stock and in-substance common stock that give the investor the ability to exercise significant influence (see paragraph 323-10-15-6) over operating and financial policies of an investee even though the investor holds 50% or less of the common stock or in-substance common stock (or both common stock and in-substance common stock).

This chapter discusses considerations related to scope — that is, which investments should and should not be accounted for under the equity method of accounting.

ASC 323-10 may apply to any entity that has an investment in the common stock and in-substance common stock of an investee. As defined in ASC 323-10-20, common stock (or common shares) is “[a] stock that is subordinate to all other stock of the issuer.” Holders of common stock generally have the right to elect members of the board of directors and to vote on corporate policy, both of which allow those shareholders to influence the operating and financial policies of an investee. Because common stock represents the residual value of an investee, in the event of liquidation, common shareholders have rights to a company’s assets only after all other senior claims (e.g., those of bondholders, preferred shareholders, and other debt holders) are paid in full. In-substance common stock represents an instrument that, although not in the legal form of common stock, has characteristics that are substantively similar to those of common stock.

Before an investor applies ASC 323-10 to an investment in an investee, it should evaluate whether any scope exceptions apply (see Section 2.3) and, if not, whether it has the ability to exercise significant influence over the operating and financial policies of that investee (see Chapter 3). The equity method of accounting applies only when the investor has an investment in common stock or in-substance common stock and, accordingly, should not be used when an investment in common stock (or in-substance common stock) does not exist, even if the investor holds other investments that allow it to exercise significant influence over the investee. However, if the investor holds both common stock (or in-substance common stock) and other investments, it should consider the rights provided by all such instruments in evaluating whether, in combination, they permit the investor to exercise significant influence over the investee.

Many of the provisions in ASC 323-10 apply to investments in the common stock of corporations (including corporate joint ventures), as well as to investments in noncorporate entities, such as partnerships, LLCs, unincorporated joint ventures (see Section 2.2), and any other form of legal entity.

Corporate and unincorporated joint ventures (collectively, “joint ventures”) are a common form of business enterprise. Although an investor in a joint venture will generally account for its investment in a joint venture the same way it would for any other equity method investment under ASC 323-10, there are some nuances, which are discussed in Chapter 10.

2.5 Investments in In-Substance Common Stock

2.5.1 Characteristics of In-Substance Common Stock

ASC 323-10

15-13 For purposes of this Topic, in-substance common stock is an investment in an entity that has risk and reward characteristics that are substantially similar to that entity’s common stock. An investor shall consider all of the following characteristics when determining whether an investment in an entity is substantially similar to an investment in that entity’s common stock:

Subordination. An investor shall determine whether the investment has subordination characteristics that are substantially similar to that entity’s common stock. If an investment has a substantive liquidation preference over common stock, it is not substantially similar to the common stock. However, certain liquidation preferences are not substantive. An investor shall determine whether a liquidation preference is substantive. For example, if the investment has a stated liquidation preference that is not significant in relation to the purchase price of the investment, the liquidation preference is not substantive. Further, a stated liquidation preference is not substantive if the investee has little or no subordinated equity (for example, common stock) from a fair value perspective. A liquidation preference in an investee that has little or no subordinated equity from a fair value perspective is nonsubstantive because, in the event of liquidation, the investment will participate in substantially all of the investee’s losses.
Risks and rewards of ownership. An investor shall determine whether the investment has risks and rewards of ownership that are substantially similar to an investment in that entity’s common stock. If an investment is not expected to participate in the earnings (and losses) and capital appreciation (and depreciation) in a manner that is substantially similar to common stock, the investment is not substantially similar to common stock. If the investee pays dividends on its common stock and the investment participates currently in those dividends in a manner that is substantially similar to common stock, then that is an indicator that the investment is substantially similar to common stock. Likewise, if the investor has the ability to convert the investment into that entity’s common stock without any significant restrictions or contingencies that prohibit the investor from participating in the capital appreciation of the investee in a manner that is substantially similar to that entity’s common stock, the conversion feature is an indicator that the investment is substantially similar to the common stock. The right to convert certain investments to common stock (such as the exercise of deep-in-the-money warrants) enables the interest to participate in the investee’s earnings (and losses) and capital appreciation (and depreciation) on a substantially similar basis to common stock.
Obligation to transfer value. An investment is not substantially similar to common stock if the investee is expected to transfer substantive value to the investor and the common shareholders do not participate in a similar manner. For example, if the investment has a substantive redemption provision (for example, a mandatory redemption provision or a non-fair-value put option) that is not available to common shareholders, the investment is not substantially similar to common stock. An obligation to transfer value at a specious future date, such as preferred stock with a mandatory redemption in 100 years, shall not be considered an obligation to transfer substantive value.

15-14 If an investment’s subordination characteristics and risks and rewards of ownership are substantially similar to the common stock of the investee and the investment does not require the investee to transfer substantive value to the investor in a manner in which the common shareholders do not participate similarly, then the investment is in-substance common stock. If the investor determines that any one of the characteristics in the preceding paragraph indicates that an investment in an entity is not substantially similar to an investment in that entity’s common stock, the investment is not in-substance common stock. If an investee has more than one class of common stock, the investor shall perform the analysis described in the preceding paragraph and the following paragraph (if necessary) by comparing its investment to all classes of common stock.

15-15 If the determination about whether the investment is substantially similar to common stock cannot be reached based solely on the evaluation under paragraph 323-10-15-13, the investor shall also analyze whether the future changes in the fair value of the investment are expected to vary directly with the changes in the fair value of the common stock. If the changes in the fair value of the investment are not expected to vary directly with the changes in the fair value of the common stock, then the investment is not in-substance common stock.

Over time, the type and form of investment vehicles have expanded beyond basic voting common stock to include convertible debt, preferred equity securities, options, warrants, interests in unincorporated entities, complex licensing and management arrangements, and a host of other financial instruments. EITF Issue 02-14 (codified in ASC 323-10) noted:

These investment vehicles can convey — by contract, articles of incorporation, indenture, or other means — any combination of rights, privileges, or preferences including (a) the right to vote with common stockholders, (b) the right to appoint members of the board of directors, (c) substantive participating rights . . . , (d) protective rights . . . , (e) cumulative and participating dividends, and (f) liquidation preferences.

Some of these rights may give an investor the ability to exercise significant influence over the operating and financial policies of an investee without holding an investment in the investee’s voting common stock. When an investment in other than common stock (debt, preferred equity securities, etc.) has all the factors in ASC 323-10-15-13, it is considered to be “in-substance” common stock, and the investor should apply the equity method if it also has significant influence over the investee. If the investment does not have all the factors in ASC 323-10-15-13, it would not be within the scope of ASC 323-10, and the equity method of accounting would be inappropriate even if the holder of the investment has significant influence over the investee.

Examples of investments that may have the characteristics of in-substance common stock include convertible stock or warrants (with no barriers to exercise), stock with a nonsubstantive liquidation preference, and participating stock redeemable at the holder’s option. Examples of investments that would generally not be considered in-substance common stock include mandatorily redeemable stock, stock with an embedded non-fair-value put option, stock with a substantive liquidation preference, and nonparticipating, nonconvertible preferred stock.

An investor may also hold an instrument (such as a call or a put option) that gives it the ability to purchase or sell the voting common stock of an investee at some point. In evaluating whether such instruments represent in-substance common stock, an investor must first determine whether the put or call option is a freestanding instrument. If the instrument is not freestanding, the investor should further determine whether the put or call option is an embedded feature within a host arrangement that requires bifurcation and separate accounting. The equity method of accounting does not apply to either a freestanding instrument or bifurcated embedded feature since those instruments are accounted for in accordance with ASC 815 (see Section 2.3). Put and call options, as well as other instruments that are not accounted for under ASC 815 (i.e., the host instrument), may have the characteristics in ASC 323-10-15-13 and therefore represent in-substance common stock.

ASC 323-10 contains examples that illustrate the evaluation of whether an investment is in-substance common stock (see Sections 2.5.1.1 through 2.5.1.3). Each example assumes that the investor is not required to consolidate the investee under ASC 810-10, that it has the ability to exercise significant influence over the operating and financial policies of the investee (see Chapter 3), and that its investment does not meet the definition of a derivative instrument under ASC 815.

It is important to note that EITF Issue 02-14 provided the initial guidance on the evaluation of in-substance common stock. Paragraph 5 of EITF Issue 02-14 states, in part:

This Issue does not apply to investments accounted for under Statement 133, non-corporate entities accounted for under SOP 78-9, or to limited liability companies that maintain “specific ownership accounts” for each investor as discussed in Issue No. 03-16, “Accounting for Investments in Limited Liability Companies.

We believe that the EITF Issue 02-14 scoping guidance continues to be applicable and, accordingly, the in-substance common stock guidance in ASC 323-10-15-3 through 15-5 should be applied only to investments in corporations. Thus, it would not apply, for example, to investments in partnerships, LLCs, trusts, or other unincorporated entities that maintain specific ownership accounts (see Section 2.2) or to investments within the scope of ASC 815 (see Section 2.3).

2.5.1.1 Subordination

ASC 323-10

Case A: Subordination Substantially Similar to Common Stock

55-3 Investor organized Investee and acquired all of the common stock of Investee on January 1, 2003. On January 1, 2004, Investee sells 100,000 shares of preferred stock to a group of investors in exchange for $10,000,000 ($100 par value; liquidation preference of $100 per share). The fair value of the entity’s common stock is approximately $100,000 on January 1, 2004.

55-4 In this Case, the stated liquidation preference is equal to the fair value of the preferred stock. However, the fair value of the common stock ($100,000), if compared with the fair value of the preferred stock, indicates that Investee has little or no common stock from a fair value perspective. An investor should therefore conclude that the liquidation preference is not substantive and that the subordination characteristics of its preferred stock investment are substantially similar to the subordination characteristics of Investee’s common stock. The investor should also evaluate whether the preferred stock has the characteristics in paragraph 323-10-15-13(b) through 15-13(c), and paragraphs 323-10-15-14 through 15-15 (if necessary) to reach a conclusion about whether the preferred stock is in-substance common stock.

Case B: Subordination Not Substantially Similar to Common Stock

55-5 Assume the same facts and circumstances as in Case A, except that the fair value of Investee’s common stock is approximately $15,000,000 on January 1, 2004.

55-6 In this Case, the stated liquidation preference is equal to the fair value of the preferred stock. In addition, Investee has adequate subordinated equity from a fair value perspective (more than little or no subordinated equity) to indicate that the liquidation preference is substantive. An investor therefore should conclude that the subordination characteristics of its preferred stock investment are not substantially similar to the subordination characteristics of Investee’s common stock. Accordingly, the preferred stock investment is not in-substance common stock. Evaluation of the characteristics in paragraph 323-10-15-13(b) through 15-13(c) and paragraphs 323-10-15-14 through 15-15 is not required.

To determine whether a liquidation preference is substantive, an investor should consider the significance of the stated liquidation preference in relation to the purchase price of the investment as well as the significance of the fair value of the subordinated equity (i.e., common stock) of the investee. Said differently, a stated liquidation preference is not considered substantive if the investee has little or no subordinated equity from a fair value perspective. The table below summarizes indicators (not all inclusive) of whether an investment’s subordination characteristics are substantially similar to those of common stock.

Substantially Similar	Not Substantially Similar
The stated liquidation preference is not significant in relation to the purchase price (or there is no stated liquidation preference). There is little or no fair value associated with the investee’s common stock; therefore, in the event of liquidation, the investment would most likely participate in substantially all of the investee’s losses. ASC 323 does not provide a definition of “little or no value.” However, Case A above does provide an example in which the investee’s common stock was 1 percent of the preferred stock, which was concluded to be nonsubstantive. Although we do not believe that 1 percent is a bright line, and all facts and circumstances should be considered, the example provides insight into a threshold that would be considered “little or no value.”	The stated liquidation preference is significant in relation to the purchase price. The fair value of the investee’s common stock is significant. Therefore, in the event of liquidation, the investment would be protected since common stock would most likely absorb a substantial portion of the investee’s losses.

Substantially Similar

Not Substantially Similar

The stated liquidation preference is not significant in relation to the purchase price (or there is no stated liquidation preference).
There is little or no fair value associated with the investee’s common stock; therefore, in the event of liquidation, the investment would most likely participate in substantially all of the investee’s losses. ASC 323 does not provide a definition of “little or no value.” However, Case A above does provide an example in which the investee’s common stock was 1 percent of the preferred stock, which was concluded to be nonsubstantive. Although we do not believe that 1 percent is a bright line, and all facts and circumstances should be considered, the example provides insight into a threshold that would be considered “little or no value.”

The stated liquidation preference is significant in relation to the purchase price.
The fair value of the investee’s common stock is significant. Therefore, in the event of liquidation, the investment would be protected since common stock would most likely absorb a substantial portion of the investee’s losses.

2.5.1.2 Risks and Rewards of Ownership

ASC 323-10

Case C: Investment Expected to Participate in Risks and Rewards of Ownership

55-7 Investor purchases a warrant in Investee for $2,003,900 on July 1, 20X4. The warrant enables Investor to acquire 100,000 shares of Investee’s common stock at an exercise price of $1.00 per share (total exercise price of $100,000) on or before June 30, 20X5; the warrant does not participate in dividends. The fair value of the common stock is approximately $21.00 per share. The warrant is exercisable at any time. Investor does not expect Investee to declare dividends before exercise.

55-8 Investor should evaluate whether the warrant is expected to participate in Investee’s earnings (and losses) and capital appreciation (and depreciation) in a manner that is substantially similar to common stock. To evaluate the extent to which the warrant is expected to participate with the common shareholders in Investee’s earnings (and losses), Investor should evaluate whether the warrant allows Investor to currently participate in dividends on a basis substantially similar to common stock. In this Case, Investor does not participate in dividends. Investor, however, can exercise the warrant (convert into common stock) at any time, thereby enabling Investor to participate in Investee’s earnings (and losses) on an equivalent basis to common stock. Because Investor does not expect Investee to declare dividends before exercise, Investor participates in Investee’s earnings in a manner substantially similar to common stock. In addition, warrants that are exercisable into common stock are designed to participate equally with the common shareholders in increases in the Investee’s fair value. Therefore, the warrant participates in Investee’s capital appreciation.

55-9 Investor should also evaluate whether the warrant is expected to participate in Investee’s capital depreciation in a manner substantially similar to common stock. An investor has alternatives for making this evaluation. In this Case, Investor could compare the current fair value of Investee’s common stock with the fair value of the warrant (on an equivalent unit basis) to determine whether the warrant is exposed to capital depreciation in a manner that is substantially similar to the entity’s common stock. The current fair value of the Investee’s common stock of $21.00 is substantially similar to the current fair value of each warrant of $20.04 (on an equivalent unit basis). Therefore, the warrant’s expected participation in Investee’s capital depreciation is substantially similar to the common shareholders’ participation. This comparison of fair values is different from the paragraph 323-10-15-15 evaluation that is performed (if necessary) to determine whether the future changes in fair value of the investment are expected to vary directly with the changes in the fair value of the entity’s common stock.

55-10 Accordingly, Investor should conclude that, before exercise, the warrants are expected to participate in Investee’s earnings (and losses) and capital appreciation (and depreciation) in a manner that is substantially similar to common stock. Investor should also evaluate whether the warrant has the characteristics in paragraph 323-10-15-13(a) and 323-10-15-13(c) and paragraphs 323-10-15-14 through 15-15 (if necessary) to reach a conclusion about whether the warrant is in-substance common stock.

Case D: Investment Not Expected to Participate in Risks and Rewards of Ownership

55-11 Investor purchases a warrant in Investee for $288,820 on July 1, 20X4. The warrant enables Investor to acquire 100,000 shares of Investee’s common stock at an exercise price of $21.00 per share (total exercise price of $2,100,000) on or before June 30, 20X5; the warrant does not participate in dividends. The fair value of the common stock is approximately $21.00 per share. The warrant is exercisable at any time. Investor does not expect Investee to declare dividends before exercise.

55-12 Investor should evaluate whether the warrant is expected to participate in Investee’s earnings (and losses) and capital appreciation (and depreciation) in a manner that is substantially similar to common stock. To evaluate the extent to which the warrant is expected to participate with the common shareholders in Investee’s earnings (and losses), Investor should evaluate whether the warrant allows Investor to currently participate in dividends on a basis substantially similar to common stock. In this Case, Investor does not participate in dividends. Investor, however, can exercise the warrant (convert into common stock) at any time, thereby enabling Investor to participate in Investee’s earnings (and losses) on an equivalent basis to common stock. Because Investor does not expect Investee to declare dividends before exercise, Investor participates in Investee’s earnings in a manner substantially similar to common stock. In addition, warrants that are exercisable into common stock are designed to participate equally with the common shareholders in increases in Investee’s fair value. Therefore, the warrant participates in Investee’s capital appreciation.

55-13 Investor should also evaluate whether the warrant is expected to participate in Investee’s capital depreciation in a manner substantially similar to common stock. An investor has alternatives for making this evaluation. In this Case, Investor could compare the current fair value of Investee’s common stock with the current fair value of the warrant (on an equivalent unit basis) to determine whether the warrant is exposed to capital depreciation in a manner that is substantially similar to the entity’s common stock. The current fair value of the Investee’s common stock of $21.00 is substantially different from the current fair value of each warrant of $2.88 (on an equivalent unit basis). Therefore, the warrant’s expected participation in Investee’s capital depreciation is substantially different from the common shareholders’ participation. This comparison of fair values is different from the paragraph 323-10-15-15 evaluation that is performed (if necessary) to determine whether the future changes in fair value of the investment are expected to vary directly with the changes in the fair value of the entity’s common stock.

55-14 Accordingly, Investor should conclude that, before exercise, the warrants are not expected to participate in Investee’s earnings (and losses) and capital appreciation (and depreciation) in a manner that is substantially similar to common stock and, accordingly, the warrants are not in-substance common stock. Evaluation of the characteristics in paragraph 323-10-15-13(a) and 323-10-15-13(c) and paragraphs 323-10-15-14 through 15-15 is not required.

To determine whether an investment is substantially similar to common stock, the investor should assess whether the investment is expected to participate in the earnings (and losses) and capital appreciation (and depreciation) in a manner substantially similar to how an investment in the investee’s common stock would participate. The table below summarizes indicators (not all inclusive) of when an investment has risks and rewards of ownership that are substantially similar to those of common stock.

Substantially Similar	Not Substantially Similar
The investment participates in an investee’s dividend payments in a manner substantially similar to how an investment in the investee’s common stock would participate, and it is expected that the investee will pay dividends. The investment can be converted into the investee’s common stock without any significant restrictions or contingencies, thereby allowing the investor to participate in the capital appreciation in a manner substantially similar to how common shareholders would participate. The current fair value of the investee’s common stock is substantially similar to the current fair value of the investment (on an equivalent unit basis).	The investment is not entitled to dividend payments in which the common stockholders participate, and it is expected that the investee will pay dividends. The investment is entitled to dividend payments that common shareholders do not receive. There are significant restrictions or contingencies related to conversion of the investment into the investee’s common stock that prohibit the investor from participating in the capital appreciation in a manner substantially similar to how common shareholders would participate. The current fair value of the investee’s common stock is not substantially similar to the current fair value of the investment (on an equivalent unit basis).

Substantially Similar

Not Substantially Similar

The investment participates in an investee’s dividend payments in a manner substantially similar to how an investment in the investee’s common stock would participate, and it is expected that the investee will pay dividends.
The investment can be converted into the investee’s common stock without any significant restrictions or contingencies, thereby allowing the investor to participate in the capital appreciation in a manner substantially similar to how common shareholders would participate.
The current fair value of the investee’s common stock is substantially similar to the current fair value of the investment (on an equivalent unit basis).

The investment is not entitled to dividend payments in which the common stockholders participate, and it is expected that the investee will pay dividends.
The investment is entitled to dividend payments that common shareholders do not receive.
There are significant restrictions or contingencies related to conversion of the investment into the investee’s common stock that prohibit the investor from participating in the capital appreciation in a manner substantially similar to how common shareholders would participate.
The current fair value of the investee’s common stock is not substantially similar to the current fair value of the investment (on an equivalent unit basis).

The participation in dividends is a relevant indicator only if the investor expects the investee to pay dividends to its common shareholders (e.g., during the warrant’s exercise period).

2.5.1.3 Obligation to Transfer Value

ASC 323-10

Case E: Investee Not Obligated to Transfer Substantive Value

55-15 Investor purchases redeemable convertible preferred stock in Investee for $2,000,000. The investment can be (a) converted into common stock valued at $2,000,000 or (b) redeemed for $10,000 at the option of the Investor. The common shareholders do not have a similar redemption feature.

55-16 Investor should evaluate whether exercise of the $10,000 redemption feature obligates Investee to transfer substantive value to Investor and whether the common shareholders do not participate in a similar manner. In this Case, the $10,000 redemption feature is not substantive. Accordingly, Investor should conclude that redeemable convertible preferred stock does not require Investee to transfer substantive value to Investor and that common shareholders do not participate. Investor should also evaluate whether the redeemable convertible preferred stock has the characteristics in paragraph 323-10-15-13(a) through 15-13(b) and paragraphs 323-10-15-14 through 15-15 (if necessary) to reach a conclusion about whether the redeemable convertible preferred stock is in-substance common stock.

Case F: Investee Obligated to Transfer Substantive Value

55-17 Investor purchases redeemable convertible preferred stock in Investee for $2,000,000. The investment can be (a) converted into common stock valued at $2,000,000 or (b) redeemed for $2,000,000 at the option of the Investor. The common shareholders do not have a similar redemption feature. Investor expects that Investee will have the ability to pay the redemption amount.

55-18 Investor should evaluate whether exercise of the $2,000,000 redemption feature obligates Investee to transfer substantive value to Investor and whether the common shareholders do not participate in a similar manner. In this Case, the $2,000,000 redemption feature is substantive because the redemption amount is substantive as compared to the fair value of the investment and, based on Investor’s expectation as of the date that the investment was made, Investee has the ability to pay the redemption amount. Accordingly, Investor shall conclude that redeemable convertible preferred stock requires Investee to transfer substantive value to Investor and that common shareholders do not participate. Accordingly, the redeemable convertible preferred stock is not in-substance common stock. Evaluation of the characteristics in paragraph 323-10-15-13(a) through 15-13(b) and paragraphs 323-10-15-14 through 15-15 is not required.

If the investee is expected to transfer substantive value to an investor and the common shareholders do not participate in a similar manner, an investment is not considered to be substantially similar to common stock. The table below summarizes indicators (not all inclusive) of when an investment is substantially similar to common stock.

Substantially Similar	Not Substantially Similar
An investment has a redemption provision that is not substantive when compared with the fair value of the investment. The holders of the subordinated equity (i.e., common shareholders) participate in a redemption in a similar manner.	An investment has a redemption provision (such as a fixed-price mandatory redemption or a non-fair-value put option) that is substantive when compared with the fair value of the investment. A substantive redemption provision is not available to common shareholders. As a result, if redemption of the investment were to occur, the investee would be obligated to transfer substantive value to the investment holder; however, the common and preferred shareholders (i.e., the holders of the subordinated equity) would not be provided the same benefit.

Substantially Similar

Not Substantially Similar

An investment has a redemption provision that is not substantive when compared with the fair value of the investment.
The holders of the subordinated equity (i.e., common shareholders) participate in a redemption in a similar manner.

An investment has a redemption provision (such as a fixed-price mandatory redemption or a non-fair-value put option) that is substantive when compared with the fair value of the investment.
A substantive redemption provision is not available to common shareholders. As a result, if redemption of the investment were to occur, the investee would be obligated to transfer substantive value to the investment holder; however, the common and preferred shareholders (i.e., the holders of the subordinated equity) would not be provided the same benefit.

Only substantive provisions should be considered in the evaluation. Thus, provisions to transfer value should be evaluated carefully to determine whether they are substantive. For example, as stated in ASC 323-10-15-13(c), “[p]referred stock with a mandatory redemption in 100 years, shall not be considered an obligation to transfer substantive value,” since an obligation to transfer value at a date so far into the future is not considered to be substantive. Further, if, as of the date an investment was made, an investee does not have the ability to pay the amount to which the investor is (or will be) entitled, the provision would not be substantive.

2.5.2 Initial Determination and Reconsideration Events

ASC 323-10

15-16 The initial determination of whether an investment is substantially similar to common stock shall be made on the date on which the investor obtains the investment if the investor has the ability to exercise significant influence over the operating and financial policies of the investee. That determination shall be reconsidered if any of the following occur:

The contractual terms of the investment are changed resulting in a change to any of its characteristics described in paragraph 323-10-15-13 and the preceding paragraph. An expected change in the contractual terms of an investment that are provided for in the original terms of the contractual agreement shall be considered for purposes of the initial determination under paragraph 323-10-15-13 and not as a reconsideration event. However, a change in the form of the investment (for example, debt to equity or preferred stock to another series of stock) is a reconsideration event.
There is a significant change in the capital structure of the investee, including the investee’s receipt of additional subordinated financing.
The investor obtains an additional interest in an investment in which the investor has an existing interest. As a result, the method of accounting for the cumulative interest is based on the characteristics of the investment at the date at which the investor obtains the additional interest (that is, the characteristics that the investor evaluated to make its investment decision), and will result in the investor applying one method of accounting to the cumulative interest in an investment of the same issuance.

15-17 The determination of whether an investment is similar to common stock shall not be reconsidered solely due to losses of the investee.

15-18 If an investor obtains the ability to exercise significant influence over the operating and financial policies of an investee after the date the investor obtained the investment, the investor shall perform an initial determination, pursuant to paragraphs 323-10-15-13 and 323-10-15-15, using all relevant and necessary information that exists on the date that the investor obtains significant influence.

An investor must perform its initial evaluation of whether its investment represents in-substance common stock when it determines that it has the ability to exercise significant influence over the operating and financial policies of an investee (see Chapter 3 for further discussion of significant influence). This date may be after the date its initial investment was acquired.

The investor should continually monitor events and circumstances to determine whether its initial conclusion should be reconsidered. This reassessment should be performed only if one of the events in ASC 323-10-15-16 occurs. Although investee losses can significantly change (i.e., reduce or eliminate) the investee’s capital structure, the investor should not reconsider its initial determination solely because of such losses (see Section 5.2 for further discussion).

At the time of the initial determination and of any subsequent reassessment, an investor should perform its evaluation on the basis of all facts and circumstances. Accordingly, the investor would consider its cumulative interest in the investee as opposed to only those interests that were recently acquired. The total fair value of an investment as of the date of a reconsideration event should be used in the reconsideration analysis. As a result of the occurrence of a reconsideration event, and on the basis of the investor’s reassessment at that time, an investment that was previously determined not to be in-substance common stock may become in-substance common stock (or vice versa).

Chapter 3 — Applying the Equity Method of Accounting

3.2 General Presumption

ASC 323-10

15-7 Determining the ability of an investor to exercise significant influence is not always clear and applying judgment is necessary to assess the status of each investment.

An investor may have investments in an investee that include common stock or in-substance common stock and instruments other than common stock (e.g., preferred stock, warrants, or debentures). The equity method of accounting is applicable only when the investor has an investment in common stock or in-substance common stock and, accordingly, should not be applied when an investment in common stock does not exist, even if the investor holds other investments that allow it to exercise significant influence over the investee. However, if the investor holds both common stock and other investments, it should consider the rights provided by all such instruments in evaluating whether, in combination, they provide it with the ability to exercise significant influence over the investee. In addition, as further discussed in Section 3.2.6, only existing voting rights should be considered.

Example 3-1

Entity A holds the following interests in Corporation B:

Common stock representing 15 percent of the voting rights in B.
Preferred stock that does not meet the requirements to be considered in-substance common stock that provides A with two of the five seats on B’s board of directors.
In evaluating whether A has significant influence over B, A must use judgment and consider the rights provided by all such instruments.

The ability to exercise significant influence over the operating and financial policies of an investee is primarily driven by an investor’s ownership interest and the associated voting rights held through its investment in the investee’s common stock. The presumed levels of ownership that provide the investor with the ability to exercise significant influence vary depending on the legal form of the investee.

The table below summarizes presumed levels of ownership for each legal form of an investee that typically allow an investor to exercise significant influence. Intended as a general guide, the table does not establish bright lines at specific ownership levels (e.g., the difference between a 20 percent and a 19.9 percent investment in common stock or in-substance common stock or both may not be substantive). Therefore, evaluating an investor’s ability to exert significant influence requires judgment, and the investor should evaluate all facts and circumstances when determining how to account for any investment.

Table 3-1 Presumed Levels of Ownership Based on the Legal Form of the Investee That Generally Allow an Investor to Exercise Significant Influence

Legal Form of an Investee	Roadmap Discussion	Investment in Common Stock or In-Substance Common Stock (Assuming Consolidation Is Not Required)
Legal Form of an Investee	Roadmap Discussion	5% or Less	More Than 5% but Less Than 20%	20% or More
Corporations (other than joint ventures)	Section 3.2.1	Rebuttable presumption exists that an investor does not have significant influence.		Rebuttable presumption exists that an investor does have significant influence.
LLCs that do not maintain specific ownership accounts (e.g., similar to partnership capital accounts)	Section 3.2.2	Rebuttable presumption exists that an investor does not have significant influence.		Rebuttable presumption exists that an investor does have significant influence.
LLCs that do maintain specific ownership accounts (e.g., similar to partnership capital accounts)	Section 3.2.2	Equity method required unless interest is “so minor” (per ASC 323-30-S99-1) that investor has virtually no influence (generally less than 3 percent), in which case the investor should generally account for the interest under ASC 321. In certain instances, it may be acceptable to account for investments of less than 3 to 5 percent under the equity method, depending on the facts and circumstances.	Equity method required.
Partnerships and unincorporated joint ventures	Section 3.2.3	Equity method required unless interest is “so minor” (per ASC 323-30-S99-1) that investor has virtually no influence (generally less than 3 percent), in which case the investor should generally account for the interest under ASC 321. In certain instances, it may be acceptable to account for investments of less than 3 to 5 percent under the equity method, depending on the facts and circumstances.	Equity method required.
General partnership interests in partnerships	Section 3.2.4	Equity method required.
Entity that meets the definition of corporate joint venture (i.e., shared control)	Section 3.2.5	Equity method required.

In the case of corporations and LLCs that do not maintain specific ownership accounts, a presumption may exist that an investor has the ability to exercise significant influence, but such a presumption may be overcome (see Section 3.3.1 for conditions indicating lack of significant influence). Similarly, a presumption may not exist if an investor does not meet the levels of ownership described above; however, that ownership interest, in combination with other interests and indicators (see Section 3.3), may indicate that the investor has the ability to exercise significant influence. Each of the types of investments described in the table above is discussed further below.

3.2.1 Corporations

ASC 323-10

15-8 An investment (direct or indirect) of 20 percent or more of the voting stock of an investee shall lead to a presumption that in the absence of predominant evidence to the contrary an investor has the ability to exercise significant influence over an investee. Conversely, an investment of less than 20 percent of the voting stock of an investee shall lead to a presumption that an investor does not have the ability to exercise significant influence unless such ability can be demonstrated. The equity method shall not be applied to the investments described in this paragraph insofar as the limitations on the use of the equity method outlined in paragraph 323-10-25-2 would apply to investments other than those in subsidiaries.

If an investor holds more than a 20 percent interest (directly or indirectly, as discussed in Section 3.2.6) in an investee that has a legal form of a corporation, it is presumed that the investor has the ability to exercise significant influence in the absence of evidence to the contrary (see Section 3.3.1). Similarly, if the same investor holds less than a 20 percent interest in an investee, it may, in combination with other indicators, have the ability to exercise significant influence over that investee (see Section 3.3).

3.2.2 Limited Liability Companies

As discussed in Section 2.2.1, an investment in an LLC that does not maintain specific ownership accounts for each investor should be evaluated in the same manner as an investment in a corporation, which is further discussed in the previous section. An investment in an LLC that does maintain specific ownership accounts for each investor should be evaluated in the same manner as an investment in a partnership, which is further discussed in the next section.

3.2.3 Partnerships and Unincorporated Joint Ventures

ASC 323-30 — SEC Materials — SEC Staff Guidance

SEC Staff Announcement: Accounting for Limited Partnership Investments

S99-1 The following is the text of SEC Staff Announcement: Accounting for Limited Partnership Investments.

The SEC staff’s position on the application of the equity method to investments in limited partnerships is that investments in all limited partnerships should be accounted for pursuant to paragraph 970-323-25-6. That guidance requires the use of the equity method unless the investor’s interest “is so minor that the limited partner may have virtually no influence over partnership operating and financial policies.” The SEC staff understands that practice generally has viewed investments of more than 3 to 5 percent to be more than minor.

In EITF Topic D-46 (codified in ASC 323-30-S99-1), the SEC acknowledged that, in practice, investments in limited partnerships of more than 3 percent to 5 percent have generally been viewed as “more than minor” and thus are subject to the equity method. Because profits and losses are allocated to individual partner accounts, the partner’s share of earnings is allocated for income tax purposes, and the nature of partnership interests usually gives rise to some degree of influence (stated or unstated), it is presumed that either consolidation or the equity method should be used to account for all partnership interests. This approach de-emphasizes significant influence, instead requiring the equity method of accounting because it enables noncontrolling investors to reflect the underlying nature of their investments.

Because the SEC staff refers to a range of “3 to 5 percent” in EITF Topic D-46, investments of more than 3 percent to 5 percent have generally been viewed as “more than minor.” Thus, any investment of more than 5 percent is subject to the equity method, and any investment from 3 percent to 5 percent should be accounted for under the equity method unless the presumption of significant influence is overcome. However, an investment of less than 3 percent is typically considered “minor” and therefore may be accounted for at fair value in accordance with ASC 321 (unless the measurement alternative is elected)1 or under the equity method in accordance with ASC 970-323-25-6.

In a speech at the 2019 AICPA Conference on Current SEC and PCAOB Developments, then OCA Professional Accounting Fellow Erin Bennett provided the SEC’s perspectives on assessing whether an investor’s interest is “more than minor” in an LLC structure with separate capital accounts or whether it is so minor that the investor may have virtually no influence over the LLC’s operating and financial policies.

Ms. Bennett noted that when evaluating whether an entity’s interest is more than minor, the SEC staff assesses LLC structures with separate capital accounts in the same manner as partnerships under ASC 323-30-35-3. She described a consultation in which the registrant held a 25 percent interest in the member units of an LLC with separate capital accounts. The registrant argued that the “virtually no influence” threshold did not apply to its investment since this threshold was (1) intended for real estate companies with “less complicated fact patterns” and (2) not appropriate for an investment whose nature and intent were “passive.” Accordingly, the registrant believed that it would be more appropriate to evaluate the indicators of significant influence. Ms. Bennett provided the following insights into the staff’s position and ultimate objection to the registrant’s view:

For investments in limited partnerships, the SEC staff has stated that the equity method should be applied unless the investor’s interest is so minor that the investor may have virtually no influence over partnership operating and financial policies, with practice generally viewing investments of more than 3-5% to be more than minor.

A recent consultation with OCA focused on whether the equity method should be applied to a registrant’s investment in a limited liability company (LLC). The registrant held over 25% of the LLC’s member units, which were entitled to a preferential allocation of profits. The registrant did not have board representation or voting rights over key operating and financial decisions, but did have certain limited rights, most of which were protective in nature. Furthermore, the registrant had significant ongoing commercial arrangements with the LLC.

In performing its evaluation of whether the equity method applied to its investment, the registrant first concluded that its investment in the LLC was similar to an investment in a limited partnership because the LLC was required to maintain specific ownership accounts for each member. The registrant noted that the limited partnership guidance states that investors in partnerships should apply the equity method if the investor has the ability to exercise significant influence. The registrant also considered the staff’s position that the application of the equity method to investments in limited partnerships should be applied unless the investor’s interest is so minor that the limited partner may have virtually no influence over partnership operating and financial policies. The registrant observed that the “virtually no influence” guidance cited in the SEC staff’s position was originally written in the context of investments in real estate companies with less complicated fact patterns than the registrant’s facts. The registrant believed that the nature and intent of its investment was truly passive, such that an assessment of the overall significant influence indicators was more relevant, irrespective of the form of the ownership. Therefore, based on the complex terms of its investment, including no voting rights and a preferential profit allocation, the registrant concluded that it did not have significant influence and the equity method did not apply. The registrant also believed that not applying the equity method would better reflect the economics of its investment.

In this fact pattern, the staff objected to the registrant’s conclusion that the equity method did not apply. The staff concluded that the staff’s longstanding position on the application of the equity method to investments in limited partnerships should be applied. Given the registrant’s significant ownership interest, certain limited rights other than protective rights, and ongoing commercial arrangements, the staff concluded the registrant had more than “virtually no influence” over the LLC. [Footnotes omitted]

Note that while the guidance in EITF Topic D-46 is intended for public entities, in practice, it is generally applied to investments held by nonpublic entities.

3.2.4 General Partnership Interest in Partnerships

If a GP does not control the partnership, it should account for its investment in the partnership under the equity method of accounting, regardless of its ownership percentage (see Section 2.2.3).

3.2.5 Corporate Joint Ventures

All joint venture investments in which the investor shares in joint control, incorporated or unincorporated, should be accounted for under the equity method without regard to the investor’s ownership percentage.

3.2.6 Potential Voting Rights

ASC 323-10

15-9 An investor’s voting stock interest in an investee shall be based on those currently outstanding securities whose holders have present voting privileges. Potential voting privileges that may become available to holders of securities of an investee shall be disregarded.

An investor may hold certain rights that allow it to acquire additional voting interests in an investee. For example, an investor may have a call option to purchase additional equity in an investee that is not a partnership, or a limited partner may have the contractual right to purchase partnership interests held by other partners. Potential voting rights may also exist through other types of securities that are convertible into voting interests (e.g., convertible securities).

In the determination of whether significant influence exists, ASC 323-10-15-9 applies only to “[a]n investor’s voting stock interest” and not to potential voting interests, such as stock options, convertible debt, or derivatives thereof. However, ASC 323-10-15-13 lists several characteristics that might indicate that an investment (other than an investment in common stock) is in-substance common stock (see Section 2.5). Therefore, when determining whether the use of the equity method is appropriate, an investor should consider investments in common stock and investments that are in-substance common stock, which may include, but not be limited to, the following:

As stated in Section 3.2, if an investor holds both common stock and other investments (including in-substance common stock), it should consider the rights afforded by all such instruments in evaluating whether, in combination, they provide it with the ability to exercise significant influence over an investee. To be considered in the assessment, such voting rights must be currently exercisable.
An investor with an investment that qualifies as in-substance common stock may be able to exercise its voting rights on an as-if-converted basis or may be precluded from exercising voting rights until the in-substance common stock is converted into common stock. In the latter instance, despite the investment’s qualifying as in-substance common stock, such voting rights would not be considered in the assessment of significant influence because they are not currently exercisable (i.e., the voting rights are contingent upon conversion).

Example 3-2

Entity A holds a 15 percent voting common stock interest in Entity B, as well as convertible preferred stock that will allow it to acquire an additional 10 percent voting common stock interest in B in three years. Entity A’s ownership of the convertible preferred stock, if converted, would give A a 25 percent voting common interest in B. However, this would not lead to a presumption that A exercises significant influence over B given that A’s investment in convertible preferred stock does not provide it with exercisable voting rights because of the time restriction and the requirement to convert the instrument to exercise the voting rights.

Although the convertible preferred stock may qualify as in-substance common stock in three years when the conversion feature becomes exercisable, A would continue to be precluded from considering the potential voting rights in assessing significant influence at that time because A will possess such voting rights only upon conversion.

3.2.7 Direct and Indirect Interest in an Investee

In determining whether it has the ability to exercise significant influence over an investee, an investor should consider all voting interests, which include investments that are both direct and indirect (i.e., those held by the investor’s other investees). In certain instances, an investor that does not have the ability to exercise significant influence through its direct interests may have such ability through a combination of direct and indirect interests.

The examples below illustrate the consideration of direct and indirect interests. Each example assumes that the investor and the investee(s) are corporations.

Example 3-3

Direct Investment in an Investee’s Consolidated Subsidiary

Entity A owns a 30 percent voting interest in Entity B that is accounted for under the equity method of accounting (i.e., A has the ability to exercise significant influence over B) and a 15 percent voting interest in Entity C. Entity B owns an 80 percent voting interest in C that is considered a controlling financial interest, requiring B to consolidate C under ASC 810-10.

Because B controls C, and A has the ability to exercise significant influence over B, A has the ability to exercise significant influence over C, despite the fact that A has only a 15 percent direct voting interest in C. Therefore, A should account for its investment in C under the equity method of accounting.

Example 3-4

Investment of 20 Percent or Greater That Does Not Qualify for Equity Method of Accounting

Assume the same facts as in the example above, except that Entity B owns an 18 percent voting interest in Entity C. In this scenario, Entity A has a 20.4 percent interest in C, which is the sum of its 15 percent direct interest and 5.4 percent indirect interest (30 percent × 18 percent) through B.

As reflected in Table 3-1, an investment in common stock of 20 percent or greater leads to a presumption that an investor has the ability to exercise significant influence and should therefore apply the equity method of accounting. However, in the example above, the ownership percentage alone would not provide A with the ability to exercise significant influence over C since neither A nor B has that ability. Although A has significant influence over B, that does not indicate that it has the ability to significantly influence how B exercises its 18 percent voting interest in C. Entity A should evaluate other indicators of significant influence (see Section 3.3) to determine whether it has significant influence over C. If not, A should not account for its investment in C under the equity method of accounting.

Example 3-5

Investment Held by Commonly Controlled Subsidiaries

Entity A has a controlling financial interest in, and therefore consolidates each of, Entity B, Entity C, and Entity D under ASC 810-10. Entities B, C, and D each own a 10 percent voting interest in Entity E.

Entity A indirectly owns less than a 20 percent voting interest in E (i.e., 6 percent through B, 7 percent through C, and 6 percent through D). However, given that A consolidates B, C, and D, A effectively controls 30 percent of the voting interests in E. Thus, it is presumed that A has the ability to exercise significant influence over E (in the absence of evidence to the contrary).

Entity A’s ability to exercise significant influence over E, however, is not determinative as to how each subsidiary should account for its individual investments in preparing its stand-alone financial statements. Thus, each subsidiary should separately evaluate its individual facts and circumstances in determining whether it has the ability to exercise significant influence over E. Investments held by related parties may be one of the factors to consider in such an evaluation (see Section 3.3).

3.2.7.1 Earnings or Losses of an Investee’s Subsidiary

If an investor accounts for direct interests in both an investee and an investee’s subsidiary under the equity method of accounting, it should ensure that it does not double count the earnings or losses of the investee’s subsidiary. That is, the investor should record only its proportionate share of (1) the earnings or losses of the investee and (2) the earnings or losses of the investee’s subsidiary. When determining its proportionate share of the investee’s earnings or losses, the investor should adjust the investee’s financial information to exclude the earnings or losses of the investee’s subsidiary in which the investor has a direct interest. See additional considerations related to subsequent measurement in this scenario in Section 5.1.7.2.

Footnotes

See ASC 321-10-35-2.

3.3 Other Indicators of Significant Influence

ASC 323-10

15-6 Ability to exercise significant influence over operating and financial policies of an investee may be indicated in several ways, including the following:

Representation on the board of directors
Participation in policy-making processes
Material intra-entity transactions
Interchange of managerial personnel
Technological dependency
Extent of ownership by an investor in relation to the concentration of other shareholdings (but substantial or majority ownership of the voting stock of an investee by another investor does not necessarily preclude the ability to exercise significant influence by the investor).

As discussed in Section 3.2, there are presumed levels of ownership (depending on the legal form of the investee) that generally provide an investor with the ability to exercise significant influence over the investee. For example, an investment of less than 20 percent leads to a presumption that, in the absence of evidence to the contrary, an investor does not have the ability to exercise significant influence over a corporate investee. However, the determination of whether the investor has the ability to exercise significant influence over the investee’s reporting and financial policies should not be limited to the evaluation of voting rights (which can be conferred by instruments other than common stock as discussed in Section 2.5) given that significant influence may be exhibited through other means. Accordingly, the investor should consider all facts and circumstances, including, but not limited to, those outlined in ASC 323-10-15-6 and further discussed in the table below when determining whether it has the ability to exercise significant influence over the investee.

Table 3-2 Indicators of Significant Influence

Indicator	Comment
Representation on the board of directors	Representation on the board of directors (through contractual agreement or otherwise) allows an investor to influence the operating and financial policies of an investee by virtue of its presence and participation at the board of directors’ meetings. Therefore, any board representation is an indicator of significant influence notwithstanding an investor’s ownership in the legal entity, even if the amount of board representation is mathematically less than 20 percent of the board of directors. That is, we do not believe that the presumption related to a 20 percent voting interest, as discussed in Section 3.2, applies to board representation because such representation itself is frequently an indication that the investor is able to obtain the ability to influence the investee’s policies. However, not all representation on the board of directors carries the same weight. For example, if an investor has one of four seats (25% representation), that would be a clear indication of significant influence in the absence of strong factors indicating otherwise. Conversely, if an investor has one out of ten seats (10% representation), that may be less indicative of significant influence; however, since any board representation is an indicator that an investor may be able to exercise significant influence, all facts and circumstances should be considered, including but not limited to: Which presumption the investor is analyzing (i.e., whether the investor owns 20% or more of the voting stock of an investee and must overcome the presumption of significant influence vs. owning less than 20% of voting stock). Whether the investor is guaranteed a certain number of board seats as long as the investor’s ownership percentage is above an existing threshold (e.g., 10% voting interest). We believe that an investor’s guaranteed representation on the board is a stronger indicator of significant influence than an investor’s ability to obtain representation by voting its ownership interest, especially in instances in which the voting stock held by the investor in an investee is less than 20 percent. Whether the investor has the right to appoint a disproportionately higher number of directors as compared with its ownership percentage or if an investor, in addition to its board representation, participates on significant investee committees, such as the executive committee or the finance committee.
Participation in policy-making processes	An investor can participate in policy-making processes through its voting rights, veto rights, and other participating rights. The right and ability to participate in these processes are fundamental to the analysis; the investor is not required to participate. Further, the investor may not assert that it does not have significant influence merely because it does not have the intent to exercise its rights. If an investor does not have a right to appoint a board member but may appoint an “observer” to the board of directors’ meetings (a right that generally does not provide the observer with voting ability), the investor should exercise judgment when determining whether the observer seat allows it to exercise significant influence over the investee. The investor’s access to the confidential information discussed at the board meeting would usually not, in and of itself, mean that the investor would have the ability to exercise significant influence. Sometimes, an investor holding a minority interest is granted substantive participating veto rights over certain actions that are described with phrases such as “other than in the ordinary course of business.” When such a phrase, describing what would otherwise be “participating rights” under ASC 810-10-25-12, is vaguely defined, it does not, in the SEC staff’s view, cause a participating veto right to be considered nonparticipating.
Material intra-entity transactions	Routine, intra-entity transactions that involve nonspecialized goods or services (i.e., goods or services that are readily available in the market), even if material to the investee (as either a purchaser or supplier of such goods or services), may not give the investor the ability to exercise significant influence over the investee. However, other factors related to intra-entity transactions may suggest that the investor, along with its interest in voting common stock, has significant influence over the investee. These factors may include, but are not limited to, the following: The level of specialization associated with the good or service. Consideration should be given in the context of the investee’s providing or acquiring such goods or services to or from the investor. Market availability of the goods or services provided by the investor to the investee and the potential cost to the investee of switching service providers or suppliers. The scarcer a good or service is in the market, the more likely it may be that the investee is dependent on the investor. Investee sales to the investor (generally of more specialized goods or services) as a percentage of total sales as well as the total number of investee customers (including consideration of the investee’s substantive ability to expand its customer base).
Interchange of managerial personnel	When an investor’s management also serves in a management capacity at an investee (e.g., CEO, CFO, COO), it may indicate that the investor has the ability to exercise significant influence over the investee. However, such a determination requires significant judgment. Among other things, the investor should consider the level of responsibility given to individuals in management. It should also consider the role, responsibilities, and composition of the investee’s board of directors, including its level of oversight and control over management and its level of independence from the investor’s board of directors (i.e., the existence of interchange of managerial personnel at the board level).
Technological dependency	An investor may provide technology to an investee that is critical to its operational ability. Such a situation may cause the investee to be technologically dependent on the investor and, as a result, allow the investor to exert some level of influence over the investee. When determining the level of influence it can exercise, the investor should consider the terms of the licensed technology. For example, the technology granted to the investee for a period that would give the investor an option not to renew such a license would be more indicative of significant influence than if the investee had already obtained a perpetual license to such technology. As mentioned in “Material intra-entity transactions” above, when evaluating whether the investee’s technological dependency provides the investor with significant influence, the investor should also consider the technology alternatives available to the investee and the costs that the investee might reasonably be expected to incur were it to license alternative technology. For example, if the investee could license similar technology from other companies without incurring significant costs, such a licensing agreement would usually not provide the investor with the ability to exercise significant influence over the operating and financial policies of the investee.
Extent of ownership by an investor in relation to the concentration of other shareholdings	An investor should consider its extent of ownership in relation to the concentration of other shareholdings. A majority ownership interest in the investee may be concentrated among a small group of investors. Alternatively, the voting interests may be widely dispersed (with no investor holding a significant voting interest). Accordingly, an investor holding less than a 20 percent voting interest in a widely dispersed corporate investee may have the ability to exercise significant influence when all other investors, individually, have considerably smaller ownership interests. In addition, although one investor may hold a majority ownership interest in an investee (e.g., 70 percent), that does not necessarily preclude other investors with smaller ownership interests (e.g., 30 percent) from having the ability to exercise significant influence over that investee.

In addition to the indicators noted above, the following conditions may indicate that an investor can exercise significant influence over an investee:

The investee is, in effect, a joint venture in which the investor shares in joint control.
The investor has a firm agreement to increase the investment to 20 percent or greater in the subsequent year.
The investor’s significant stockholders, parent company, other subsidiaries of a common parent, or officers hold additional investments in the investee.
The investor has exercised significant influence over decisions of the investee on several occasions.

Many questions have arisen about whether to apply the equity method to an investment or to account for it at fair value in accordance with ASC 321 (unless the measurement alternative is elected),2 particularly in situations involving a less than 20 percent investment in common stock that may be coupled with one or more contractually provided seats on the board of directors. In separate speeches (summarized below), the SEC staff provided its perspectives on several of the considerations discussed above, including the evaluation of whether an investor (1) must apply the equity method of accounting to an investment in common stock (1999 speech) and (2) has significant influence (2020 speech).

Specifically, the SEC staff does not use bright-line tests in the application of ASC 323-10. In the 1999 speech, then Professional Accounting Fellow Paul Kepple noted that when considering whether an investor must apply the equity method of accounting to an investment in common stock, the staff has evaluated:

The nature and significance of the investments, in any form, made in [an] investee. The staff does not consider the difference between a 20 percent common stock investment [and] a 19.9 percent investment to be substantive, as some have asserted in applying [ASC 323-10]. [T]he staff will consider whether [an] investor has other forms of investments or advances, such as preferred or debt securities, in [an] investee in determining whether significant influence results. [In addition, the staff will consult the guidance in ASC 323-10-15-13 through 15-19 to determine whether other forms of investments or advances are in-substance common stock. See Section 2.5 for further discussion on investments in in-substance common stock.]
The capitalization structure of [an] investee. The [staff] would consider whether [an] investee effectively is being funded by common or [noncommon] stock investments and how critical the investments made by [an] investor are to the investee’s capitalization structure (e.g., [whether the investor is] the sole funding source).
Voting rights, veto rights, and other protective and participating rights held by [an] investor. The greater the ability of [an] investor to participate in the financial, operating, or governance decisions made by [an] investee, via any form of governance rights, the greater the likelihood that significant influence exists.
Participation on [an] investee’s board of directors (or equivalent), whether through contractual agreement or not. The staff [would] consider, in particular, whether any representation is disproportionate to the investment held. For example, an investor that is contractually granted 2 of 5 board seats, coupled with a 15 percent common stock investment, will [most] likely be viewed [as having] significant influence over [an] investee.
Other factors as described in [ASC 323-10-15]. . . .

While the starting point in any evaluation of significant influence is [an] investor’s common stock ownership level in [an] investee, the staff does not believe that a “bright line” approach is appropriate and will consider . . . all of the factors noted above in [reaching conclusions about any] given set of facts and circumstances. [Footnotes omitted]

Subsequently, in the 2020 speech, which was given at the 2020 AICPA Conference on Current SEC and PCAOB Developments, then OCA Professional Accounting Fellow Jeffrey Nick addressed investments in entities other than limited partnerships and LLCs without separate capital accounts (i.e., investments subject to ASC 323-10). He discussed a consultation related to whether the equity method should be applied to a registrant’s investment in a corporation in which the registrant held less than 20 percent of the investee’s outstanding voting stock. The registrant also (1) had access to nonpublic information about the corporation as a result of various informal arrangements with the corporation, (2) shared with the corporation certain managerial personnel, and (3) “was a party to a contractual agreement with certain other investors to vote in concert with respect to electing members to the board of directors.” Mr. Nick provided the following insights into the staff’s assessment of the existence of significant influence and ultimate objection to the registrant’s view:

An investor generally accounts for an investment in common stock or in-substance common stock of a corporation that it does not consolidate under the equity method if it can exercise significant influence over operating and financial policies of the investee. The evaluation of significant influence for investments in corporations, as described in Accounting Standards Codification (“ASC”) Topic 323-10, requires the exercise of judgment and the consideration of whether certain indicators exist that provide evidence of the existence or lack of significant influence.

Consider a fact pattern presented to OCA staff where a registrant evaluated whether it had significant influence over an investee in which it held less than 20% of the outstanding voting stock. This registrant was a party to a contractual agreement with certain other investors to vote in concert with respect to electing members to the board of directors. The aggregation of the voting stock among the group provided the group with the ability to directly appoint specified individuals to the board of directors, and the specified individuals comprised the majority of the board and included representatives from the registrant. Without the registrant’s contribution or input, the aggregate vote encompassed by the contractual agreement would not have been sufficient to guarantee the appointment of the specified individuals to the board of directors. In addition to this contractual right that it shared with other parties, the registrant shared various at-will managerial personnel with the investee pursuant to separate employment agreements, and had access to confidential information of the investee pursuant to certain informal arrangements. The registrant evaluated the factors that could indicate the existence of significant influence and concluded that, because the registrant did not have a contractual right on its own to place representation on the board of directors or contractual rights related to any of the other indicators, it did not meet the requirements for applying the equity method of accounting.

Based on the total mix of information presented in this fact pattern, OCA staff objected to the registrant’s conclusion that it did not have significant influence over the investee. [Footnotes omitted]

On the basis of the facts as described by the SEC staff, we assume that the registrant only needed to vote in concert with others to appoint the specified individuals to the board of directors but that the contractual agreement did not require the specified individuals on the board to vote as a group on matters at board meetings. That is, we assume that each appointed director would be permitted to vote in his or her best interest.

ASC 323-10 does not address whether related-party interests should be included in an investor’s ownership percentage in the evaluation of whether the investor has significant influence over the investee. While investments held by related parties (e.g., a parent company, other subsidiaries of a common parent, or officers) are one of the conditions indicating that significant influence could exist, we believe that the interest held by the investor’s related parties should not automatically be included in the evaluation of whether the investor has significant influence over the investee. Rather, all facts and circumstances should be considered, including the nature of the related-party relationship and the design and purpose of the related-party holding. Circumstances in which related-party interests should be combined in the determination of whether the investor has significant influence include, but are not limited to, those in which:

The investor used a related party to increase its influence or interest in an attempt to avoid accounting for the investment under the equity method.
The investor and the investor’s employee (for example) hold an investment in the same investee and the investor has the ability to influence how the employee votes with respect to its ownership interest or board representation.

3.3.1 Conditions Indicating Lack of Significant Influence

ASC 323-10

15-10 Evidence that an investor owning 20 percent or more of the voting stock of an investee may be unable to exercise significant influence over the investee’s operating and financial policies requires an evaluation of all the facts and circumstances relating to the investment. The presumption that the investor has the ability to exercise significant influence over the investee’s operating and financial policies stands until overcome by predominant evidence to the contrary. Indicators that an investor may be unable to exercise significant influence over the operating and financial policies of an investee include the following:

Opposition by the investee, such as litigation or complaints to governmental regulatory authorities, challenges the investor’s ability to exercise significant influence.
The investor and investee sign an agreement (such as a standstill agreement) under which the investor surrenders significant rights as a shareholder. (Under a standstill agreement, the investor usually agrees not to increase its current holdings. Those agreements are commonly used to compromise disputes if an investee is fighting against a takeover attempt or an increase in an investor’s percentage ownership. Depending on their provisions, the agreements may modify an investor’s rights or may increase certain rights and restrict others compared with the situation of an investor without such an agreement.)
Majority ownership of the investee is concentrated among a small group of shareholders who operate the investee without regard to the views of the investor.
The investor needs or wants more financial information to apply the equity method than is available to the investee’s other shareholders (for example, the investor wants quarterly financial information from an investee that publicly reports only annually), tries to obtain that information, and fails.
The investor tries and fails to obtain representation on the investee’s board of directors.

15-11 The list in the preceding paragraph is illustrative and is not all-inclusive. None of the individual circumstances is necessarily conclusive that the investor is unable to exercise significant influence over the investee’s operating and financial policies. However, if any of these or similar circumstances exists, an investor with ownership of 20 percent or more shall evaluate all facts and circumstances relating to the investment to reach a judgment about whether the presumption that the investor has the ability to exercise significant influence over the investee’s operating and financial policies is overcome. It may be necessary to evaluate the facts and circumstances for a period of time before reaching a judgment.

ASC 323-10-15-10 lists several indicators (not all-inclusive) that may suggest that the significant influence presumption is overcome when an investor holds 20 percent or more of the outstanding voting common stock of an investee. In addition, the following conditions may indicate that an investor lacks the ability to exercise significant influence:

The chairperson of the investee owns a large, but not necessarily controlling, block of the investee’s outstanding stock; the combination of the chairperson’s substantial shareholding and his or her position with the investee may preclude the investor from being able to influence the investee.
Adverse political and economic conditions exist in foreign countries (especially restrictions on the repatriation of dividends) in which the investee is located.
The investor has less than 20 percent ownership of the investee with an option to acquire additional ownership that would increase the investor’s stake to 20 percent or more, but there is no substantive plan or agreement to do so in the near future.
The investee is to settle its litigation, particularly when that litigation involves bankruptcy, by issuing shares to the settling parties, and it is probable that the new shares, when issued, will reduce the investor’s ownership percentage to less than 20 percent.
The investee actively and publicly resists the exercise of influence by the investor.

None of the circumstances above are necessarily conclusive that the investor is unable to exercise significant influence over the investee’s operating and financial policies. The investor should evaluate all facts and circumstances related to the investment when determining whether the presumption of significant influence over the investee is overcome.

In addition, the fact that an investor has not exercised significant influence in the past or does not intend to exercise it in the future does not indicate that the general presumption of significant influence is overcome. See Section 3.3 for additional details on the 2020 speech that addresses significant influence.

Footnotes

See footnote 1.

Chapter 4 — Initial Measurement

4.1 Overview

ASC 323-10-30 describes how investments that are accounted for by using the equity method of accounting should initially be measured (see Section 4.2). An equity method investment is presented on the balance sheet as a single amount and is generally reflected at its cost basis upon acquisition. When determining the initial cost of the investment, the entity should include in the cost basis certain transaction costs, certain contingent consideration arrangements (see Section 4.4), and previously held interests in the entity.

An investor is required to account for any differences between the cost of the investment and the underlying equity in the investee’s net assets, referred to as basis differences, as if the investee were a consolidated subsidiary (see Section 4.5).

An investor that had previously accounted for an investment on a basis other than the equity method may subsequently be required to apply the equity method to that investment. For example, an investor holding an investment accounted for at fair value under ASC 321 may obtain the ability to exercise significant influence over such an investee by obtaining or otherwise increasing an ownership interest in the investee’s voting common stock (or in-substance common stock). If the investor is subsequently required to apply the equity method, it should apply the initial measurement principles discussed within this chapter.

Chapter 5 — Subsequent Measurement

5.1 Equity Method Earnings and Losses

ASC 323-10

35-4 Under the equity method, an investor shall recognize its share of the earnings or losses of an investee in the periods for which they are reported by the investee in its financial statements rather than in the period in which an investee declares a dividend. An investor shall adjust the carrying amount of an investment for its share of the earnings or losses of the investee after the date of investment and shall report the recognized earnings or losses in income. An investor’s share of the earnings or losses of an investee shall be based on the shares of common stock and in-substance common stock held by that investor. (See paragraphs 323-10-15-13 through 15-19 for guidance on identifying in-substance common stock. Subsequent references in this Section to common stock refer to both common stock and in-substance common stock.)

35-5 The amount of the adjustment of the carrying amount shall be included in the determination of net income by the investor, and such amount shall reflect adjustments similar to those made in preparing consolidated statements including the following adjustments:

Intra-entity profits and losses. Adjustments to eliminate intra-entity profits and losses.
Basis differences. Adjustments to amortize, if appropriate, any difference between investor cost and underlying equity in net assets of the investee at the date of investment.
Investee capital transactions. Adjustments to reflect the investor’s share of changes in the investee’s capital.
Other comprehensive income.

ASC 970-323

35-2 Investors shall record their share of the real estate venture’s losses, determined in conformity with generally accepted accounting principles (GAAP), without regard to unrealized increases in the estimated fair value of the venture’s assets.

After initial measurement of an equity method investment, an investor should record its share of an investee’s earnings or losses in income on the basis of the amount of common stock and in-substance common stock held by the investor. In accordance with ASC 323-10-35-4, the investor should calculate its share of an investee’s earnings and losses by adjusting the investee’s earnings or losses for amounts allocable to NCI. Potential common stock issued by the investee (i.e., securities such as options, warrants, convertible securities, or contingent stock agreements) should not be included in the calculation of the investor’s share of the investee’s earnings or losses unless these securities represent in-substance common stock. See Section 2.5 for further discussion related to the determination of whether an investment is in-substance common stock. The investor’s equity method investment balance is increased by the investor’s share of the investee’s income and decreased by the investor’s share of the investee’s losses in the periods in which the investee reports the earnings and losses rather than in the periods in which the investee declares dividends. In addition, adjustments to the investor’s share of equity method earnings or losses (and corresponding adjustments to the carrying value of the equity method investment) are made for certain items as discussed in detail in Section 5.1.5.

While the guidance above requires an investor to recognize its share of an investee’s earnings or losses, it does not prescribe the order in which adjustments are made to the investor’s share of equity method earnings or losses or the allocation method to be applied. In some cases, the calculation of the investor’s share of the investee’s earnings or losses may be straightforward (e.g., when there is only one share class and the distributions received by the investors are consistent with their percentage ownership in the investee). However, allocation of earnings or losses on the basis of the investor’s ownership percentage may be more difficult to apply in complex structures in which there are multiple share classes and investors have different rights and priorities. See Sections 5.1.2 and 5.1.2.1 for further discussion of when the allocation of the investee’s earnings or losses is disproportionate in relation to the investor’s ownership interest in the investee.

5.1.1 Impact of Preferred Dividends on an Investor’s Share of Earnings (Losses)

ASC 323-10

35-16 If an investee has outstanding cumulative preferred stock, an investor shall compute its share of earnings (losses) after deducting the investee’s preferred dividends, whether or not such dividends are declared.

An investor is required to calculate its share of an equity method investee’s earnings (losses) after deduction of any investee preferred dividends on cumulative preferred stock, regardless of whether the dividends are declared. Conversely, no adjustment is required for preferred dividends on noncumulative preferred stock unless those dividends have been declared.

Example 5-1

Investor A, Investor B, and Investor C each own investments in Investee Z as follows:

On January 1, 20X2, A acquires 45 percent (45,000 of 100,000 shares) of the voting common stock of Z for $90,000. Investor A accounts for its investment by using the equity method because of its ability to exercise significant influence over Z. Investor A will recognize its share of Z’s earnings on a pro-rata basis in accordance with its ownership interest in Z.
On January 1, 20X2, B acquires 10,000 shares of cumulative preferred stock of Z for $50,000, which entitles B to receive an annual dividend of 5 percent (whether or not the dividend is declared).

Investee Z has net income of $25,000 for the year ended December 31, 20X2. Although not declared, the cumulative preferred dividend on B’s investment in preferred stock is $2,500. Assume there are no basis differences, intra-entity profit eliminations, or any other adjustments to net income.

Investor A calculates its share of the earnings of Z to be $10,125 by:

Deducting the cumulative preferred stock dividend from Z’s net income ($25,000 − $2,500 = $22,500) (adjusted net income).
Calculating its pro rata share of adjusted net income (45% × $22,500 = $10,125).

On December 31, 20X2, A’s equity method investment balance would be $100,125 (A’s initial investment of $90,000 plus its share of Z’s adjusted net income of $10,125).

5.1.1.1 Impact of Accretion of Temporary Equity

ASC 480-10-S99-2 provides that:

The initial carrying amount of redeemable preferred stock should be its fair value at date of issue. [For redeemable preferred stock classified in temporary equity] [w]here fair value at date of issue is less than the mandatory redemption amount, the carrying amount shall be increased by periodic accretions.

When calculating its share of an equity method investee’s earnings or losses, the investor should adjust the net income of the equity method investee for this accretion of preferred stock. See Section 9.5 of Deloitte’s Roadmap Distinguishing Liabilities From Equity for additional guidance on the accretion of redeemable preferred stock classified as temporary equity.

5.1.2 Disproportionate Allocation of an Investee’s Earnings or Losses in Relation to an Investor’s Ownership Interest

ASC 970-323

35-16 Venture agreements may designate different allocations among the investors for any of the following:

Profits and losses
Specified costs and expenses
Distributions of cash from operations
Distributions of cash proceeds from liquidation.

35-17 Such agreements may also provide for changes in the allocations at specified times or on the occurrence of specified events. Accounting by the investors for their equity in the venture’s earnings under such agreements requires careful consideration of substance over form and consideration of underlying values as discussed in paragraph 970-323-35-10. To determine the investor’s share of venture net income or loss, such agreements or arrangements shall be analyzed to determine how an increase or decrease in net assets of the venture (determined in conformity with GAAP) will affect cash payments to the investor over the life of the venture and on its liquidation. Specified profit and loss allocation ratios shall not be used to determine an investor’s equity in venture earnings if the allocation of cash distributions and liquidating distributions are determined on some other basis. For example, if a venture agreement between two investors purports to allocate all depreciation expense to one investor and to allocate all other revenues and expenses equally, but further provides that irrespective of such allocations, distributions to the investors will be made simultaneously and divided equally between them, there is no substance to the purported allocation of depreciation expense.

As described in Section 5.1, when applying the equity method of accounting, an investor should typically record its share of an investee’s earnings or losses on the basis of the percentage of the equity interest owned by the investor. However, contractual agreements often specify attributions of an investee’s profits and losses, certain costs and expenses, distributions from operations, or distributions upon liquidation that are different from investors’ relative ownership percentages. For example, developers in the renewable energy sector often use limited partnerships or similar structures for tax purposes. A developer of a renewable energy facility that does not generate sufficient taxable income to offset the tax incentives or investment tax credits (ITCs) generated from its operations may monetize these tax credits by identifying investors that are able to use the tax incentives and credits. These renewable “flip” structures are typically set up as tax pass-through entities to give the investors (i.e., tax equity investors) the ability to use the tax benefits of the partnership. Within these structures, there are typically disproportionate equity distributions until a flip date, at which point the distributions change. In addition, the tax benefits that pass through to the investor are not recognized in the investee’s net income but generally affect the claim that the tax equity investor has on the remaining book value. This is just one example of a structure in which the calculation of an investor’s share of an investee’s earnings or losses may involve more complexity.

Although ASC 970-323 was written for equity method investments in the real estate industry, we believe that it is appropriate to refer to this literature for guidance on developing an appropriate method of allocating a non-real-estate equity method investee’s economic results among investors when a contractual agreement, rather than relative ownership percentages, governs the economic allocation of earnings or losses. ASC 970-323 implies that for the allocation of the investee’s earnings or losses to be substantive from a financial reporting perspective, it must hold true and best represent cash distributions over the life of the entity. Reporting entities should focus on substance over form. The investor should consider the substance of all relevant agreements when determining how an increase or decrease in the investee’s net assets will affect cash payments to the investor over the investee’s life and upon its liquidation.

Connecting the Dots

We believe that the guiding principle for allocating an investee’s earnings or losses to equity method investors is to ascertain whether allocations that would otherwise be made in the current year are at significant risk of being unwound in subsequent periods because a different allocation method will be used for subsequent cash distributions. Hence, it is generally not appropriate to use a single blended rate to recognize an investor’s share of an investee’s earnings and losses when distributions or earnings and losses of the investee will change over the life of the investment on the basis of contractual terms. Rather, in such instances professional judgment must be used, and consideration should be given to the facts and circumstances at hand. Preparers should consider consulting with their independent auditors or their professional accounting advisers.

Examples of such considerations are illustrated in ASC 323-10-35-19 (see Section 5.2), ASC 323-10-55-30 through 55-47, and ASC 323-10-55-48 through 55-57 (see Section 5.2.3.1).

Overall, when selecting the most appropriate method with which to recognize earnings on an equity method investment, an investor should consider the principal objective of the equity method, which ASC 323-10-35-4 states is to recognize the investor’s “share of the earnings or losses of an investee in the periods for which they are reported by the investee.” That is, the investor should appropriately reflect the effect of investee transactions on an investor for a given reporting period.

Therefore, when cash flows, tax attributes, and earnings are contractually allocated to investors in disparate ways over the life of an investee, it would be inappropriate for the investor to forecast expectations of the investee’s performance to determine a weighted-average expected return on the investor’s investment when allocating current-period earnings. That is, we believe that the allocation method should generally be consistent with how the contractual provisions allocate earnings in the current period or how the investor’s rights to the book value change in that current period.

However, we do not think that this means that contractual earnings allocation provisions should be followed blindly. For example, it may be the case that earnings allocation percentages change contractually over the investee’s life while operating and liquidating cash distributions remain constant. In such situations, the substance of the contractual cash distribution provisions may imply relative membership interests in the investee, while earnings are allocated to achieve certain other form-based objectives (e.g., an after-tax return). In summary, when earnings, tax attributes, and cash flows are contractually allocated differently, we think that the substance of those provisions should be carefully considered.

See Section 6.2 of Deloitte’s Roadmap Noncontrolling Interests for further discussion of allocations that are disproportionate to ownership interests.

Example 5-2

Investors A and C have 40 percent and 60 percent equity interests, respectively, in Investee B, a partnership. The investors use the equity method to account for their interests in B. Distributions (including those that would occur if the investee were liquidated) are shared evenly, in accordance with the terms of the partnership agreement.

In this example, A and C would record their proportionate shares of B’s profits and losses on the basis of the allocation method specified in the partnership agreement (i.e., equal distribution), since this allocation reflects the substance of the investment. That is, A and C would not record their equity method earnings on the basis of 40 percent and 60 percent, respectively, of B’s profits and losses.

Example 5-3

Investor Z has an equity method investment in an LLC that owns income-producing real estate properties. For financial reporting purposes, the LLC agreement states that 100 percent of depreciation expense and 50 percent of all other income and expense items are to be allocated to Z. However, the agreement states that 50 percent of all cash distributed by the LLC during its operations and upon liquidation should be allocated to Z.

In this example, there is no basis for the allocation of 100 percent of depreciation expense to Z. Therefore, Z would record its equity method earnings on the basis of 50 percent of the LLC’s total net profits and losses (including depreciation expense).

5.1.2.1 Hypothetical Liquidation at Book Value Method

Although the Codification does not prescribe a specific method for allocating an investee’s earnings or losses to investors, reporting entities will often use the hypothetical liquidation at book value (HLBV) method, which is a balance sheet approach to encapsulating the change in an investor’s claim on an investee’s net assets as reported under U.S. GAAP. Under the HLBV method, changes in the investor’s claim on the investee’s net assets that would result from the period-end hypothetical liquidation of the investee at book value form the basis for allocating the equity method investor’s share of the investee’s earnings or losses. However, in applying the HLBV method, investors should not consider other potential effects of a hypothetical liquidation, such as debt prepayment or lease termination penalties.

The HLBV method arose in response to increasingly complex capital structures, the lack of prescribed implementation guidance on how an equity method investor should determine its share of earnings or losses generated by the equity method investee, and the ensuing diversity in practice. In an attempt to establish in the authoritative literature the appropriate accounting for equity method investments in entities with complex structures, the AICPA issued a proposed Statement of Position (SOP), Accounting for Investors’ Interests in Unconsolidated Real Estate Investments, in November 2000. The proposed SOP, which was not ultimately finalized, was intended for investments of unconsolidated real estate. However, the proposal led to increased use of the HLBV method as an acceptable means to allocate earnings or losses of an equity method investee among its investors when each investor’s right to participate in the earnings or losses of the investee is disproportionate to its ownership interest.

Notwithstanding the HLBV method’s origins (or its absence from the Codification), we believe that given the FASB’s focus on substance over form, the HLBV method will often be an acceptable method for allocating an investee’s earnings or losses. Other methods may also be acceptable depending on the facts and circumstances.

Under the HLBV method, a reporting entity allocates an investee’s earnings or losses to each investor by using the following formula:

The two examples below illustrate the calculation of an investor’s equity method earnings or losses under the HLBV method. In addition, Case B from the example in ASC 323-10-55-54 through 55-57 also illustrates, in substance, the application of the HLBV method (see Section 5.2.3.1).

Example 5-4

Partnership X (or “investee”) was formed to develop and construct a renewable solar energy facility. Partnership X will own the facility and sell electricity at a fixed rate to a local utility under a long-term power purchase agreement. Partnership X is a flow-through entity for tax purposes; therefore, the tax attributes (such as ITCs and accelerated tax depreciation) related to the solar energy facility are allocated to X’s partners in accordance with X’s operating agreement between the partners.

The fair market value of the solar energy facility is $35 million. The tax equity investor and sponsor (collectively, the “investors”) will contribute $15.5 million and $19.5 million, respectively, to X. Assume that both the tax equity investor and the sponsor account for their investments in X under the equity method.1

Partnership X has a complex capital structure that requires an allocation of income, gain, loss, tax deductions, and tax credits before and after a “flip date” to the investors that is not consistent with the investors’ relative ownership percentages. The flip date is defined as the point in time when the tax equity investor receives a target after-tax internal rate of return (IRR) on its investment (in this example, tax equity investor’s target after-tax IRR is 8 percent). The tax equity investor achieves its IRR through cash distributions as well as the allocation of ITCs and other tax benefits.

Under the partnership agreement, income, gain, loss, tax deductions, and tax credits for each tax year will be allocated between the tax equity investor and the sponsor as follows:2

	Pre-Flip	Post-Flip
Tax equity investor	99 percent	5 percent
Sponsor	1 percent	95 percent

Cash distributions for each tax year, which are not designed to approximate GAAP earnings in each period, will be allocated between the tax equity investor and the sponsor as follows:

	Pre-Flip	Post-Flip
Tax equity investor	25 percent	5 percent
Sponsor	75 percent	95 percent

Tax gain (or loss) recognized upon the partnership’s liquidation will be distributed according to the following waterfall:

First, to partners with negative Internal Revenue Code (IRC) Section 704(b)3 capital accounts, the amount needed to bring their capital accounts to zero.
Second, to the partners in accordance with their pre-flip sharing ratios (1 percent to the sponsor and 99 percent to the tax equity investor), until the tax equity investor achieves its target IRR.
Finally, to the partners in accordance with their post-flip tax sharing ratios (95 percent to the sponsor and 5 percent to the tax equity investor), any remaining gain (or loss).

Note that in this example, we assumed a generic set of liquidation provisions in computing HLBV equity method income (loss). In practice, there is tremendous diversity in liquidation provisions from deal to deal since partners develop provisions that more accurately reflect their economic arrangements.

Given X’s complex capital structure, both the tax equity investor and the sponsor have elected a policy of calculating their share of X’s earnings or losses by using the HLBV method. To determine the amount allocated to each investor under the HLBV method, the tax equity investor and sponsor must perform an analysis of the investors’ IRC Section 704(b) capital accounts (as adjusted per the liquidation provisions of the partnership agreement). The mechanics of the HLBV method in this type of flip structure involve a complex combination of U.S. GAAP and tax concepts, typically consisting of the following steps (as of each reporting period end):4

Determine the investee’s period-end U.S. GAAP capital account balance.
Determine the investee’s and each investor’s starting IRC Section 704(b) capital account balance.
Calculate the investee’s IRC Section 704(b) book gain (loss) on hypothetical liquidation (U.S. GAAP capital account from step 1 less starting IRC Section 704(b) capital account balance from step 2).
Allocate the investee’s IRC Section 704(b) book gain (loss) from step 3 in the following order (specifics as determined by the liquidation provisions in the relevant agreement):
1. Allocate the gain to restore negative IRC Section 704(b) capital account balances to zero.
2. Allocate the gain to the tax equity investor until the target IRR is achieved.
3. Allocate the remaining gain (loss) in accordance with the appropriate residual sharing percentages.
Add/subtract the gain (loss) allocated in step 4 to each investor’s IRC Section 704(b) capital account balance determined in step 2.
Determine the change in each investor’s claim on the investee’s book value during the period (adjusted for contributions and distributions).

The attribution of X’s HLBV equity method income (loss) is calculated for the tax equity investor and the sponsor in years 1 through 3 and is shown below. Note that intra-entity profit and loss eliminations and tax impacts have been ignored for simplicity.

Step 1: Determine the investee’s period-end U.S. GAAP capital account balance:

Step 2: Determine the investee’s and each investor’s starting IRC Section 704(b) capital account balance:

Step 3: Calculate the investee’s IRC Section 704(b) book gain (loss) on hypothetical liquidation (U.S. GAAP capital account from step 1 less starting IRC Section 704(b) capital account balance from step 2):

Step 4: Allocate the investee’s IRC Section 704(b) book gain (loss) on liquidation:

Step 4(a): Allocate gain to restore negative capital accounts:

Step 4(b): Allocate gain to tax equity investor until target after-tax return (IRR) is achieved:**

Step 4(c): Allocate remaining gain (loss) in accordance with appropriate residual sharing percentages:

Step 5: Add/subtract the gain (loss) allocated in step 4 to each investor’s starting IRC Section 704(b) capital account balance determined in step 2:

Step 6: Determine the change in each investor’s claim on the investee’s book value during the period (adjusted for contributions and distributions):

Below are the journal entries the tax equity investor and the sponsor would use to record their contributions, equity method earnings or losses, and distributions related to their equity method investments in Partnership X on the basis of the calculation and summary above.

Note that in year 2, as illustrated in the journal entries below, the tax equity investor recognizes a larger loss (and the sponsor a larger gain) than in the other years; this is a result of the ITC’s being realized. See the Connecting the Dots box below this example for a discussion of diversity in practice related to recognizing the change in the tax equity investor’s rights to book value as a result of the ITC’s being realized. The journal entries below do not illustrate the calculation of any basis difference, as discussed in the Connecting the Dots box. Instead, the entries show the recording of the entire change in HLBV through earnings immediately.

Connecting the Dots

We are aware of diversity in practice related to recognizing earnings and losses under the HLBV equity method involving ITCs. The accounting for ITCs under ASC 740 by the tax equity investor can vary depending on whether the investor elects, as an accounting policy, either to (1) recognize the ITC as an immediate reduction to income tax expense (the “flow-through method”) or (2) recognize the ITC on a deferred basis over the life of the underlying asset (the “deferral method”). See Deloitte’s Roadmap Income Taxes for further discussion of these methods of recognizing the ITC in earnings. If the flow-through method is applied, the equity method loss that results from the application of the HLBV method should always be recognized in earnings. However, if the deferral method is applied, diversity exists in accounting for the decrease in the right to book value as a result of the ITC’s impact on the application of the HLBV method.

When applying the deferral method for ITCs, some tax equity investors, as illustrated in Example 5-4, recognize the change in the right to book value in equity method earnings of the tax equity investor in the period in which the ITC is earned (i.e., the period in which the underlying asset is placed in service). However, other tax equity investors believe that it is more appropriate to consider the change in the right to book value as a result of the ITC’s impact on the application of HLBV to be a basis difference that would be amortized in accordance with ASC 323-10-35-13 (see Section 5.1.5.2 for a discussion of basis differences). If a tax equity investor applies the basis difference approach, we recommend consultation with an accounting adviser.

This basis difference approach would not be appropriate for the sponsor if it consolidated the investee in accordance with ASC 810.

Example 5-5

Investee R, a partnership, is capitalized by equity contributions from Investor V and Investor T as follows:

Assets, liabilities, and equity for R as of December 31, 20X4, 20X5, and 20X6, are:

Investee R had net income of $50 during 20X5 and $300 during 20X6.

Assume that V accounts for its investment in R under the equity method. Investee R is a limited life entity that does not make regular distributions to its investors. Upon liquidation of R, its net assets are distributed as follows:

Return of the investors’ capital contributions.
Return of $100 to T.
Remainder to the investors on a pro rata basis.

Given R’s complex capital structure, V has elected a policy of calculating its share of R’s earnings or losses by using the HLBV method. Thus, net income for 20X5 and 20X6 is allocated on the basis of the hypothetical liquidations of net assets as of December 31, 20X4, 20X5, and 20X6, as depicted in the chart below. Note that intra-entity profit and loss eliminations and tax impacts have been ignored for simplicity.

Investor V’s share of R’s earnings during 20X5 is zero, because its claim on the book value has remained unchanged during the year (i.e., T was allocated 100 percent of the net income). Investor V’s share of R’s earnings during 20X6 is $125 (V’s $325 claim on December 31, 20X6, net assets less its $200 claim on December 31, 20X5, net assets).

Connecting the Dots

We believe that while it will often be acceptable for an entity to use the HLBV method to allocate an investee’s earnings or losses, there may be instances in which it would be inappropriate for an entity to use the HLBV method. Because the HLBV method inherently focuses on how an investee’s net assets will be distributed in liquidation, a detailed understanding of the investee’s intention with respect to cash distributions is important. We believe that when provisions governing the attribution of liquidating distributions differ significantly from those governing the attribution of ordinary distributions, it would be inappropriate to rely on the HLBV method to allocate the earnings or losses of a going-concern investee if the investee is expected to make significant ordinary distributions throughout its life.

5.1.2.2 Capital-Allocation-Based Arrangements

Capital-allocation-based arrangements are fee arrangements in which one or more parties receives compensation for managing the capital of one or more investors. These arrangements typically include two payment streams: (1) a management fee (usually a fixed percentage of the net asset value of the assets under management) and (2) an incentive-based fee (i.e., a fee based on the extent to which a fund’s performance exceeds predetermined thresholds). Often, a private-equity or real estate fund manager (who may be the GP and have a small ownership percentage in the fund) will receive incentive-based fees by way of a disproportionate allocation of capital from a fund’s limited partnership interests if certain investment returns are achieved (commonly referred to as “carried interests”). This is an example of a capital-allocation-based arrangement that involves an equity interest (the partnership interests held by the GP).

Before the adoption of ASU 2014-09 (codified as ASC 606), GP investors that did not have a controlling financial interest in the underlying partnership generally accounted for their GP interest, excluding the disproportionate allocation of profits, by using the equity method of accounting as prescribed in ASC 323. With respect to the incentive-based-fee portion of their GP investments, investors usually applied EITF Topic D-96 (codified in ASC 605-20-S99-1), which specifies two acceptable approaches to accounting for the receipt of fees for performance-based fee arrangements such as an incentive-based fee in a capital-allocation-based arrangement:

Method 1 — Because of the possibility that fees earned by exceeding performance targets early in the measurement period may be reversed if performance targets are missed later in the measurement period, no incentive-based-fee income is recorded until the end of the measurement period (which in some cases may be coterminous with the life of the fund under management).
Method 2 — Incentive-based-fee income is recorded on the basis of the amount that would be due under the relevant formula at any point in time as if the contract were terminated at that date.

Notwithstanding the above, before the adoption of ASU 2014-09, some investors may have been treating the incentive-based-fee portion of their GP investments within the scope of ASC 323 on the basis of footnote 1 of EITF Topic D-96 (although not codified in ASC 605-20-S99-1), which states:

The SEC staff understands that in certain entities within the scope of AICPA Statement of Position No. 78-9, Accounting for Investments in Real Estate Ventures, the manager is the general partner in a partnership and receives fees in the form of partnership allocations. If the general partner manager has been accounting for such arrangements on the equity method in accordance with that SOP, the manager may continue to apply that method.

With the issuance of ASU 2014-09, the question has arisen about whether these capital-allocation-based arrangements are within the scope of ASC 606 or whether they would be accounted for under other U.S. GAAP (particularly ASC 323).

We believe that if these capital-allocation-based arrangements are within the scope of ASC 606, the incentive-based-fee portion would represent variable consideration. As illustrated in Example 25 in ASC 606-10-55-221 through 55-225, the application of the variable consideration constraint may result in a delay in recognition of incentive-based fees for entities that previously chose to apply Method 2. In some cases, this delay may be significant. See Deloitte’s Roadmap Revenue Recognition for further discussion of constraining estimates of variable consideration.

Notwithstanding Example 25, ASC 606 does not contain explicit guidance on whether capital-allocation-based arrangements that involve an equity interest are within its scope.

We believe that the accounting for an entity’s capital-allocation-based arrangements will vary in accordance with the nature and substance of the arrangement. Specifically, certain entities may be able to demonstrate that the incentive-based fee is an attribute of an equity interest. In such instances, the entity would be able to make an accounting policy election to account for the incentive-based fee under the provisions of ASC 606 or ASC 323 since the equity interest, inclusive of the incentive fee, would qualify for the scope exception outlined in ASC 606-10-15-2(c)(3). See Section 2.4.2.1.1 for further discussion.

Thus, entities should carefully evaluate the scoping guidance within these topics to determine whether their capital-allocation-based arrangements should be accounted for thereunder, particularly ASC 323.

If an investor determines that the incentive-based-fee portion of its capital-allocation-based arrangements is within the scope of ASC 323 (and thus qualifies for the scope exception to ASC 606 noted above), we believe that the scope exception would be applied only to the incentive-based fee. We believe that the management-fee portion of the capital-allocation-based arrangement, if present, should be accounted for under ASC 606.

Application of the equity method under ASC 323-10-35-4 would permit the investor to recognize its share of earnings or losses, inclusive of the incentive-based fee, in the periods in which they are recognized by the underlying investee. The guidance states, in part, that “[a]n investor’s share of the earnings or losses of an investee shall be based on the shares of common stock and in-substance common stock held by that investor.” However, when an agreement designates allocations among the investors of the investee’s profits and losses, certain costs and expenses, distributions from operations, or distributions upon liquidation that are different from ownership percentages, it may not be appropriate for the investor to record equity method income on the basis of the equity interest owned. Examples of these considerations are illustrated in ASC 323-10-55-30 through 55-47, ASC 323-10-55-48 through 55-57 (see Section 5.2.3.1), and ASC 323-10-35-19 (see Section 5.2). ASC 323-10-55-54 through 55-57 also illustrate, in substance, the application of the HLBV method (see Sections 5.2.3.1 and 5.1.2.1). This guidance is consistent with that in ASC 970-323-35-16 and 35-17 (see Section 5.1.2), under which the equity method is applied to investments in entities that have legal agreements designating the allocation of profits and losses and distributions. Given that capital-allocation-based arrangements often provide for a disproportionate allocation of profits on the basis of the fair value of underlying investments in a fund, the investor should carefully determine the most appropriate method of calculating its share of earnings or losses of the investee after considering all of the arrangement’s facts and circumstances.

ASC 323-10-45-1 states that “[u]nder the equity method, an investment in common stock shall be shown in the balance sheet of an investor as a single amount” and that “an investor’s share of earnings or losses from its investment shall be shown in its income statement as a single amount.” Therefore, if the investor has determined that it is appropriate to account for the incentive-based-fee portion of its capital-allocation-based arrangement under ASC 323, we believe that the investor should present its GP investment in the underlying investee as one unit of account in the same line item in the balance sheet. Regarding income statement presentation, we are aware of the following two potentially acceptable views:

The entire amount of the investor’s share of earnings, including its pro rata allocation of profits as well as allocations under the incentive-based-fee portion of the capital-allocation-based arrangement, represents revenue earned by the investor and should therefore be presented in the revenue total in the income statement. However, since these revenues would be considered outside the scope of ASC 606, the amounts should not be labeled as revenue from contracts with customers in the investor’s financial statements or in the accompanying footnotes and disclosures.
The entire amount of the investor’s share of earnings, including its pro rata allocation of profits as well as allocations under the incentive-based-fee portion of the capital-allocation-based arrangement, should be reflected in a separate line item outside of revenue in the income statement.

5.1.3 Differences Between Investor and Investee Accounting Policies and Principles

An investor and its equity method investee may prepare their financial statements by using different accounting policies and principles. Depending on the circumstances, the investor may be required to make adjustments to the investee’s financial statements when calculating its share of the investee’s earnings or losses.

5.1.3.1 Equity Method Investee Does Not Follow U.S. GAAP

ASC 970-323

35-20 In the real estate industry, the accounts of a venture may reflect accounting practices, such as those used to prepare tax basis data for investors, that vary from GAAP. If the financial statements of the investor are to be prepared in conformity with GAAP, such variances that are material shall be eliminated in applying the equity method.

The term “earnings or losses of an investee” is defined in ASC 323-10-20 as “[n]et income (or net loss) of an investee determined in accordance with U.S. generally accepted accounting principles (GAAP).” Therefore, if an investee is not following U.S. GAAP, an investor that reports under U.S. GAAP must make adjustments to convert the investee’s financial statements into U.S. GAAP so it can apply the equity method and record its share of the investee’s earnings or losses. This situation may arise, for example, when the investee’s financial statements are prepared under IFRS Accounting Standards or some other basis of accounting (i.e., in the real estate industry when the investee’s financial statements were prepared by using tax basis information that differs from U.S. GAAP).

Generally accepted accounting principles in some countries other than the United States permit an investor to recognize its share of net income in an equity method investee by using the investee’s basis of accounting, which may be different from that of the investor. For example, a foreign registrant using French GAAP may have an equity method investee that reports under German GAAP. Because a conversion of the investee’s net income into French GAAP is not required under French GAAP, the financial statements of the investor will simply reflect the investor’s share of the investee’s German GAAP net income.

At the 2000 AICPA Conference on Current SEC Developments, the SEC staff indicated that a foreign registrant that is reconciling to U.S. GAAP must convert the net income of its equity method investees into net income prepared under U.S. GAAP and must list the difference as a reconciling item.

5.1.3.2 Investee Has Elected a Private-Company Alternative

ASC 323-10 — Glossary

Public Business Entity

A public business entity is a business entity meeting any one of the criteria below. Neither a not-for-profit entity nor an employee benefit plan is a business entity.

It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing).
It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency other than the SEC.
It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer.
It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U.S. GAAP financial statements (including notes) and make them publicly available on a periodic basis (for example, interim or annual periods). An entity must meet both of these conditions to meet this criterion.

An entity may meet the definition of a public business entity solely because its financial statements or financial information is included in another entity’s filing with the SEC. In that case, the entity is only a public business entity for purposes of financial statements that are filed or furnished with the SEC.

The PCC determines alternatives to existing nongovernmental U.S. GAAP to address the needs of users of private-company financial statements on the basis of criteria mutually agreed upon by the PCC and the FASB. The FASB has issued certain ASUs that contain these PCC alternatives. When an investor accounts for its interest in an investee, the determination of whether PCC alternatives are allowed and whether there is any impact to the investor’s recognition of its share of the investee’s earnings or losses depends on whether the investor and the investee meet the definition of a PBE.

If the investor and the investee are not PBEs — If both the investor and the investee are not PBEs, the investor and the investee may use PCC alternatives. The investor may conform the investee’s accounting policies with its own to unwind a PCC alternative elected by the investee. However, if the investee does not apply a PCC alternative, the investor may not change the investee’s accounting policies to conform with its own.
If the investor is not a PBE but the investee is a PBE — If the investor is not a PBE but the investee is a PBE, the investor may apply PCC alternatives. The investee is prohibited from applying PCC alternatives in its own separate financial statements. Further, the investor is prohibited from conforming the investee’s accounting policies to its accounting policies (i.e., the investor cannot apply the PCC alternatives to the investee’s financial statements when the investor is preparing its own financial statements).
If the investor and the investee are PBEs — If the investor and the investee are PBEs, both the investor and the investee are prohibited from applying PCC alternatives.
If the investor is a PBE but the investee is not a PBE — If the investor is a PBE but the investee is not a PBE, the investor is prohibited from applying PCC alternatives. The investee may elect to apply PCC alternatives in its separate financial statements; however, when applying the equity method of accounting, the investor may need to make adjustments in certain circumstances.

While not authoritative, the guidance in AICPA Technical Q&As Section 7100.08 distinguishes between when the investor meets criterion (a) versus when it meets criteria (b) through (e) of the ASC master glossary definition of a PBE in the determination of whether any adjustments to equity method pickups would be required.

If the investor is a PBE according to criterion (a) of the ASC master glossary definition, the investor is required to reverse the investee’s PCC alternatives when calculating its equity method pickup. The SEC staff has indicated in discussions that PBEs are prohibited from including PCC alternatives in their financial statements on an “indirect” basis when they apply the equity method of accounting. Although the PCC alternatives are considered part of U.S. GAAP, precluding their use by an investor that meets the definition of a PBE (referred to herein as a “PBE investor”) is consistent with requiring investors that apply the equity method to adjust the accounting of an investee that applies other GAAP (e.g., IFRS Accounting Standards) (see Section 5.1.3.1).

If the investor is a PBE according to criteria (b) through (e) of the ASC master glossary definition, the investor is not required to reverse the investee’s PCC alternatives when calculating its equity method pickup. However, the investor may elect to do so in certain circumstances (e.g., if it plans to go public).

Example 5-6

Company P holds an interest in Company Q and accounts for it by applying the equity method. Because P is an SEC registrant, it is a PBE for financial reporting purposes according to criterion (a) of the ASC master glossary definition. Company Q is a private company that has elected to amortize goodwill in accordance with ASC 350-20-15-4 in its own financial statements. In addition, P is not required to include Q’s separate financial statements in its own SEC filings (in accordance with Regulation S-X, Rule 3-09).5 Therefore, for P’s SEC filing purposes, Q does not explicitly meet criterion (a) of the definition of a PBE because Q is not one of the “other entities whose financial statements or financial information are required to be or are included in a filing.” Company P’s accounting under the equity method cannot reflect Q’s election to amortize goodwill. Although Q may be eligible to amortize goodwill when it prepares its stand-alone financial statements, Q’s accounting must be changed to that of a PBE when P applies the equity method to account for its interest in Q. Thus, P would reverse the amortization recorded by Q (and the related tax effects, if any) and evaluate whether the adjusted carrying value of goodwill on Q’s books, without the election to amortize goodwill, would be deemed impaired if Q performed the impairment analysis required of a PBE (i.e., an annual test performed at the reporting-unit level).

See Section 5.1.3.4 for details regarding application of the definition of a PBE to an equity method investee and a discussion of the extent to which PBE effective dates of new accounting standards apply when a PBE investor accounts for its interest in an investee that may or may not be a PBE.

5.1.3.3 Investee Applies Different Accounting Policies Under U.S. GAAP

While a PBE investor cannot apply the equity method to account for its interest in an investee until it adjusts the investee’s financial statements to eliminate any elected private-company accounting alternatives (as discussed in the previous section), there is no need to align the investee’s accounting policies with those of the investor as long as the investee’s policies can be applied by a PBE. That is, in accordance with the ASC master glossary definition of the term “earnings or losses of an investee,” as long as the investee’s accounting policies are acceptable under U.S. GAAP, the investee’s financial statements should not be adjusted to conform to the accounting policies of the investor.

For instance, if an equity method investee accounts for its inventory under the last-in, first-out method while the investor uses the first-in, first-out method (or vice versa), the investor should not adjust the investee’s financial statements to conform to the investor’s inventory policy. However, it is important for the investor to understand the impact of these differing accounting policies when calculating equity method earnings and, specifically, whether any intra-entity profit or loss eliminations are required. For example, assume that an investor and its equity method investee enter into a sales contract and the investor determines that the contract is a derivative while the investee elects the normal purchases and normal sales derivative scope exception. This difference in accounting policy leads the investor to account for the contract at fair value, with changes in fair value reported in earnings, while the investee accounts for the same contract on an accrual basis. In this case, the investor will have to eliminate unrealized intra-entity profits or losses recognized on the contract. See Section 5.1.5.1 for details on intra-entity profit or loss eliminations.

5.1.3.4 Investee Adopts a New Accounting Standard on a Different Date

New accounting standards often establish divergent adoption requirements (e.g., different effective dates) for PBEs and non-PBEs. The determination of whether an investor registrant must adjust an equity method investee’s adoption of a new standard to make it conform to the manner of adoption required of PBEs depends on whether the equity method investee is considered a PBE. For example, an equity method investee whose financial statements are included in a registrant’s filing under Regulation S-X, Rule 3-09, because the equity method investee is significant to the registrant is considered a PBE under U.S. GAAP.

In his remarks before the 2016 AICPA Conference on Current SEC and PCAOB Developments, Jonathan Wiggins, associate chief accountant in the OCA, stated, in part:

Whether an entity is a public business entity can have a significant impact on financial reporting, particularly since certain FASB guidance, including the new revenue, leases, and financial instruments standards, have different effective dates for public business entities. You should ensure that all entities that meet the definition of a public business entity adopt such guidance using the effective dates for public business entities for purposes of the financial statements or financial information included in a filing with the SEC.

OCA has received related questions regarding the accounting for equity method investees that do not otherwise meet the FASB’s definition of a public business entity. [Footnotes omitted]

When a PBE investor accounts for its interest in an investee, the determination of whether the PBE effective dates of new accounting standards apply to (1) the investee’s financial statements or financial information filed with or furnished to the SEC and (2) the PBE investor’s recognition of its share of the investee’s earnings or losses depends on whether the investee (1) is a PBE itself, (2) is a PBE because of its relationship with the PBE investor, or (3) is not a PBE.

If the investee is a PBE itself — If the investee is a PBE itself (i.e., it meets the definition of a PBE regardless of its relationship with the PBE investor), the investor’s equity method of accounting should be based on the financial statements that the investee prepared by applying the specific PBE transition dates and provisions, if any, of the new accounting standard being adopted. In addition, the investee’s financial statements or financial information filed or furnished by the PBE investor must reflect the investee’s adoption of the new accounting standard and its compliance with the specific PBE transition dates and provisions, if any.
If the investee is a PBE because of its relationship with the PBE investor — In some instances, an investee meets the definition of a PBE according to the ASC master glossary “solely because its financial statements or financial information is included in another entity’s filing with the SEC.” For example, an SEC filer may include financial statements or financial information of investees that otherwise would not meet the definition of a PBE (referred to herein as “specified PBEs”) in its own filings with the SEC under the following Regulation S-X rules:6
- Rule 3-05, “Financial Statements of Businesses Acquired or to Be Acquired.”
- Rule 3-09, “Separate Financial Statements of Subsidiaries Not Consolidated and 50 Percent or Less Owned Persons.”
- Rule 3-10(g), “Recently Acquired Subsidiary Issuers or Subsidiary Guarantors.”
- Rule 3-14, “Special Instructions for Real Estate Operations to Be Acquired.”
- Rule 4-08(g), “Summarized Financial Information of Subsidiaries Not Consolidated and 50 Percent or Less Owned Persons.”
- Rule 10-01(b)(1), “Interim Financial Statements.”
If the investee is not a PBE — Mr. Wiggins indicated that in the determination of the applicable effective dates of accounting standards, he believes that when an SEC registrant uses the equity method to account for its investment in an entity that is not a PBE, amounts recognized by the registrant would not be considered financial information included in a filing with the SEC under the FASB’s definition of a PBE. Thus, the non-PBE equity method investee would not be required to use PBE effective dates solely to determine the registrant’s application of the equity method of accounting.

See Section 6.4.2.1 for details regarding form and content considerations.

Note that if an investee early adopts a new accounting standard while the investor adopts that standard on the required adoption date, the investor is not required to eliminate the effects of the investee's early adoption in its financial statements since both the investor and investee have complied with the adoption dates for that standard. However, care must be taken in the elimination of intercompany transactions to avoid the recognition of profit or loss that results from the investee’s adoption of a new accounting standard before adoption by the investor.

5.1.3.4.1 Application of PBE Adoption Dates to Equity Method Investees With Different Fiscal Year-Ends

Determining the adoption date for a new accounting standard when a PBE investor and its equity method investee that meets the definition of a PBE have different fiscal year-end dates can be complex. Mr. Wiggins noted that when an equity method investee meets the definition of a PBE, the registrant’s equity method accounting would be expected “to be based on the [investee’s] financial statements prepared using the public business entity effective dates.” Therefore, we believe that when the investee has a different fiscal year-end than the investor, it would be appropriate for the investee to use the adoption date based on the investee’s fiscal year-end, which may be later than the investor’s adoption date.

Example 5-7

Investor K is a PBE that holds an equity method investment in Investee M. Although M is a private company, it meets the definition of a PBE because its financial statements are included in K’s SEC filing under Regulation S-X, Rule 3-09, given that M is significant to K. Investor K has a December 31 fiscal year-end, whereas M has a June 30 fiscal year-end.

Note that M is permitted to use the non-PBE effective dates in accordance with the relief provided by the SEC, as described in ASU 2020-02, which we understand has been extended to include deferral of the effective dates in ASU 2020-05. However, to illustrate the use of different fiscal year-ends and not the SEC relief, this example assumes that both K and M are applying the PBE effective dates.

In its filing of financial statements for the year ending December 31 with the SEC, K would include M’s financial statements for the year ending June 30. Because there is a greater-than-three-month lag between K’s and M’s fiscal year-end dates, the equity method earnings (losses) reported in K’s financial statements are adjusted in such a way that K is recording its equity method earnings (losses) in M for the 12 months ending December 31. See Section 5.1.4 for details related to accounting for an investor’s share of earnings on a time lag.

ASC 606 and ASC 842 are effective for PBEs for annual periods beginning after December 15, 2017, and December 15, 2018, respectively (i.e., calendar periods beginning on January 1, 2018, and January 1, 2019, respectively), and interim periods therein. Since M meets the definition of a specified PBE, it may choose to adopt these standards by using the PBE effective date.

Investee M would not be precluded from adopting ASC 606 and ASC 842 by using its own PBE effective date (i.e., July 1, 2018, and July 1, 2019, respectively). In the year of adoption, this would result in the reflection in K’s equity method earnings (losses) in M of six months of M’s accounting before the adoption of ASC 606 and ASC 842 and six months of M’s accounting after the adoption of ASC 606 and ASC 842. If M were required to use the PBE adoption date of K (i.e., January 1, 2019), this would effectively cause M to adopt ASC 606 and ASC 842 as of July 1, 2017, and July 1, 2018, respectively, which is, respectively, one year before its own PBE effective date and more than two years before the non-PBE effective date.

5.1.3.5 Investee Applies Specialized Industry Accounting

ASC 323-10

25-7 For the purposes of applying the equity method of accounting to an investee subject to guidance in an industry-specific Topic, an entity shall retain the industry-specific guidance applied by that investee.

ASC 810-10

25-15 For the purposes of consolidating a subsidiary subject to guidance in an industry-specific Topic, an entity shall retain the industry-specific guidance applied by that subsidiary.

Under ASC 323-10-25-7, if an equity method investee applies industry-specific guidance, the investor should retain the application of the industry-specific guidance when preparing its financial statements. For example, specialized industry accounting allows investment companies to carry their investments at fair value, with changes in the fair value of the investments recorded in the statement of operations. Since ASC 323-10 essentially requires a one-line consolidation, an investor that holds investments that qualify for specialized industry accounting for investment companies (in accordance with ASC 946) should follow that guidance regardless of whether the investment is accounted for under the equity method or is consolidated. Therefore, the investor should record in its statement of operations its share of the earnings or losses, realized and unrealized, as reported by its equity method investees that qualify for specialized industry accounting for investment companies.

5.1.4 Accounting for an Investor’s Share of Earnings on a Time Lag

ASC 323-10

35-6 If financial statements of an investee are not sufficiently timely for an investor to apply the equity method currently, the investor ordinarily shall record its share of the earnings or losses of an investee from the most recent available financial statements. A lag in reporting shall be consistent from period to period.

In some situations, an equity method investee’s fiscal-year-end date will not be the same as an investor’s. In addition, an equity method investee may have the same fiscal-year-end date as the investor, but the financial statements of the equity method investee may not be made available to the investor in a sufficiently timely manner. The investor should consider all facts and circumstances when assessing the appropriateness of reporting its share of the equity method investee’s financial results on a time lag. For instance, investors may receive periodic financial information from investees in the form of capital statements, performance reports, statements of net asset value, or statements of unit value. Such financial information is most likely derived from investee accounting records that are substantively the same as financial statements. Accordingly, investors should carefully evaluate their conclusions concerning what constitutes an investee’s “most recent available financial statements.”

It is generally acceptable for an investor to apply the equity method accounting by using an equity method investee’s financial statements with a different reporting date as long as the reporting dates of the investor and investee are no greater than three months apart. Since equity method accounting generally results in single-line consolidation, ASC 810-10-45-12 provides the following analogous guidance:

It ordinarily is feasible for the subsidiary to prepare, for consolidation purposes, financial statements for a period that corresponds with or closely approaches the fiscal period of the parent. However, if the difference is not more than about three months, it usually is acceptable to use, for consolidation purposes, the subsidiary’s financial statements for its fiscal period; if this is done, recognition should be given by disclosure or otherwise to the effect of intervening events that materially affect the financial position or results of operations.

When the investor reports its share of the results of its equity method investee on a time lag, the investee’s results should be for the same length of time as the investor’s results. For example, in the investor’s 12-month financial statements, the investee’s results also would be for the full 12 months, although the results will be for a different 12 months than the investor’s stand-alone results. It would not be appropriate to include the investee’s results for a period that is greater or less than 12 months. The investor’s evaluation of whether to report its share of the equity method investee’s financial results on a time lag should be performed for each investment separately. For instance, the investor may use a reporting time lag for certain equity method investees but not for others. The decision to use a reporting time lag for an equity method investee should be applied consistently for that investee in each reporting period.

The investor should evaluate material events occurring during the time lag (i.e., the period between the investee’s most recent available financial statements and the investor’s balance sheet date) to determine whether the effects of such events should be disclosed or recorded in the investor’s financial statements. By analogy to ASC 810-10-45-12, “recognition should be given by disclosure or otherwise to the effect of intervening events that materially affect the [investor’s] financial position or results of operations” (emphasis added).

An investor may elect a policy of either disclosing all material intervening events or both disclosing and recognizing them. Either policy is acceptable and should be consistently applied to all material intervening events that meet the recognition requirements of U.S. GAAP. When the investor chooses to recognize material intervening events, either in accordance with its elected policy or because the events are so significant that disclosure alone would not be sufficient, it should take care to reflect only the impact of such events. Further, the investor should track recognized material intervening events for the time lag to ensure that those events are not recognized again in subsequent periods. It would generally not be appropriate to present the investor’s share of more than 12 months of operations for the investee in the investor’s financial statements (in addition to the effects of the recognized event or another change in the investor’s accounting for the investee). See Section 11.1.3 of Deloitte’s Consolidation Roadmap for further discussion of when recognition or disclosure or both are appropriate for material intervening events. This guidance applies to material (or significant) intervening events that would affect the investee’s financial results rather than transactions or events of the investor. For instance, if the investor sold its interest in the investee during the reporting lag, the sale is a transaction of the investor. Therefore, in such circumstances, the disposal of the investee should be recognized in the period in which the disposition occurs, regardless of whether a reporting lag exists. It would be inappropriate to defer recognition of the transaction at the investor level because the transaction falls into a different interim or annual period for the investee. Further, if an investor disposes of its interest in an equity method investee that reports its financial results on a lag, the investor only recognizes its share of the investee’s profit (loss) for the period up to the most recently available financial statements of the investee. Any resulting gain or loss on the disposal of the investee should be recognized by the investor in the period in which the sale occurred (i.e., not on a lag).

Also, an investor’s other-than-temporary impairment (OTTI) testing of its equity method investments should be performed as of the investor’s balance sheet date, in accordance with ASC 323-10-35-32. The investor should evaluate all impairment indicators that occur during the time lag. See Section 5.5 for additional guidance on evaluating equity method investments for OTTIs, including examples of impairment indicators.

The example below illustrates the adoption of a new accounting standard when an investor records its share of earnings of its equity method investee on a time lag.

Example 5-8

Investor Q is a public company that has adopted ASC 606 as of January 1, 2018, by using the modified retrospective approach. Investor Q records its share of earnings of its equity method investee, G, on a one-quarter lag. Specifically, for the first quarter of 2018, Q will record its share of G’s earnings for the period from October 1, 2017, through December 31, 2017. Because of this time lag, the impact from G’s adoption of ASC 606 would not be included in Q’s results until April 1, 2018. In this situation, we believe that Q should report its share of the impact from G’s adoption of ASC 606 as an adjustment to equity on April 1, 2018. Although Q’s ASC 606 adoption date is January 1, 2018, Q records its share of G’s earnings on a one-quarter lag. Therefore, it is appropriate that Q’s share of G’s cumulative equity adjustment because of ASC 606 adoption should also be reported on a lag (on April 1, 2018). We believe that since Q recognizes its share of G’s first quarter earnings in the second quarter, Q should also recognize the cumulative equity adjustment resulting from G’s adoption of ASC 606 on the first day of the second quarter (April 1, 2018).

In addition, ASC 810-10-45-13 requires investors to record the elimination of a reporting time lag “as a change in accounting principle in accordance with the provisions of Topic 250.” ASC 250-10-45-2 indicates that an entity may change an accounting principle only if the change is considered preferable, stating, in part:

A reporting entity shall change an accounting principle only if either of the following apply:

The change is required by a newly issued Codification update.
The entity can justify the use of an allowable alternative accounting principle on the basis that it is preferable. [Emphasis added]

While the criterion in ASC 250-10-45-2(b) above refers to preferable methods of applying accounting principles in situations with multiple allowable alternatives, investors should view the application and discontinuance of the reporting time lag as a matter of acceptability rather than preference. That is, the method an investor uses to apply a reporting time lag and its discontinuance or modification of this method are matters of fact and necessity rather than elections among multiple acceptable alternatives. Generally, under ASC 250, voluntary changes in accounting principles must be presented retrospectively.

Even if an investor’s use of a reporting time lag for its equity method investee was appropriate in previous periods, the investor must discontinue the use of such time lag once the equity method investee can produce reliable and timely financial statements by using the same reporting date as the investor.

Note that if an investor that historically did not use a reporting time lag for its equity method investee subsequently determines that results should be reported on a time lag, that change would be considered a change in accounting policy subject to the requirements in ASC 250. In practice, it is often difficult to justify an investor’s use of a reporting time lag for its equity method investee when it has historically not used a time lag. Similarly, it is difficult to justify lengthening the period of a time lag, and such a change is expected to be rare. In the evaluation of a new or extended time lag period, the inability to obtain timely financial information from the equity method investee is generally not sufficient to justify the change. Further, such inability to obtain timely information may indicate that the investor lacks significant influence over the equity method investee.

5.1.5 Adjustments to Equity Method Earnings and Losses

As noted in ASC 323-10-35-5 (see Section 5.1), to determine its share of an investee’s earnings or losses in income, an investor should adjust its share of equity method earnings or losses (and make corresponding adjustments to the carrying value of the equity method investment) for the following:

Intra-entity profits and losses (see the next section).
Amortization or accretion of basis differences (see Section 5.1.5.2).
Investee capital transactions (see Section 5.1.5.3).
Other comprehensive income (OCI) (see Section 5.1.5.4).

5.1.5.1 Intra-Entity Profits and Losses

ASC 323-10

35-7 Intra-entity profits and losses shall be eliminated until realized by the investor or investee as if the investee were consolidated. Specifically, intra-entity profits or losses on assets still remaining with an investor or investee shall be eliminated, giving effect to any income taxes on the intra-entity transactions, except for any of the following:

A transaction with an investee (including a joint venture investee) that is accounted for as a deconsolidation of a subsidiary or a derecognition of a group of assets in accordance with paragraphs 810-10-40-3A through 40-5.
A transaction with an investee (including a joint venture investee) that is accounted for as a change in ownership transaction in accordance with paragraphs 810-10-45-21A through 45-24.
A transaction with an investee (including a joint venture investee) that is accounted for as the derecognition of an asset in accordance with Subtopic 610-20 on gains and losses from the derecognition of nonfinancial assets.

35-8 Because the equity method is a one-line consolidation, the details reported in the investor’s financial statements under the equity method will not be the same as would be reported in consolidated financial statements under Subtopic 810-10. All intra-entity transactions are eliminated in consolidation under that Subtopic, but under the equity method, intra-entity profits or losses are normally eliminated only on assets still remaining on the books of an investor or an investee.

35-9 Paragraph 810-10-45-18 provides for complete elimination of intra-entity income or losses in consolidation and states that the elimination of intra-entity income or loss may be allocated between the parent and the noncontrolling interests. Whether all or a proportionate part of the intra-entity income or loss shall be eliminated under the equity method depends largely on the relationship between the investor and investee.

35-10 If an investor controls an investee through majority voting interest and enters into a transaction with an investee that is not at arm’s length, none of the intra-entity profit or loss from the transaction shall be recognized in income by the investor until it has been realized through transactions with third parties. The same treatment applies also for an investee established with the cooperation of an investor (including an investee established for the financing and operation or leasing of property sold to the investee by the investor) if control is exercised through guarantees of indebtedness, extension of credit and other special arrangements by the investor for the benefit of the investee, or because of ownership by the investor of warrants, convertible securities, and so forth issued by the investee.

35-11 In other circumstances, it would be appropriate for the investor to eliminate intra-entity profit in relation to the investor’s common stock interest in the investee. In these circumstances, the percentage of intra-entity profit to be eliminated would be the same regardless of whether the transaction is downstream (that is, a sale by the investor to the investee) or upstream (that is, a sale by the investee to the investor).

35-12 Example 3 (see paragraph 323-10-55-27) illustrates the application of this guidance.

ASC 970-323

30-7 An investor shall not record as income its equity in the venture’s profit from a sale of real estate to that investor; the investor’s share of such profit shall be recorded as a reduction in the carrying amount of the purchased real estate and recognized as income on a pro rata basis as the real estate is depreciated or when it is sold to a third party. Similarly, if a venture performs services for an investor and the cost of those services is capitalized by the investor, the investor’s share of the venture’s profit in the transaction shall be recorded as a reduction in the carrying amount of the capitalized cost.

35-14 Intra-entity profit shall be eliminated by the investor in relation to the investor’s noncontrolling interest in the investee, unless one of the exceptions in paragraph 323-10-35-7 applies. An investor that controls the investee and enters into a transaction with the investee shall eliminate all of the interentity profit on assets remaining within the group. (See Subsection 323-30-35 for accounting guidance concerning partnership ownership interest.)

35-15 A sale of property in which the seller holds or acquires a noncontrolling interest in the buyer shall be evaluated in accordance with the guidance in paragraphs 360-10-40-3A through 40-3B. No profit shall be recognized if the seller controls the buyer.

As discussed in Section 10.2.1 of Deloitte’s Consolidation Roadmap, ASC 810-10-45-1 and ASC 810-10-45-18 require intercompany balances and transactions to be eliminated in their entirety. The amount of profit or loss eliminated would not be affected by the existence of a noncontrolling interest (e.g., intra-entity open accounts balances, security holdings, sales and purchases, interest, or dividends). Since consolidated financial statements are based on the assumption that they represent the financial position and operating results of a single economic entity, the consolidated statements would not include any gain or loss transactions between the entities in the consolidated group.

Although ASC 810 provides for complete elimination of intercompany profits or losses in consolidation, it also states that the elimination of intercompany profit or loss may be allocated proportionately between the parent and noncontrolling interests.

Because the equity method is a one-line consolidation, an investor should eliminate its intra-entity profits or losses resulting from transactions with equity method investees until the investor or the investee realizes the profits or losses through transactions with independent third parties.

When performing the analysis about whether an intra-entity sale should be recognized, an investor must determine whether there are any unstated rights or privileges present in the transaction and whether the transaction includes, in whole or in part, a capital contribution or distribution that should be accounted for separately. If recognition of the sale is deemed appropriate, the investor would recognize gross revenue, costs, and profits (or losses) on the transaction, all of which would flow through those respective financial statement line items, as well as its proportionate share of expense recorded by the investee through the application of equity method accounting, which would flow through the same financial statement line item as equity method earnings (losses).

In applying the equity method, the investor will first need to determine whether intra-entity assets remain on the books of either the investor or the investee (e.g., inventory). If assets do remain on the books of either the investor in an upstream transaction (i.e., a sale by the investee to the investor) or the investee in a downstream transaction (i.e., a sale by the investor to the investee), the determination of whether all or only the investor’s proportionate share of the intra-entity profit or loss is eliminated depends on (1) an evaluation of the nature of the relationship between the investor and the investee (i.e., generally, whether the investor controls the investee through a majority voting interest or other means as described in ASC 323-10-35-10) and (2) whether the intra-entity transaction is conducted at arm’s length in the normal course of business. If an investor controls the investee through a majority voting interest and the intra-entity transaction is not conducted at arm’s-length terms, all of the intra-entity profit or loss is required to be eliminated by the investor. However, situations in which an investor would have control over an investee through a majority voting interest would be rare because an investor with a controlling financial interest in a legal entity must consolidate the legal entity under ASC 810.

In ASU 2017-05, the FASB noted that it had ”placed more emphasis on eliminating differences between the derecognition of assets and the derecognition of businesses or nonprofit activities.” Therefore, it decided to amend ASC 323-10-35-7 “to require that no gain or loss should be eliminated when an entity transfers an asset subject to Subtopic 610-20.” The accounting for intra-entity transactions is summarized in the following table:

An investor is required to assess an Intra-entity transaction in which assets remain on the books to determine whether the transaction is at arm’s length. Factors to consider when assessing whether an intra-entity transaction is at arm’s length include, but are not limited to, the following:

Does the sales price approximate the fair value of the assets transferred, and will payment of the sales price be collected?
Does the transaction have economic substance?
Does the seller have an obligation to support the asset sold, even after the transaction is completed?

Intra-entity profit or loss elimination is required even if the elimination exceeds the carrying amount of the investor’s equity method investment and therefore results in a negative equity method investment balance. In such instances, it may be acceptable to credit the investor’s inventory or fixed asset balances as appropriate.

Note that an investor also recognizes the tax effects of the intra-entity transactions, including any deferred taxes, regardless of whether profit or loss is eliminated. (See Sections 4.5.2 and 12.3 of Deloitte’s Roadmap Income Taxes for additional guidance on the tax considerations for equity method investees.) The examples below illustrate the elimination of intra-entity profit or loss in both upstream and downstream transactions that are within the scope of both ASC 606 and ASC 610-20. To reflect the intra-entity profit eliminations, an investor should consider which presentation is most meaningful in the circumstances in accordance with ASC 323-10-55-28. We believe that there should be consistent application of an accounting policy for similar facts and circumstances (i.e., it would not be appropriate to apply different alternatives for the same or similar transactions or circumstances).

The investor should also disclose its accounting policy for the aforementioned eliminations.

In addition, investors and equity method investees that engage in downstream or upstream transactions should consider the related-party disclosure requirements as discussed in Section 6.3.2. Once the intra-entity profit or loss is realized by the investor or investee through transactions with independent third parties (and therefore no intra-entity asset remains), no elimination is required.

ASC 323-10

55-27 The following Cases illustrate how eliminations of intra-entity profits might be made in accordance with paragraph 323-10-35-7. Both Cases assume that an investor owns 30 percent of the common stock of an investee, the investment is accounted for under the equity method, the income tax rate to both the investor and the investee is 40 percent, the inventory is a good that is an output of the entity’s ordinary activities, and the contract is with a customer that is within the scope of Topic 606 on revenue from contracts with customers:

Investor sells inventory downstream to investee (Case A)
Investee sells inventory upstream to investor (Case B).

Case A: Investor Sells Inventory Downstream to Investee

55-28 Assume an investor sells inventory items to the investee (downstream). At the investee’s balance sheet date, the investee holds inventory for which the investor has recorded a gross profit of $100,000. The investor’s net income would be reduced $18,000 to reflect a $30,000 reduction in gross profit and a $12,000 reduction in income tax expense. The elimination of intra-entity profit might be reflected in the investor’s balance sheet in various ways. The income statement and balance sheet presentations will depend on what is the most meaningful in the circumstances.

Case B: Investee Sells Inventory Upstream to Investor

55-29 Assume an investee sells inventory items to the investor (upstream). At the investor’s balance sheet date, the investor holds inventory for which the investee has recorded a gross profit of $100,000. In computing the investor’s equity pickup, $60,000 ($100,000 less 40 percent of income tax) would be deducted from the investee’s net income and $18,000 (the investor’s share of the intra-entity gross profit after income tax) would thereby be eliminated from the investor’s equity income. Usually, the investor’s investment account would also reflect the $18,000 intra-entity profit elimination, but the elimination might also be reflected in various other ways; for example, the investor’s inventory might be reduced $18,000.

Example 5-9

Assets Remain on the Books but Will Be Sold Through to a Third Party

Downstream Transaction

Investor A holds a 40 percent ownership interest in Investee C and accounts for its investment in C under the equity method. Earnings in C are allocated pro rata on the basis of the ownership interests in C. Investee C purchases 10 units of inventory from A in an arm’s-length transaction for $1,000 per unit, which is accounted for in accordance with ASC 606. Investor A’s cost associated with each unit of inventory is $600, thus generating an intra-entity profit of $400 for each unit of inventory sold. As of C’s balance sheet date, 5 units of inventory were sold to independent third parties and 5 units remain in C’s ending inventory. Investor A should eliminate $800 of intra-entity profit: (5 units remaining in C’s inventory × $400 profit for each unit of inventory) × A’s 40% ownership interest in C.

To reflect this intra-entity profit elimination, A should consider which presentation is most meaningful in the circumstances in accordance with ASC 323-10-55-28. Potential acceptable alternatives for recording the intra-entity profit elimination for this downstream transaction include the following; however, there could be additional alternatives (such alternatives ignore the effect of income taxes):

If the transaction between A and C was not considered to be at arm’s length, 100 percent of A’s $2,000 profit on the 5 units remaining in C’s ending inventory (5 units remaining in ending inventory × $400 profit on each unit) would be eliminated.

Upstream Transaction

The above example represents a downstream transaction; however, if this were an upstream transaction in which C was selling the units of inventory to A, the intra-entity elimination by A could be reflected differently than what is shown depending on the alternative selected by A. Potential acceptable alternatives for recording the intra-entity profit elimination if this were an upstream transaction include the following; however, there could be additional alternatives (such alternatives ignore the effect of income taxes):

Example 5-10

Assets Remain on the Books That Will Not Be Sold to a Third Party

Assume the same facts as in the example above, except the investee does not intend to sell the inventory, which has a useful life of five years.

Downstream Transaction

See the example above for initial intra-entity profit elimination alternatives.

Subsequently, the investor would recognize the deferred intra-entity profit of $800 over the five-year useful life of the asset, which effectively adjusts the investor’s share of the depreciation expense recorded by the investee.

Upstream Transaction

See the example above for initial intra-entity profit elimination alternatives.

Subsequently, the investor recognizes the deferred intra-entity profit of $800 over the five-year useful life of the asset.

Example 5-11

Sale of an Asset Within the Scope of ASC 610-20

Downstream Transaction

Investor B holds a 35 percent ownership interest in Investee W and accounts for its investment under the equity method. Investor B sells equipment (that is not an output of its ordinary activities) to W in an arm’s-length transaction for $10,000. Investor B’s cost associated with the equipment is $9,000, resulting in an intra-entity profit of $1,000. Investee W does not intend to sell the equipment, which has a useful life of five years.

On the transaction’s closing date, B concludes that the transaction is the sale of a nonfinancial asset within the scope of ASC 610-20 and determines that W has control of the nonfinancial asset under ASC 606. Therefore, B determines that it should derecognize the equipment under ASC 610-20 and recognize a gain of $1,000 ($10,000 − $9,000) (i.e., no portion of the profit or loss should be eliminated).

Upstream Transaction

Assume the same facts as above, except that the transaction is upstream, wherein W sells the equipment to B (B is not a customer as defined in ASC 606). Intra-entity profit elimination should be recorded in a manner consistent with an upstream sale of assets that (1) are within the scope of ASC 606 and (2) will not be sold to a third party. Thus, B should consider which presentation is most meaningful in the circumstances in accordance with ASC 323-10-55-28. Investor B should disclose its accounting policy for such eliminations.

5.1.5.2 Amortization or Accretion of Basis Differences

ASC 323-10

35-13 A difference between the cost of an investment and the amount of underlying equity in net assets of an investee shall be accounted for as if the investee were a consolidated subsidiary. Paragraph 350-20-35-58 requires that the portion of that difference that is recognized as goodwill not be amortized. However, if an entity within the scope of paragraph 350-20-15-4 elects the accounting alternative for amortizing goodwill in Subtopic 350-20, the portion of that difference that is recognized as goodwill shall be amortized on a straight-line basis over 10 years, or less than 10 years if the entity demonstrates that another useful life is more appropriate. Paragraph 350-20-35-59 explains that equity method goodwill shall not be reviewed for impairment in accordance with paragraph 350-20-35-58. However, equity method investments shall continue to be reviewed for impairment in accordance with paragraph 323-10-35-32.

35-14 See paragraph 323-10-35-34 for related guidance when an investment becomes subject to the equity method.

ASC 323-10-35-13 requires an investor to account for the “difference between the cost of an [equity method] investment and the amount of underlying equity in net assets of an investee . . . as if the investee were a consolidated subsidiary.” The investor therefore determines any differences between the cost of an equity method investment and its share of the fair values of the investee’s individual assets and liabilities by using the acquisition method of accounting in accordance with ASC 805. Such differences are commonly known as “basis differences” and result from the investor’s requirement to allocate the cost of the equity method investment to the investee’s individual assets and liabilities. Any excess of the cost of an equity method investment over the proportional fair value of the investee’s assets and liabilities (commonly referred to as “equity method goodwill”) is recognized in the equity investment balance. See Section 4.5 for details regarding the initial measurement of basis differences.

ASC 323-10-35-5 specifies that after initial measurement, adjustments to the investor’s share of investee earnings or losses (and corresponding adjustments to the carrying value of the equity method investment) are made for amortization or accretion of basis differences (aside from equity method goodwill, which is not amortized unless the PCC alternative is elected — see ASC 323-10-35-13 and Section 5.1.3.2). Note that an investor should make these adjustments to its share of the investee’s earnings or losses regardless of the allocation method the investor used to determine its share of investee’s earnings or losses.

If an investee subsequently disposes of an asset that initially gave rise to an equity method basis difference recognized by the investor, that basis difference should be written off at the time of sale and the investor should adjust the equity in earnings to correctly reflect the investor’s proportionate share of the investee’s reported gain or loss. Note that the guidance in ASC 323-10-35-13 does not provide specific insights into the determination of the period over which basis differences should be amortized or accreted. Generally, basis differences are amortized or accreted over the life of the underlying assets and liabilities to which the basis differences are attributable. For instance, if a positive basis difference exists because the investor’s proportionate share of the fair value of the investee’s net assets exceeds its book value and the positive basis difference is solely attributable to fixed assets of the equity method investee with an estimated remaining useful life of 25 years, the positive basis difference would be amortized over the 25-year life of those specific fixed assets. The amortization of the positive basis difference would result in increased depreciation expense recognized by the investor related to the fixed assets of the investee to reflect the investor’s basis in the investee, thus reducing the investor’s equity method earnings in each period. Similarly, if a negative basis difference exists because the investor’s proportionate share of the fair value of the investee’s net assets is less than its book value and the negative basis difference is solely attributable to fixed assets of the equity method investee with an estimated remaining useful life of 25 years, the negative basis difference would be accreted over the 25-year life of those specific fixed assets. The accretion of the negative basis difference would result in decreased depreciation expense recognized by the investor related to the fixed assets of the investee to reflect the investor’s basis in the investee, thus increasing the investor’s equity method earnings in each period. See Section 4.5.1 for further discussion of the limited circumstances in which initial negative basis differences are recorded as bargain purchase gains upon initial measurement of an equity method investment.

Example 5-12

Investor X purchases a 40 percent interest in Investee Z for $2 million, applies the equity method of accounting, and will recognize earnings in Z pro rata on the basis of its ownership interest. The book value of Z’s net assets is $3.5 million. The table below shows the book values and fair values of Z’s net assets (along with X’s proportionate share) as of the investment acquisition date.

As shown in the table above:

The book value of Z’s current assets and current liabilities approximate their fair value.
Investor X determined that Z has patented technology that was internally developed; therefore, costs associated with developing this technology were expensed as incurred rather than recorded as an intangible asset on Z’s books. The patented technology has a fair value of $300,000 and a remaining useful life of 30 years as of the investment acquisition date.
Investor X determined that the fair value of Z’s fixed assets is $4 million with a remaining useful life of 20 years as of the investment acquisition date.

Assume that for the year after the investment acquisition date, Z’s net income is $1 million. Below is a calculation of X’s equity method earnings for the period. Assume that allocations of profit and loss as well as distributions are made in accordance with investor ownership percentages. Further, taxes and intra-entity profit eliminations are ignored for simplicity.

As shown above, the basis differences attributable to Z’s fixed assets and intangible assets are amortized over their estimated remaining useful lives, creating adjustments to X’s proportionate share of Z’s earnings for the period. As discussed, the $80,000 related to equity method goodwill is not amortized; however, it should be assessed along with the entire equity method investment for impairment in accordance with ASC 323-10-35-32 and 35-32A. See Section 5.5 for further guidance on impairment testing.

5.1.5.3 Investee Capital Transactions

ASC 323-10

35-15 A transaction of an investee of a capital nature that affects the investor’s share of stockholders’ equity of the investee shall be accounted for on a step-by-step basis.

35-15A For guidance on a share issuance by an investee, see paragraph 323-10-40-1.

Adjustments to an investor’s share of equity method earnings or losses (and corresponding adjustments to the carrying value of the equity method investment) may be necessary for certain investee capital transactions, including share issuances, share repurchases, and transactions with noncontrolling interest holders, since all of these transactions may affect the investor’s share of the equity method investee’s net assets.

5.1.5.3.1 Treasury Share Repurchases

An investee may repurchase its own shares in a treasury stock transaction. This transaction may affect an investor’s claim to the investee’s net assets.

If the investor participates in the treasury stock transaction (i.e., shares are repurchased from the investor) and it causes a decrease in the investor’s claim to the investee’s net assets, the investor would need to assess whether the decrease results in a loss of significant influence and account for the decrease accordingly (see Sections 5.6.4 and 5.6.5). If the investor does not participate in the treasury stock transaction (i.e., shares are repurchased from other investors only), there will be an increase in the investor’s claim to the investee’s net assets; however, there will also be a decrease to the investee’s net assets in the amount of consideration paid to repurchase the shares. If there is an increase to the investor’s ownership interest with significant influence retained (that is, the investor continues to account for its investment under the equity method), the investor would account for the increase in its claim to the investee’s net assets on a step-by-step basis in a manner similar to that in the accounting described in Section 5.6.3. Although the investor has not directly paid consideration for its increase in ownership interest, it has indirectly acquired an additional ownership interest for consideration equal to the investor’s proportionate share of the consideration paid by the investee for the repurchase. This transaction would not result in a change to the investor’s equity method investment balance, but it would result in a change to the investor’s basis differences that are tracked in memo accounts, as illustrated in the example below.

If a treasury stock transaction results in a change to an investor’s ownership interest with significant influence retained, the investor should adjust its share of equity method investee earnings and losses as of the date of the treasury stock transaction to reflect (1) the change in ownership and (2) the impact of any additional basis differences.

Example 5-13

Investor X holds a 40 percent interest in Investee Z, applies the equity method of accounting, and will recognize earnings in Z pro rata on the basis of its ownership interest. Investee Z repurchases 10 percent of its outstanding voting common shares from third parties for $500,000, which increases X’s ownership interest in Z to 44 percent. Assume that X does not obtain a controlling financial interest in Z. The book value of Z’s net assets at the time of the repurchase is $4.5 million. Although X has not directly paid consideration for its 4 percent increase in ownership interest, it has indirectly acquired an additional ownership interest for consideration of $200,000, which is equal to its 40 percent proportionate share of the $500,000 of consideration paid by Z for the repurchase. The table below shows the book values and fair values of Z’s net assets at the time of the repurchase (along with a calculation of X’s incremental 4 percent share) as of the share repurchase date. Taxes and intra-entity profit eliminations are ignored for simplicity.

As shown in the table above:

The book values of Z’s current assets and current liabilities approximate their fair values at the time of repurchase.
Investor X determined that Z has patented technology that was internally developed; therefore, costs associated with developing this technology were expensed as incurred rather than recorded as an intangible asset on Z’s books. The patented technology has a fair value of $100,000 at the time of repurchase.

On the basis of the calculations in the above table, the $20,000 difference between the cost of X’s investment ($200,000) and its proportionate share of the book value of Z’s net assets ($180,000) is attributable to Z’s fixed assets ($16,000) and Z’s patented technology ($4,000). The basis differences are presented as part of X’s overall investment in Z and subsequently tracked in memo accounts. That is, X would not present the $4,000 separately as an “intangible asset” on its balance sheet.

This transaction would not result in a change to X’s equity method investment balance, but it would result in a change to X’s basis differences that are tracked in memo accounts, as illustrated in the table above. On a prospective basis, X would adjust its share of equity method investee earnings and losses to reflect (1) the 4 percent increase in ownership and (2) the impact of the additional basis differences.

5.1.5.3.2 Shares Issued to Employees of an Investee

If an investee issues additional shares as a result of employees’ exercise of options, an investor should determine the corresponding impact on its ownership interest in the investee. When the investee issues stock compensation awards to its employees, it recognizes stock compensation expense as the awards vest in accordance with ASC 718 with a corresponding increase to additional paid-in capital (APIC) (as long as the awards are classified as equity). During the vesting period, the investor would recognize its share of the stock compensation expense through its equity method pickup; however, there is no guidance regarding the investor’s accounting for the investee’s increase in APIC. Two acceptable methods that are applied in practice are as follows:

During the vesting period, the investor reflects the change in its share of the investee’s equity as an adjustment to the investor’s equity method investment with a corresponding adjustment to the investor’s own equity. When these adjustments are coupled with the investor’s recognition of its share of the investee’s stock compensation expense through equity earnings (losses), there is ultimately no net impact on the equity method investment account balance. Instead, the resulting net impact is to equity method earnings (losses) and the investor’s own equity.
During the vesting period, the investor does not make any adjustments to its equity method investment balance but instead tracks its share of the increase in the investee’s APIC as a reconciling item in memo accounts.

We do not believe that the investor should record its share of the investee’s increase in APIC in equity earnings (losses) given that this would essentially negate the impact of recording the investor’s share of the investee’s stock compensation during the vesting period.

Regardless of the method applied during the vesting period, the investor is required to adjust for the change in its share of the investee’s net assets once the options are exercised (shares are issued to the employees in exchange for consideration equal to the exercise price of the options). See Sections 5.6.4 and 5.6.5 for details on accounting for decreases in an investor’s level of ownership or degree of influence.

5.1.5.3.3 Investee Acquisitions and Dispositions of Noncontrolling Interests

An equity method investee may consolidate certain less than wholly owned subsidiaries and present noncontrolling interests in its financial statements. The investee may transact with noncontrolling interest holders, either acquiring or disposing of noncontrolling interests while retaining a controlling financial interest in the subsidiary. As noted in ASC 810-10-45-23, a parent’s acquisition or disposition of any noncontrolling interest should be accounted for as an equity transaction, with any difference between price paid and the carrying amount of the noncontrolling interest reflected directly in equity and not in net income as a gain or loss. Investee-level transactions with noncontrolling interest holders do not directly involve the investor; however, these transactions would affect the investor’s claim to the investee’s net assets because of the change in the investee’s equity.

If the equity method investee acquires a noncontrolling interest while retaining a controlling financial interest in the subsidiary and thereby causes an increase in the equity method investor’s claim to the investee’s net assets, we believe that the investor should account for the increase on a step-by-step basis, as illustrated in Section 5.1.5.3.1.

If the equity method investee’s subsidiary sells existing shares or issues additional shares to another party while retaining a controlling financial interest in the subsidiary (i.e., creates or increases outstanding noncontrolling interests), the equity method investor should consider the substance of the transaction. We believe that in these circumstances, there are potentially two accounting outcomes:

If, in substance, the transaction is structured so that the investor essentially sold a portion of its interest in the equity method investee, we believe that it is appropriate to apply ASC 323-10-35-35 and ASC 323-10-40-1, whereby the investor records a gain or loss in equity method earnings (losses). See Section 5.6.4 for details on accounting for decreases in an investor’s level of ownership when significant influence is retained.
We also understand that others believe that the issuance of noncontrolling interests at the investee level while the investee retains a controlling financial interest in the subsidiary generally represents an equity transaction not only for the investee but also for the investor in accordance with ASC 810-10-45-23. Under this accounting outcome, the transaction would be accounted for as a change in the investor’s share of the investee’s equity as an adjustment to the investor’s equity method investment with a corresponding adjustment to the investor’s own equity.

We believe that either accounting outcome could potentially be acceptable; however, the investor should carefully analyze the transaction and apply the view that best aligns with the substance of the disposal transaction.

For details related to accounting for equity issuances by an investee, see Section 5.6.

5.1.5.4 Other Comprehensive Income

ASC 323-10

35-18 An investor shall record its proportionate share of the investee’s equity adjustments for other comprehensive income (unrealized gains and losses on available-for-sale securities; foreign currency items; and gains and losses, prior service costs or credits, and transition assets or obligations associated with pension and other postretirement benefits to the extent not yet recognized as components of net periodic benefit cost) as increases or decreases to the investment account with corresponding adjustments in equity. See paragraph 323-10-35-37 for related guidance to be applied upon discontinuation of the equity method.

An investor should record its proportionate share of an equity method investee’s OCI (which may include foreign currency translation adjustments, actuarial gains or losses, and gains and losses on AFS debt securities, among other items) as an increase or decrease to its equity method investment account for the investee, with a corresponding debit or credit to OCI, which will ultimately be reflected within AOCI in the equity section of the financial statements. See Section 6.2.3 for further discussion of acceptable presentation alternatives related to an investor’s share of an equity method investee’s OCI. See Section 5.6.5.1 for further discussion of the impact to OCI when there is a decrease in the level of ownership or degree of influence of an equity method investment. Also, see Section 4.5.3 for further discussion of basis differences related to assets and liabilities measured at fair value and recorded in the investee’s AOCI.

Example 5-14

On December 31, 20X5, Investor G acquires a 25 percent interest in Investee T for $500. Investor G accounts for its investment in T under the equity method and will recognize earnings in T pro rata on the basis of its ownership interest. For the year ended December 31, 20X6, T has net income of $1,000 and records a $100 gain in OCI related to foreign currency translation adjustments. Assuming no basis differences or intra-entity profit or loss eliminations, G should record the following entries for the year ended December 31, 20X6:

5.1.6 Dividends Received From an Investee

ASC 323-10

35-17 Dividends received from an investee shall reduce the carrying amount of the investment.

As discussed in Section 5.1, an investor’s equity method investment balance is increased by its share of an investee’s income and decreased by its share of the investee’s losses in the periods in which the investee reports the income and losses rather than in the periods in which the investee declares dividends. Therefore, when dividends or distributions are received from the equity method investee, the investor should record a reduction to its equity method investment balance rather than recording income. See Section 6.2.4 for details related to cash flow classification of dividends and distributions from equity method investees.

To determine whether cash distributions by an equity method investee that exceed an investor’s carrying amount should be recorded as income or as a liability, the investor should evaluate whether the following two criteria are met: (1) the distributions are not refundable by agreement, law, or convention7 and (2) the investor is not liable (and may not become liable) for the obligations of the investee or otherwise committed or expected to provide financial support to the investee. If these two criteria are met, the investor should record the excess cash distributions as income. Otherwise, the investor should record the excess cash distributions as a liability. If the investor suspends equity method loss recognition8 and has recorded the cash distributions as income or a liability, the investor should record future equity method earnings reported by the investee only after its share of the investee’s cumulative earnings during the suspended period exceeds the investor’s income or liability recognized for the excess cash distributions.

The guidance above is supported by the AICPA Issues Paper “Accounting by Investors for Distributions Received in Excess of Their Investment in a Joint Venture” (an addendum to the AICPA Issues Paper “Joint Venture Accounting”), issued on October 8, 1979, which states the following in its advisory conclusion:

A noncontrolling investor in a real estate venture should account for cash distributions received in excess of its investment in a venture as income when (a) the distributions are not refundable by agreement or by law and (b) the investor is not liable for the obligations of the venture and is not otherwise committed to provide financial support to the venture.

ASC 970-323-35-3 through 35-10 provide further details about an investor’s accounting for its share of losses that are greater than its investment (see Section 5.2). This literature also defines general partnership interests as having unlimited liability; therefore, these interests would meet criterion (2) as described above.

Example 5-15

Investor A and Investor B form Investee C by investing $1 million each in exchange for a 50 percent ownership interest. Investors A and B both use the equity method to account for their investment in C and will recognize earnings in C pro rata on the basis of their ownership interests. Investee C subsequently incurs a U.S. GAAP loss of $2.4 million. As a result, A’s and B’s investment balances are exceeded by $200,000 each, but because the losses are owing to noncash depreciation expense, C has available cash and distributes $100,000 to both A and B.

The $100,000 distribution made to A is not refundable by agreement, law, or convention, and A is not liable (and may not become liable) for the obligations of C or otherwise committed or expected to provide financial support to C. Therefore, A should reduce its investment in C to zero and record the $100,000 received as income. Investor A would initially record the following journal entry:

If C subsequently becomes profitable, A cannot increase its basis in its investment in C until C’s cumulative earnings during the suspended period exceed the $100,000 excess distribution. For example, if C subsequently reported earnings of $1.5 million, A would record $450,000 of equity method earnings, which represents A’s portion of C’s subsequent earnings (50% × $1.5 million = $750,000), net of A’s previously unrecognized losses ($200,000), less income previously recognized by A for the cash distribution ($100,000). The following journal entry would be recorded:

Example 5-16

Investor A and Investor B form Investee C by investing $1 million each for a 50 percent ownership interest. Investee C is not a VIE under ASC 810-10. Investors A and B both use the equity method to account for their investment in C and will recognize earnings in C pro rata on the basis of their ownership interests. Investee C subsequently incurs a U.S. GAAP loss of $2.4 million. As a result, A’s and B’s investment balances are exceeded by $200,000 each, but because the losses are owing to noncash depreciation expense, C has available cash and distributes $100,000 to both A and B.

The $100,000 distribution made to B is not refundable by agreement, law, or convention, and B is not liable (and may not become liable) for C’s obligations. However, B has a history of providing financial support to C. Therefore, B should reduce its investment in C to zero and should record a liability (negative investment balance) of $300,000, representing its initial investment of $1 million less (1) its share of equity in losses of $1.2 million and (2) the cash distributions it received of $100,000. Investor B would initially record the following journal entry:

Investor B would continue to recognize earnings or losses of C under the equity method. However, B would reduce the liability (e.g., negative investment balance) to zero before recording an asset for its share of earnings in C. For example, if C subsequently reported earnings of $1.5 million, B would record $750,000 of equity method earnings, which represents B’s portion of C’s subsequent earnings (50% × $1.5 million). Investor B would record the following journal entry:

Example 5-17

Four investors form Partnership Z, a limited partnership. The table below summarizes the amounts contributed by, and ownership interests of, each investor.

Partnership Z is not a VIE under ASC 810-10. Partnership Z acquires an operating real estate project for $180 million, using a nonrecourse mortgage loan to finance the additional $80 million purchase price. Partnership Z subsequently incurs U.S. GAAP losses of $100 million. Therefore, each investor’s investment balance is reduced to zero, but because the losses are owing to noncash depreciation expense, Z has available cash and distributes it to the investors.

As the GP, A is not required to consolidate Z since Z is not a VIE (see Deloitte’s Consolidation Roadmap). Accordingly, A uses the equity method to account for its investment in Z. In these circumstances, A should continue to recognize any future losses of Z and its receipt of the cash distribution by recording a liability (e.g., negative investment balance). For a GP, the existence of nonrecourse debt is not justification for discontinuing the recording of losses or for recognizing a gain for the cash distribution. Because of its general partnership interest, A is legally obligated to provide additional financial support to Z. If A recognizes losses only to the extent of its investment in Z, it would effectively be recognizing a gain on a debt extinguishment that has not occurred, which is prohibited in accordance with ASC 405-20-40-1. Company A would subsequently reduce any liability (negative investment balance) to zero before recording an asset for its share of earnings in Z.

Note that A’s journal entries would be similar to those in the previous example.

Company A should also determine whether it is required to absorb any future losses by Z that are otherwise allocable to the other partners. This decision would depend on whether any other partners, by agreement, convention, or otherwise, are required to provide additional support to Z and, if so, whether they have the financial wherewithal to do so.

In accordance with ASC 323-30-S99-1 and ASC 323-30-35-3, B, C, and D also use the equity method to account for their investments in Z. Generally, B, C, and D, as limited partners, would not have unlimited liability or a legal or other commitment to further support the partnership. Therefore, B, C, and D should reduce their respective investments to zero and record distributions that exceed their investments as income. If Z subsequently becomes profitable, B, C, and D cannot increase their basis in their investment in Z until Z’s cumulative earnings during the suspended period exceed the excess distribution amount. However, B, C, and D should carefully review contractual arrangements, review past funding practices, and consider other relevant facts and circumstances before reaching this conclusion.

Note that B, C, and D would record journal entries similar to those in Example 5-15.

5.1.7 Interests Held by an Investee

5.1.7.1 Reciprocal Interests

When an investor holds an equity method investment in an investee and the investee concurrently holds an equity method investment in the investor, such investments are known as reciprocal interests. The investor should present reciprocal interests as a reduction of both its investment in the equity method investee and its equity in the investee’s earnings. In practice, there are two methods of calculating the investee’s earnings: the treasury stock method and the simultaneous equations method. Application of the treasury stock method tends to be more common since, as illustrated in Section 6.6 of Deloitte’s Roadmap Noncontrolling Interests, the simultaneous equations method can be very complex. However, we believe that either method is acceptable as long as an investor applies its selected method consistently to all reciprocal interests. Under the treasury stock method, the equity method investor considers its shares held by the equity method investee to be treasury stock. Therefore, the investor records its share of the investee’s net income exclusive of the equity method earnings from the investee’s equity method investment in the investor. Below is an example illustrating the treasury stock method.

Example 5-18

Entity A owns a 30 percent interest in Entity B, and B owns a 20 percent interest in A. Entities A and B have 10,000 shares and 5,000 shares, respectively, of common stock issued and outstanding, and each entity paid $100 per share for its ownership interests. Entities A and B both use the equity method to account for their investment in the other party and will recognize earnings in each other pro rata on the basis of their respective ownership interests.

Entity A’s basis in its investment in B, B’s basis in A, and A’s corresponding reciprocal interest in A are calculated as follows:

Entity A’s basis in B = $100/share × (30% × 5,000 shares) = $150,000.
Entity B’s basis in A = $100/share × (20% × 10,000 shares) = $200,000.
Entity A’s reciprocal interest in A = 30% × $200,000 = $60,000.

The reduction in A’s investment should be offset by a decrease in retained earnings, and as with treasury stock, the offset to the reduction may be presented as a separate line item in A’s equity section.

Entity A’s Journal Entries

Initial investment in B:

Entity B’s investment in A and B’s reciprocal interest in B would be calculated and accounted for similarly:

B’s basis in A = $100/share × (20% × 10,000 shares) = $200,000.
A’s basis in B = $100/share × (30% × 5,000 shares) = $150,000.
B’s reciprocal interest in B = 20% × $150,000 = $30,000.

Entity B’s Journal Entries

Initial investment in A:

If earnings of A, exclusive of any equity in B, total $100,000 (“direct earnings of A”) and earnings of B, exclusive of any equity in A, total $50,000 (“direct earnings of B”), net income and earnings per share (EPS) for A and B, respectively, are calculated as follows:

Net income and EPS of A:

Although A owns 30 percent of B, A’s investment in B is reduced for its ownership interest in itself through B’s reciprocal 20 percent ownership interest in A’s stock.

Net income and EPS of B:

Although B owns 20 percent of A, B’s investment in A is reduced for its ownership interest in itself through A’s reciprocal 30 percent ownership interest in B’s stock.

5.1.7.2 Earnings or Losses of an Investee’s Subsidiary

As described in Section 3.2.7.1, when an investor accounts for direct interests in both an investee and an investee’s subsidiary under the equity method of accounting, the investor should adjust the investee’s financial information to exclude the earnings or losses of the investee’s subsidiary in which the investor has a direct interest to determine its proportionate share of the investee’s earnings or losses.

Example 5-19

Direct Investment in an Investee’s Consolidated Subsidiary

Entity A owns a 30 percent voting interest in Entity B that is accounted for under the equity method of accounting (i.e., A has ability to exercise significant influence over B) and a 15 percent voting interest in Entity C. Entity A will recognize earnings in B pro rata on the basis of its ownership interest. Entity B owns an 80 percent voting interest in C that is considered a controlling financial interest, requiring B to consolidate C under ASC 810-10.

Since B controls C, and A has the ability to exercise significant influence over B, A has the ability to exercise significant influence over C, despite the fact that A has only a 15 percent direct voting interest in C. Therefore, A should account for its investment in C under the equity method of accounting.

Entity B’s consolidated financial statements for the year ended 20X6 and A’s proportionate share of earnings (both the correct and incorrect application) are as follows (for simplicity, taxes, intra-entity transactions, and basis differences are ignored):

The incorrect computation double counts A’s proportionate share of the earnings in C since 100 percent of C’s earnings are included in net income (i.e., net income has not been adjusted to exclude the net income attributable to the noncontrolling interest, 15 percent of which is attributable to A).

5.1.7.3 Earnings or Losses of a Consolidated Subsidiary’s Investee

As described in Section 3.2.7, an investor that does not have the ability to exercise significant influence through its direct interests in an investee may have such ability through a combination of direct and indirect interests. When an investor accounts for indirect interests in an investee under the equity method of accounting, the investor should calculate its proportionate share of the equity method investee’s earnings or losses on the basis of (1) the investor’s ownership interest in the intermediary and (2) the intermediary’s ownership in the equity method investee.

Example 5-20

Entity A is a calendar-year-end entity that has a controlling financial interest in Entities B, C, and D. Therefore, under ASC 810-10, A consolidates B, C, and D, which each own a 10 percent voting interest in Entity E.

Entity A indirectly owns less than a 20 percent voting interest in E (i.e., 6 percent through B, 7 percent through C, and 6 percent through D). However, because A consolidates B, C, and D, A effectively controls 30 percent of the voting interests in E. Hence, A has the ability to exercise significant influence over E.

Assume that A, B, and C do not individually have the ability to exercise significant influence over E.

For the year ended December 31, 20X3, E has net income of $1 million. Entity A records the following journal entry to record its share of E’s earnings:

5.1.8 Contingent Consideration

ASC 323-10

35-14A If a contingency is resolved relating to a liability recognized in accordance with the guidance in paragraph 323-10-25-2A and the consideration is issued or becomes issuable, any excess of the fair value of the contingent consideration issued or issuable over the amount that was recognized as a liability shall be recognized as an additional cost of the investment. If the amount initially recognized as a liability exceeds the fair value of the consideration issued or issuable, that excess shall reduce the cost of the investment.

As discussed in Section 4.4, if the acquisition of an equity method investment involves contingent consideration, the contingent consideration is included as part of the initial cost of the equity method investment only if it meets the definition of a derivative instrument under ASC 815 or is required to be recognized by other U.S. GAAP aside from ASC 805. If the contingent consideration arrangement meets the definition of a derivative instrument, the fair value of the derivative is included in the initial cost of the equity method investment. Subsequently, changes to the fair value of the derivative are recorded in the income statement separate from the accounting for the equity method investment. Further, payments under the contingent consideration arrangement represent the settlement of the derivative instrument and therefore should not increase the cost of the equity method investment.

If the contingent consideration arrangement does not meet the definition of a derivative under ASC 815 and is not otherwise required to be recognized by other U.S. GAAP aside from ASC 805, no amounts related to the contingent consideration arrangement should be included as part of the cost of the equity method investment until the contingent consideration payments are made.

If a liability is initially recognized for a contingent consideration arrangement because an investor’s proportionate share of an investee’s net assets is greater than the investor’s initial cost in accordance with ASC 323-10-25-2A, any difference between the ultimate settlement of the contingent consideration and the initial liability recorded should be recognized as an increase or decrease to the cost of the equity method investment.

Example 5-21

Investor Q acquires an equity method investment for $1,250. Investor Q is obligated to pay an additional $100 if certain earnings targets of the investee are reached. Investor Q’s proportionate share of the investee’s net assets is $1,300, which exceeds Q’s initial cost of $1,250. In accordance with ASC 323-10-30-2B, on the date of acquisition, a liability of $50 is recorded (with a corresponding increase to the initial cost of the equity method investment) since this amount is less than the $100 maximum amount of contingent consideration not recognized. If the contingency is resolved after the initial measurement of the equity method investment and a $75 payment related to the contingent consideration arrangement is required, Q would record an increase to its equity method investment of $25. Alternatively, if the contingency is subsequently resolved and only a $20 payment related to the contingent consideration arrangement is required, Q would record a decrease to its equity method investment of $30. The impact to basis differences, if any, should be considered.

Footnotes

Note, however, that the sponsor will frequently consolidate the partnership and account for the tax equity investor’s interest as a noncontrolling interest in its consolidated financial statements. Nonetheless, the sponsor may attribute income and loss to itself and the noncontrolling interest in a manner consistent with the HLBV method by using the mechanics described herein. See Example 6-1 in Section 6.2.1 in Deloitte’s Roadmap Noncontrolling Interests.

The partnership operating agreement may call for certain allocations, such as 99:1, in the pre-flip period. However, the tax equity investor and the sponsor must still perform a detailed analysis of the partners’ 704(b) capital accounts and tax basis since the operation of the partnership tax rules/limitations can often result in allocations that do not necessarily match the stated allocation percentages in the operating agreement.

IRC Section 704(b) discusses special allocations of partnership items.

This example represents a simple HLBV waterfall calculation. Depending on the complexity of the liquidation waterfall in the operating agreement, as well as the discrete items in the entity’s financial statements, additional steps may be necessary.

See Section 6.4 for details.

This list of Regulation S-X rules is not exclusive, and any rule that requires an investee’s financial statements or financial information to be included in another entity’s filing with the SEC would cause the investee to be a “specified PBE.”

When the investor is not under a legal obligation to refund its distributions or provide financial support to the investee, it must consider specific facts and circumstances, including the relationship among the investors. For instance, if the investor has a history of refunding distributions provided by the investee or otherwise providing financial support to the investee, the investor may be expected, by convention, to refund its distributions and provide financial support in the future.

In situations in which the investor’s share of equity method losses equals or exceeds its equity method investment balance plus any advances, equity method loss recognition should generally be discontinued (that is, the investor should stop reflecting the equity method investee’s losses in its financial statements) unless the investor has provided, or committed to provide, the investee additional financial support or the investor has guaranteed the investee’s obligations. See Section 5.2 for details.

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 5-25

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 other 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.

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

When costs are incurred by an investor 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.

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 5-26

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 5-27

Assume the same facts as in the example above, except the following:

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.

Example 5-28

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 5-29

Assume the same facts as in the example above, except that Investor A plans 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.

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 5-30

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 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 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.

5.7 Real Estate Investments

5.7.1 Sale of an Investment in a Real Estate Venture

ASC 970-323

40-1 A sale of an investment in a consolidated real estate venture (including the sale of stock in a corporate real estate venture) shall be evaluated under the guidelines set forth in paragraphs 360-10-40-3A through 40-3B. The sale of a noncontrolling investment in a real estate venture that is being accounted for in accordance with Topic 320 on investments — debt securities; Topic 321 on investments — equity securities; Topic 323 on investments — equity method and joint ventures; or Topic 325 on investments — other, shall be accounted for in accordance with the guidance in Topic 860 on transfers and servicing.

The sale of an investment in real estate, including an investment accounted for under the equity method, is not treated as a sale of the underlying real estate. In a transfer of only an equity method investment in which the investee holds nonfinancial assets, the seller will account for the transfer under ASC 860.

However, in certain unique circumstances, if a transfer to a counterparty (that does not meet the definition of a customer in ASC 606) in a contract represents a group of assets that (1) doesn’t constitute a business and (2) includes both an equity method investment and a nonfinancial asset whose fair value is equal to substantially all of the fair value of the assets transferred, the equity method investment would be considered part of the entire nonfinancial asset transaction under ASC 610-20 (see ASC 610-20-15-5). Also see Deloitte’s Roadmap Revenue Recognition for further information regarding the application of ASC 610-20.

Chapter 6 — Presentation and Disclosure

Chapter 7 — Identification of a Joint Venture

7.1 Overview

Corporate and unincorporated joint venture entities (“joint ventures”) are a common form of business enterprise. For several reasons, investors (“venturers”)1 establish joint ventures rather than undertaking business activities on their own. Venturers may use joint ventures to enter new markets, finance major projects that are beyond each venturer’s financial capabilities, or share expertise or risks. Joint ventures also allow venturers to partially exit a business or enterprise as an alternative to a complete disposition. Joint ventures can take a variety of forms, including corporations, partnerships, and LLCs.

Generally, a venturer accounts for its investment in a joint venture the same way it would for any other equity method investment under ASC 323. However, determining whether a legal entity is in fact a joint venture is necessary because such a determination may affect the financial statements of the joint venture upon the venture’s initial formation. For instance, if an entity is a joint venture, the venture may measure the initial net assets received at historical cost or at fair value, depending on facts and circumstances. In other circumstances, if an investor determines that a legal entity does not meet the definition of a joint venture, the failed joint venture may be required to account for its initial formation as a business combination in accordance with ASC 805.

There is diversity in practice in the identification of whether an enterprise is a joint venture owing to a lack of prescriptive guidance in U.S. GAAP beyond the term’s definition in the ASC master glossary, which originated in APB Opinion 18, in 1971. In practice, “joint venture” is commonly used for ventures that do not meet the definition of a joint venture in accordance with U.S. GAAP because:

Many use the phrase generously in the titles of legal/organizational documents.
Some use the phrase to describe all investments with only two investors.
Others mischaracterize investments as joint ventures because of the lack of comprehensive guidance related to what constitutes a joint venture.

Consequently, many investments that are called joint ventures do not meet the accounting definition of a joint venture.

In August 2023, the FASB issued ASU 2023-05, which addresses accounting by a joint venture for the contribution of nonmonetary assets upon the joint venture formation. However, the ASU does not amend the definition of a joint venture or corporate joint venture for GAAP purposes. See Chapter 9 for additional information.

Footnotes

We use the term “venturer” when referring to the members of or investors in a legal entity that meets the definition of a joint venture. Should the legal entity not meet, or it is unknown whether it meets, the definition of a joint venture, we will interchangeably use the terms “member” or “investor.”

Chapter 8 — Accounting by the Joint Venture

8.1 Overview

This chapter discusses the accounting by a joint venture for nonmonetary contributions upon formation before the adoption of ASU 2023-05. Therefore, the Codification references included in this chapter do not show the pending content (transition guidance in ASC 805-60-65-01) related to the ASU. For information on the accounting by a joint venture after the adoption of ASU 2023-05, see Chapter 9.

ASC 805-10

15-4 The guidance in the Business Combinations Topic does not apply to any of the following:

a. The formation of a joint venture . . . .

ASC 845-10

15-4 The guidance in the Nonmonetary Transactions Topic does not apply to the following transactions: . . .

b. A transfer of nonmonetary assets solely between entities or persons under common control, such as between a parent and its subsidiaries or between two subsidiaries of the same parent, or between a corporate joint venture and its owners . . . .

Before the issuance of ASU 2023-05,U.S. GAAP did not address the accounting by legal entities that meet the definition of a joint venture for noncash assets contributed by venturers upon the initial joint venture formation. The EITF evaluated the accounting by joint ventures for businesses received at formation but did not reach a consensus on this issue (Issue 98-4). In addition, ASC 805 and ASC 845 have expressly excluded from their scope the formation of a joint venture and transfers between joint ventures and their owners, respectively.

In the absence of prescriptive FASB guidance, some joint ventures recognized contributions of nonmonetary assets upon the venture’s initial formation by using the venturers’ carrying values (historical cost bases), while other joint ventures have recognized such contributions at their fair values. To eliminate this diversity in practice, the FASB included a project on its technical agenda to address the accounting by a joint venture for the initial contribution of nonmonetary and monetary assets to the venture. This project culminated in the August 2023 issuance of ASU 2023-05, which is effective for all joint venture formations with a formation date on or after January 1, 2025. Early adoption is permitted.

This chapter focuses on the accounting for joint ventures before the adoption of ASU 2023-05. Until such adoption, practitioners may continue to apply the guidance discussed in Section 8.2 (specifically, by using venturers’ carrying values [historical cost bases] in nonmonetary assets that meet the definition of businesses) and in Section 8.3 on the accounting by a joint venture for the initial contribution of nonmonetary assets to the joint venture (specifically, by using venturers’ carrying values [historical cost bases] in nonmonetary assets that do not meet the definition of a business). A new Chapter 9 has been added to this publication to reflect the amendments in ASU 2023-05 for those that want to apply a fair value measurement model to a joint venture formation and thus apply ASU 2023-05.

8.3 Measurement of Initial Contribution of Nonmonetary Assets That Do Not Meet the Definition of a Business

ASC 323-10

30-2 Except as provided in the following sentence, an investor shall measure an investment in the common stock of an investee (including a joint venture) initially at cost in accordance with the guidance in Section 805-50-30. An investor shall initially measure, at fair value, the following:

A retained investment in the common stock of an investee (including a joint venture) in a deconsolidation transaction in accordance with paragraphs 810-10-40-3A through 40-5
An investment in the common stock of an investee (including a joint venture) recognized upon the derecognition of a distinct nonfinancial asset or distinct in substance nonfinancial asset in accordance with Subtopic 610-20.

ASC 845-10 — SEC Materials — SEC Staff Guidance

SAB Topic 5.G, Transfers of Nonmonetary Assets by Promoters or Shareholders

S99-1 The following is the text of SAB Topic 5.G, Transfers of Nonmonetary Assets by Promoters or Shareholders.

Facts: Nonmonetary assets are exchanged by promoters or shareholders for all or part of a company’s common stock just prior to or contemporaneously with a first-time public offering.

Question: Since FASB ASC paragraph 845-10-15-4 (Nonmonetary Transactions Topic) states that the guidance in this Topic is not applicable to transactions involving the acquisition of nonmonetary assets or services on issuance of the capital stock of an enterprise, what value should be ascribed to the acquired assets by the company?

Interpretive Response: The staff believes that transfers of nonmonetary assets to a company by its promoters or shareholders in exchange for stock prior to or at the time of the company’s initial public offering normally should be recorded at the transferors’ historical cost basis determined under GAAP.

The staff will not always require that predecessor cost be used to value nonmonetary assets received from an enterprise’s promoters or shareholders. However, deviations from this policy have been rare applying generally to situations where the fair value of either the stock issuedFN1 or assets acquired is objectively measurable and the transferor’s stock ownership following the transaction was not so significant that the transferor had retained a substantial indirect interest in the assets as a result of stock ownership in the company.

__________________________________

FN1 Estimating the fair value of the common stock issued, however, is not appropriate when the stock is closely held and/or seldom or ever traded.

ASC 810-10

40-5 If a parent deconsolidates a subsidiary or derecognizes a group of assets through a nonreciprocal transfer to owners, such as a spinoff, the accounting guidance in Subtopic 845-10 applies. Otherwise, a parent shall account for the deconsolidation of a subsidiary or derecognition of a group of assets specified in paragraph 810-10-40-3A by recognizing a gain or loss in net income attributable to the parent, measured as the difference between:

The aggregate of all of the following:
1. The fair value of any consideration received
2. The fair value of any retained noncontrolling investment in the former subsidiary or group of assets at the date the subsidiary is deconsolidated or the group of assets is derecognized
3. The carrying amount of any noncontrolling interest in the former subsidiary (including any accumulated other comprehensive income attributable to the noncontrolling interest) at the date the subsidiary is deconsolidated.
The carrying amount of the former subsidiary’s assets and liabilities or the carrying amount of the group of assets.

ASC 970-323

Contribution of Real Estate

30-3 An investor that contributes real estate to the capital of a real estate venture generally should record its investment in the venture at fair value when the real estate is derecognized, regardless of whether the other investors contribute cash, property, or services. The transaction shall be accounted for in accordance with the guidance in paragraphs 360-10-40-3A through 40-3C. Some transactions are sales of an ownership interest that result in an entity being an investor in a real estate venture. An example of such a transaction includes one in which investor A contributes real estate with a fair value of $2,000 to a venture and investor B contributes cash in the amount of $1,000. The real estate is not considered a business or nonprofit activity and, therefore, is within the scope of Subtopic 610-20 on gains and losses from the derecognition of nonfinancial assets. Investor A immediately withdraws the cash contributed by investor B and, following such contributions and withdrawals, each investor has a 50 percent interest in the venture (the only asset of which is the real estate). Assuming investor A does not have a controlling financial interest in the venture, investor A applies the guidance in paragraphs 610-20-25-5 and 610-20-25-7. When investor A meets the criteria to derecognize the property, investor A measures its retained ownership interest at fair value consistent with the guidance in paragraph 610-20-32-4 and includes that amount in the consideration used in calculating the gain or loss on derecognition of the property.

There is no currently prescribed guidance under U.S. GAAP on the accounting by the joint venture when receiving contributions of assets that do not meet the definition of a business. While the SEC staff has indicated that there may be more circumstances in which the recording of the contribution of a business at fair value is appropriate, the staff has not provided recent remarks or guidance for contributions of assets that do not meet the definition of a business. Therefore, the above codified guidance written for the venturer’s accounting is frequently referenced by analogy to support the accounting by the joint venture itself. In the absence of guidance from the FASB or SEC, these various analogies have been used to justify the recognition and measurement methods shown in the table below for contributions received by the joint venture. The table below is followed by a detailed explanation of each method.

Basis of Presentation	Applicability
Historical cost	Acceptable for joint ventures formed before January 1, 2025.
Fair value (full step-up)	If a venture would like to apply fair value measurement, the entity should early adopt ASU 2023-05.
Partial step-up	As a result of ASU 2017-05, we believe that partial step-up would be prohibited.

Historical cost — Proponents of historical cost measurement believe that joint ventures should record contributions of nonmonetary assets that do not meet the definition of a business at historical cost. They observe that in the formation of the joint venture, the venturers who contributed the nonmonetary assets control (albeit jointly) the joint venture. Because the venturer has joint control over the joint venture and thus has not completely surrendered control over the contributed asset(s), a new basis of measurement is not appropriate.
Proponents of this view also look to the guidance in ASC 805-50 on common-control transactions. Although joint venture formation is not technically within the scope of the guidance on common-control transactions since the venturers, by definition, jointly control the joint venture, proponents of this view believe that joint venture formation transactions are similar to common-control transactions. Specifically, proponents of this view believe that under the guidance in ASC 805-50, because there is no change in control, there is no change in the basis of the net assets. ASC 805-50 prescribes that in a common-control transaction, the net assets are recorded by the receiving entity at the carrying amounts of the entity that is transferring the net assets. Proponents of this view believe that the accounting for the joint venture should mirror the guidance in ASC 805-50.
Some proponents of historical cost measurement have also analogized to SAB Topic 5.G (codified in ASC 845-10-S99-1) in analyzing joint venture formation transactions. That guidance states that the nonmonetary assets are normally recorded at a historical cost basis (i.e., carrying amounts).
Fair value (full step-up) — Proponents of fair value (full step-up) measurement believe that nonmonetary assets received from venturers that do not meet the definition of a business should be recorded at fair value by the joint venture. They believe that the initial measurement of nonmonetary assets received by the joint venture upon its formation should be treated no differently than any initial measurement of nonmonetary assets by an entity when received from a third party in a reciprocal exchange.
As discussed in Section 8.2.2, in accordance with ASC 810-10-40-5, retained interests in a business that is deconsolidated are initially measured at fair value. In part to align the accounting for the measurement upon derecognition of assets and businesses, the FASB issued ASU 2017-05, which also requires retained interests in a previously consolidated subsidiary that does not meet the definition of a business to be initially measured at fair value. Even though the guidance is for investors, proponents of the view that joint ventures should record contributions of nonmonetary assets that do not meet the definition of a business at fair value analogize to the guidance in ASC 323-10-30-2(b). In accordance with the proponents of fair value accounting for businesses contributed to a joint venture, they advocate that this is a reason to record the venturers’ contribution at fair value, so that there is no basis difference between the venturers’ investments and the joint venture’s financial statements.

After the issuance of ASU 2023-05, fair value (full step-up) will be the required basis of presentation. See Chapter 9 for a discussion of the FASB’s basis for conclusions regarding this approach.
Partial step-up — Some believe that the substance of some transactions in which monetary assets are withdrawn may be a partial sale of nonmonetary assets that do not meet the definition of a business and therefore that the joint venture should partially step up the contributed assets. As a result of ASU 2017-05, we believe that this approach is prohibited.

8.3.1 Summary of Views on Measurement of Initial Contribution of Nonmonetary Assets That Do Not Meet the Definition of a Business

We believe that before the adoption of ASU 2023-05, it remains acceptable for a joint venture to recognize nonmonetary assets contributed to it at the venturer’s historical cost basis when the nonmonetary assets do not meet the definition of a business. As observed above, there are some who believe that fair value recognition is also acceptable. If an entity determines that fair value recognition is appropriate, we believe that the entity should early adopt the ASU.

Chapter 9 — Accounting by the Joint Venture After Adopting ASU 2023-05

9.2 Scope and Scope Exceptions

As noted in ASC 805-60-15-2, the guidance in ASC 805-60 (added by ASU 2023-05) applies “to the financial statements of joint [ventures] as defined in Section 805-60-20.”

ASC 805-60

15-4 The guidance in this Subtopic does not apply to any of the following:

Transactions between a joint venture and its owners other than the formation of a joint venture
Formations of entities determined to be not-for-profit entities in accordance with Topic 958
Combinations between entities, businesses, or nonprofit activities under common control (see paragraph 805-50-15-6 for examples)
Entities in the construction or extractive industries that may be proportionately consolidated by any of their investor-venturers in accordance with paragraph 810-10-45-14
Collaborative arrangements within the scope of Topic 808, except for any part of the arrangement that is conducted in a separate legal entity that meets the definition of a joint venture.

The guidance in ASC 805-60 is intended to only apply to the formation of joint ventures and does not alter the accounting by the venturers. The scope exceptions noted in ASC 805-60-15-4 are generally consistent with exceptions to joint venture accounting in accordance with ASC 323-10.

9.5 Subsequent Measurement of Assets and Liabilities Recognized as a Part of Formation

A joint venture should subsequently measure and account for assets and liabilities recognized upon formation in accordance with other applicable GAAP. ASC 805-10-35 and ASC 805-20-35 provide guidance on subsequently measuring and accounting for certain assets acquired, liabilities assumed, and equity instruments issued in a business combination. ASC 805-60 references the same business combination guidance for subsequent measurement.

ASC 718 provides guidance on the subsequent measurement of replacement share-based payment awards, while the subsequent measurement of goodwill, including impairment considerations, is addressed in ASC 350-20. Goodwill, which is recognized upon joint venture formation, should not be amortized; rather, it should be tested for impairment in a manner consistent with how an entity would test goodwill that is recognized during a business combination (unless the joint venture qualifies and elects the private-company alternative to amortize goodwill under ASC 320-20). See Section 9.6.1 for more information.

ASC 805-60

35-1 A joint venture shall subsequently measure and account for the assets and liabilities recognized upon formation in accordance with the requirements for acquirers of a business in Sections 805-10-35, 805-20-35, and 805-30-35, and other generally accepted accounting principles (GAAP), as applicable.

35-2 A joint venture that is a private company may elect to apply the accounting alternatives for the subsequent measurement of goodwill described in paragraphs 350-20-35-62 through 35-82.

9.6 Other Matters

9.6.1 Disclosure Requirements

A joint venture is required to provide specific disclosures aimed at giving financial statement users a better understanding of the nature and financial effect of the joint venture’s formation in the period in which the formation occurred.

ASC 805-60

50-1 A joint venture shall disclose information that enables users of its financial statements to understand the nature and financial effect of the joint venture formation in the period in which the formation date occurs.

50-2 In the period of formation, a joint venture shall disclose the following:

The formation date
A description of the purpose for which the joint venture was formed (for example, to share risks and rewards in developing a new market, product, or technology; to combine complementary technological knowledge; or to pool resources in developing production or other facilities)
The formation-date fair value of the joint venture as a whole
A description of the assets and liabilities recognized by the joint venture at the formation date
The amounts recognized by the joint venture for each major class of assets and liabilities as a result of accounting for its formation, either presented on the face of financial statements or disclosed in the notes to financial statements (see paragraph 805-60-45-1)
A qualitative description of the factors that make up any goodwill recognized, such as expected synergies from combining operations of the contributed assets or businesses, intangible assets that do not qualify for separate recognition, or other factors.

50-3 If the initial accounting for a joint venture formation is incomplete (see paragraph 805-60-25-14) for particular assets, liabilities, noncontrolling interests, or the formation-date fair value of the joint venture as a whole and the amounts recognized in the financial statements for the joint venture formation thus have been determined only provisionally, the joint venture shall disclose the following information:

The reasons why the initial accounting is incomplete
The assets, liabilities, noncontrolling interests, or the formation-date fair value of the joint venture as a whole for which the initial accounting is incomplete
The nature and amount of any measurement period adjustments recognized during the reporting period, including separately the amount of adjustment to current-period income statement line items relating to the income effects that would have been recognized in previous periods if the adjustment to provisional amounts was recognized as of the formation date.

9.6.2 Private-Company Alternative for Certain Intangible Assets

ASC 805-60 applies to the formation of all entities that meet the definition of a joint venture or corporate joint venture regardless of whether the newly formed joint venture is a PBE or private company. For joint ventures that are private companies, ASC 805-60 provides a private-company alternative to simplify the recognition of certain identifiable intangible assets and subsume them into goodwill. This alternative applies to (1) noncompetition agreements and (2) customer-related intangible assets unless they are capable of being sold or licensed separately from other assets of a business (see Section 8.2.1.1 of Deloitte’s Roadmap Business Combinations for further discussion). If this alternative is selected, an entity must adopt the accounting alternative for amortizing goodwill in accordance with ASC 350-20.

ASC 805-60

25-12 A joint venture that is a private company may elect to apply the accounting alternative for the recognition of identifiable intangible assets described in paragraphs 805-20-25-30 through 25-33. In accordance with paragraph 805-20-15-4, a joint venture that elects to apply this accounting alternative must adopt the accounting alternative for amortizing goodwill in the Accounting Alternatives Subsections of Subtopic 350-20.

Chapter 10 — Accounting by the Venturer

Appendix A — Glossary of Selected Terms

Appendix B — Differences Between U.S. GAAP and IFRS Standards

Appendix B — Differences Between U.S. GAAP and IFRS Accounting Standards

Under IFRS Accounting Standards, the source of guidance on determining whether and how to apply the equity method of accounting is IAS 28. Both U.S. GAAP and IFRS Accounting Standards require the application of the equity method to certain investments. However, the FASB has not converged its guidance on equity method investments or on joint ventures with that of the International Accounting Standards Board (IASB®), and there is no project to consider such convergence. Therefore, while both sets of standards require the use of the equity method or joint venture accounting in certain instances, they differ in several respects in the determination of when and how it should be applied.

The tables below summarize the key differences between U.S. GAAP and IFRS Accounting Standards in the determination of whether to apply (1) the equity method of accounting or (2) joint venture accounting. For detailed interpretive guidance on IAS 28 and IFRS 11, see A26, “Investments in Associates and Joint Ventures,” and A27, “Joint Arrangements,” respectively, in Deloitte’s iGAAP publication.

Table B-1 Determining Whether to Apply the Equity Method of Accounting

Subject	U.S. GAAP	IFRS Accounting Standards
Terminology	When an investor has an investment that is accounted for under the equity method (generally because the investor exercises significant influence over another entity), that entity is referred to as an investee.	When an investor has an investment in, and exercises significant influence over, an entity, that entity is referred to as an associate.
Scope: General	As described in Section 2.3, an investor must apply the equity method of accounting when it has significant influence over an investee unless (1) it has elected the fair value option or (2) it carries its investment at fair value under specialized industry accounting guidance applicable to investment companies. In these cases, the investor would record its interest at fair value. In addition, an investment in a partnership or certain LLCs requires the use of the equity method of accounting with as little as 3 percent to 5 percent ownership even if significant influence does not clearly exist.	An investor must apply the equity method of accounting when it has significant influence over an investee unless either of the following conditions applies: The investor is a venture capital organization, mutual fund, unit trust, or similar entity (including an investment-linked insurance fund) (collectively referred to as “investment entities”). For these entities, an investor may account for investments that would otherwise be accounted for under the equity method by using fair value through profit or loss (FVTPL) in accordance with IFRS 9.1 Further, if an investor holds a portion of its investment in an investee indirectly through investment entities, the investor may account for that portion of the investment at FVTPL. This election can be applied even in circumstances in which the direct investor does not have significant influence. If the investor makes this election, however, it still must apply the equity method of accounting to any portion of the investment not held through investment entities. The investor is exempt from preparing consolidated financial statements under paragraph 4(a) of IFRS 10 (i.e., certain parent-only and subsidiary financial statements). For further information, see A26.4.2 of Deloitte’s iGAAP publication. Because IFRS Accounting Standards do not include a fair value option for equity method investments, the application of fair value rather than the equity method of accounting is more limited under IFRS Accounting Standards than it is under U.S. GAAP. For example, assume a manufacturing company reports under U.S. GAAP and has elected to apply the fair value option to its investments that would otherwise be accounted for in accordance with the equity method. In preparing IFRS financial statements, the company would be required to apply the equity method of accounting.
Scope: Investments in instruments other than common equity	As described in Section 2.5, an investor would apply the equity method of accounting for an investment in a corporation when it has significant influence over an investee and it holds an investment in common stock or in-substance common stock. In-substance common stock includes instruments that are substantially similar to common stock based on subordination, risks and rewards of ownership, and an obligation to transfer value. In addition, there are unique rules under U.S. GAAP for a partnership and certain LLCs that maintain specific ownership accounts. These rules can result in application of the equity method of accounting with as little as 3 percent to 5 percent of the ownership interests in the investee.	The evaluation of significant influence is framed in reference to “voting power,” which can arise from instruments other than ordinary common shares. For example, when 50 percent of the voting rights in an entity are held by the ordinary shareholders and the other 50 percent of the voting rights are attached to voting preferred shares, an investment in 4 percent of the ordinary shares and 36 percent of the voting preferred shares will result in a presumption that the 4 percent ordinary share ownership will be accounted for under the equity method. Preferred shares would not be accounted for under the equity method unless they are substantively the same as ordinary shares. Factors that either individually or collectively may indicate that a preferred share investment is substantively the same as an ordinary share investment include: The investee has little or no significant ordinary shares or other equity, on a fair value basis, that is subordinate to the preferred shares. The investor, regardless of ownership percentage, has demonstrated the power to exercise significant influence over the investee’s operating and financial decisions. The power to participate actively is an important factor in the determination of whether an equity interest exists by virtue of preferred shareholdings. The investee’s preferred shares have essentially the same rights and characteristics as the investee’s ordinary shares in regard to voting rights, board representation, and participation in — or rate of return approximating — the ordinary share dividend. The preferred shares have a conversion feature (with significant value in relation to the total value of the shares) to convert the preferred shares to ordinary shares. Therefore, while IFRS Accounting Standards do not specifically refer to “in-substance common stock,” the fact that significant influence is determined on the basis of “voting rights” results in similar application to investments in instruments other than common stock. For further information, see A26.3.3.4 and A26.4.4.3.3 of Deloitte’s iGAAP publication.
Applying the equity method of accounting: significant influence	As described in ASC 323-10-15-6 (see Section 3.3), significant influence “may be indicated in several ways, including the following: Representation on the board of directors Participation in policy-making processes Material intra-entity transactions Interchange of managerial personnel Technological dependency Extent of ownership by an investor in relation to the concentration of other shareholdings (but substantial or majority ownership of the voting stock of an investee by another investor does not necessarily preclude the ability to exercise significant influence by the investor).” However, this list is not all-inclusive, and all relevant facts and circumstances should be considered. Further, an investment of 20 percent or more in a corporation is presumed to provide significant influence. In addition, an investment greater than 3 percent to 5 percent in a partnership or LLC that maintains specific ownership accounts is generally considered an indication that the equity method of accounting should be applied.	IAS 28 provides considerations similar to those in U.S. GAAP for the evaluation of whether an investor holds significant influence over an investee: “representation on the board of directors or equivalent governing body of the investee; participation in policy-making processes, including participation in decisions about dividends or other distributions; material transactions between the entity and its investee; interchange of managerial personnel; or provision of essential technical information.”2 This list is not all-inclusive, and all relevant facts and circumstances should be considered. IFRS Accounting Standards also indicate that an investment representing 20 percent or more of the voting power of an entity is presumed to provide significant influence. However, IFRS Accounting Standards do not provide explicit thresholds for partnerships or LLCs. Nonetheless, the qualitative considerations regarding significant influence outlined above may yield the same accounting conclusion under IFRS Accounting Standards as would be reached under U.S. GAAP (i.e., an interest of much less than 20 percent may still yield significant influence in the context of a limited partnership). However, in other circumstances, the analysis may yield different conclusions under IFRS Accounting Standards. Each fact pattern must be analyzed separately. For example, assume that a company owns a 10 percent limited partner interest in an investment partnership. The company does not have any participation in the investment partnership’s governance, investment decisions, or other significant activities and does not have any involvement with the investment partnership other than receiving distributions. Under U.S. GAAP, the company would apply the equity method of accounting to its interest in the investment partnership. But under IFRS Accounting Standards, the company might conclude that it does not have significant influence over the investment partnership. For further information, see A26.3.2 and A26.3.4 of Deloitte’s iGAAP publication.
Applying the equity method of accounting: potential interests	As described in ASC 323-10-15-9 (see Section 3.2.6), an investor would consider only “present voting privileges.” Therefore, potential voting privileges are generally disregarded.	An investor should consider “potential voting rights that are currently exercisable or convertible.”3 Additional instruments contingent on future events or the passage of time would not be considered until the contingent event occurs or the specified time frame passes. For example, an investor may conclude that although its present voting interest is less than 20 percent, it has significant influence as a result of “potential voting rights” it holds through a currently exercisable option agreement, which, when combined with the investor’s currently held ordinary shares, would provide the investor with more than 20 percent of the voting power. That is, it might be presumed that the investor has significant influence if the combination of its voting power from its investments in ordinary shares and the potential voting power from the currently exercisable option is at least 20 percent. Even though the option could provide the investor with significant influence, the option agreement itself is not accounted for under the equity method of accounting or considered in the investor’s measurement of equity earnings. This concept also applies to warrants, options, or other instruments held by other investors. That is, an investor with greater than 20 percent of present voting interest may conclude that it does not have significant influence as a result of “potential voting rights” held by a third party through a currently exercisable option agreement if the exercise of the option would decrease the investor’s voting interest below 20 percent. This may lead to differences between U.S. GAAP and IFRS Accounting Standards regarding the existence of significant influence and thus the application of the equity method of accounting. Management’s intentions with respect to the exercise of the potential voting rights, the exercise price of such rights, and the financial capability of the holder to exercise them are ignored in the assessment of significant influence. In another example, assume Investor A holds a 25 percent interest in Investee B. Investor C holds the remaining 75 percent in B. Investee B has also issued debt to C that is convertible at any time, at C’s option, to additional shares of B. If C elects to convert the debt, A’s ownership interest would be diluted to 10 percent. Under U.S. GAAP, A would be likely to conclude that it has significant influence over B since potential voting rights are disregarded. However, under IFRS Accounting Standards, A may conclude that it does not have significant influence over B because of the currently exercisable additional interests of C. For further information, see A26.4.4.3.2 of Deloitte’s iGAAP publication.
Initial measurement: contingent consideration	As discussed in Section 4.4, contingent consideration may be recognized in two scenarios: When the contingent consideration meets the recognition criteria of U.S. GAAP (other than ASC 805), such as if the contingent consideration meets the definition of a derivative. When the noncontingent consideration offered is less than the interest in the investee’s underlying net assets.	While IFRS Accounting Standards do not provide explicit guidance, IAS 28 indicates that “the concepts underlying the procedures used in accounting for the acquisition of a subsidiary are also adopted in accounting for the acquisition of an investment in an associate.”4 Therefore, contingent consideration is generally recognized at its fair value on the acquisition date in accordance with IFRS 3. Subsequently, the liability is recognized at fair value with any changes in value recognized in the income statement. Therefore, any investment with contingent consideration may result in an initial cost basis that is greater under IFRS Accounting Standards than under U.S. GAAP. For example, assume Investor A acquires a 25 percent interest in Investee B for $100 million in cash and contingent consideration due in one year (and based on the earnings of B) ranging from $5 million to $50 million. The share of net assets A acquired is $120 million, and the fair value of the contingent consideration is $25 million. In accordance with U.S. GAAP, A would recognize the cash consideration of $100 million and contingent consideration of $20 million (since the initial cost is less than the share of net assets acquired) for a total of $120 million. In accordance with IFRS Accounting Standards, A would recognize an initial cost of $125 million since the contingent consideration would be recognized at fair value under IFRS 3. For further information, see A26.4.4.9 of Deloitte’s iGAAP publication.
Initial measurement: nonmonetary contributions, such as contributions of assets that meet the definition of a business and contributions of nonfinancial assets or in-substance nonfinancial assets	As described in Section 4.3.2, the contribution of assets that meet the definition of a business to an equity method investee should be accounted for in accordance with ASC 810, which requires full gain or loss recognition (unless the transaction is the conveyance of oil and gas mineral rights or a transfer of a good or service in a contract with a customer within the scope of ASC 606). As described in Section 4.3.4, a contribution of nonfinancial assets or in-substance nonfinancial assets that is not an output of the entity’s ordinary business activities (i.e., outside the scope of ASC 606) would generally be accounted for in accordance with ASC 610-20, which indicates that full gain or loss recognition is appropriate when the transaction meets the various recognition criteria described therein.	IFRS Accounting Standards contain conflicting guidance, which the IASB attempted to resolve through a narrow scope amendment. IAS 28 indicates that nonmonetary contributions should be recognized with partial gain recognition. This, however, conflicts with IFRS 10, which indicates that upon loss of control of a subsidiary, a parent should recognize full gain or loss. Therefore, when an entity contributes shares of a subsidiary in exchange for an equity method investment, the entity in effect has an accounting policy choice between applying the approach in IFRS 10 (“full gain recognition”) or IAS 28 (partial gain recognition) since both IAS 28 and IFRS 10 have equal standing under IFRS Accounting Standards. The IASB issued Sale or Contribution of Assets Between an Investor and Its Associate or Joint Venture (Amendments to IFRS 10 and IAS 28) in September 2014 to resolve this conflict. The amendments would require an investor to determine whether the assets contributed represented a business. If they did, IFRS 10 would apply, and full gain recognition would be appropriate. If they did not, IAS 28 would apply, and partial gain recognition would be appropriate. However, the effective date of the amendments has been deferred indefinitely because several practical implementation issues were identified. The amendments will be considered as part of the IASB’s larger research project on the equity method of accounting. Therefore, until further guidance is issued, entities may continue to make an accounting policy choice between partial gain recognition and full gain recognition when applying IFRS Accounting Standards, whereas U.S. GAAP provides more specific requirements on the basis of whether the assets contributed constitute a business. For further information, see A26.4.4.15 of Deloitte’s iGAAP publication.
Initial measurement: acquisition-date excess of investor’s share	The excess of (1) the investor’s share of the fair value of the investee’s identifiable assets and liabilities over (2) the carrying value of the identifiable assets and liabilities on the acquisition date is included as part of the basis difference and is amortized, if appropriate, over the useful life of the investee’s asset. The residual excess of the cost of the investment over the proportional fair value of the investee’s assets and liabilities is recognized within the equity investment balance as equity method goodwill, which is not amortized.	The excess of (1) the investor’s share of the net fair value of the associates’ identifiable assets and liabilities over (2) the cost of the investment as of the acquisition date is recognized as income in the period in which the investment is acquired.
Subsequent measurement: step acquisitions	As described in Section 5.6.2, when an additional interest in an entity is acquired that results in a change in the accounting for the investment to the equity method, the investor should apply the equity method of accounting on a prospective basis from the date it obtains significant influence over the investee.	IFRS Accounting Standards do not provide explicit guidance regarding the transition to the equity method of accounting. We believe that two approaches are acceptable. First, by analogy to business combination guidance (IFRS 3), a transaction resulting in significant influence could be viewed as a disposal of an existing interest and the acquisition of an interest that conveys significant influence. Second, the fair value of the existing interest may be considered the “deemed cost” of that portion of the interest on the date significant influence is obtained. Regardless of the approach used, the equity method of accounting would be applied only from the date significant influence was obtained forward. Thus, the entity would be required under both U.S. GAAP and IFRS Accounting Standards to apply the equity method prospectively. However, differences may continue to exist regarding the determination of the initial basis in the equity method investee and the recognition of any related gain or loss. For further information, see A26.4.4.8 of Deloitte’s iGAAP publication.
Subsequent measurement: losses that exceed interests	As described in Section 5.2, an investor generally discontinues use of the equity method of accounting when the value of an investment reaches zero unless the investor has guaranteed obligations of the investee or is otherwise committed to provide further financial support to the investee. However, an investor should continue to recognize additional losses if the imminent return to profitable operations appears to be assured.	IFRS Accounting Standards typically require an investor to discontinue use of the equity method of accounting when the value of an investment reaches zero unless the investor has incurred legal or constructive obligations or made payments on behalf of the associate. However, unlike the requirements under U.S. GAAP, those under IFRS Accounting Standards do not permit an investor to continue to provide for additional losses if an imminent return to profitable operations by an associate appears to be assured. For example, assume Investor A has a 25 percent interest in Investee B. Investor A’s carrying value is $50 million, and its share of B’s losses for the current year is $75 million. Investee B has recently refocused its product line and has sufficient sales contracts for the following year to ensure profitability. In accordance with U.S. GAAP, A would reduce its investment balance to zero and record a liability for $25 million, representing the excess of its share of losses over the existing carrying value. In accordance with IFRS Accounting Standards, A would reduce its investment balance to zero but would not record any further losses or liability. For further information, see A26.4.4.16 of Deloitte’s iGAAP publication.
Subsequent measurement: impairment	As described in Section 5.5, an investor must determine whether its equity method investment has a loss in value and, if so, whether that loss is other than temporary. If an impairment is determined to be appropriate, investments with other-than-temporary losses must be written down to fair value. Impairment losses cannot be reversed in subsequent periods.	An investor first looks for any indicators of impairment as described in either (1) paragraphs 58 through 62 of IAS 39 (before the adoption of IFRS 9) or (2) paragraphs 41A through 41C of IAS 28 (after the adoption of IFRS 9). Under both standards, the impairment indicators focus on identifiable loss events that will affect future cash flows. Loss events can arise only from past events. If an impairment indicator exists, the investor must then measure any impairment as described in IAS 28. Impairments are measured in accordance with IAS 36 as the excess of the investment’s carrying value over its recoverable amount. The recoverable amount is calculated as the higher of the investment’s (1) fair value less cost to sell or (2) value in use. The investor can calculate the value in use by using either (1) the present value of the investor’s share of estimated future cash flows from the associate’s operations, including proceeds from the investment’s disposal, or (2) the present value of the investor’s estimated future dividends from the associate and estimated proceeds from the investment’s disposal. Under IAS 28, the investor should reverse previously recorded impairment losses to the extent that the recoverable amount of the investment subsequently increases. However, the investment can be written up no higher than its original cost basis. Since IFRS Accounting Standards do not contemplate the concept of other-than-temporary losses but do allow reversals of impairments and use different measurement methods than do U.S. GAAP, significant differences may arise between IFRS Accounting Standards and U.S. GAAP when an entity is accounting for impairments of equity method investments. For further information, see A26.4.4.19 and A26.4.4.20 of Deloitte’s iGAAP publication.
Subsequent measurement: investee accounting policies	As described in Section 5.1.3.3, an investor is not required to conform an investee’s accounting policies to its own as long as the investee’s accounting policies are an acceptable alternative under U.S. GAAP. The investor may elect to conform the investee’s accounting policies to its own when applying the equity method of accounting.	IFRS Accounting Standards specifically require an investor to conform an investee’s accounting policies to its own when applying the equity method of accounting.5 This may result in differences in accounting for equity method investments between U.S. GAAP and IFRS Accounting Standards. For further information, see A26.4.4.13 of Deloitte’s iGAAP publication.
Subsequent measurement: investee fiscal year-end	As described in Section 5.1.4, an investor must record equity earnings or losses on the basis of the investee’s “most recent available financial statements.” It is usually acceptable for the investor to apply the equity method of accounting by using the equity method investee’s financial statements with a different reporting date as long as the reporting dates of the investor and investee are no greater than three months apart. In addition, the difference between the investor’s and investee’s reporting dates should be consistent in each reporting period. Finally, the investor is generally not required to record its share of the investee’s significant transactions or events occurring during the lag period. However, recognition should be given by disclosure or otherwise for intervening events that materially affect the investor’s financial position or results of operations.	The investor’s and investee’s reporting dates must be the same unless it is impracticable for them to be the same. When it is impracticable, the dates must be no more than three months apart, and the lag period should be consistent. In addition, as of the investor’s reporting date, the investor must record its share of the associate’s significant transactions or events that have occurred during the lag period. Therefore, differences may arise between U.S. GAAP and IFRS Accounting Standards, because IFRS Accounting Standards require recognition if such intervening transactions are significant, whereas U.S. GAAP do not. For further information, see A26.4.4.12 of Deloitte’s iGAAP publication.
Subsequent measurement: loss of significant influence	As discussed in Section 5.6.5, when an investor loses significant influence over an investee, it recognizes any retained investment on the basis of historical cost and thus recognizes no gain or loss solely because of the loss of significant influence (and thus the discontinuance of the equity method of accounting). Note, however, that other U.S. GAAP (e.g., ASC 321) subsequently applicable to the investment may require measurement at fair value with changes in fair value recognized in income. In accordance with ASC 321, an investor must remeasure the retained investment in accordance with ASC 321-10-35-1 or ASC 321-10-35-2, as applicable. In the application of ASC 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 the investor’s discontinuance of the equity method, the entity must remeasure its retained investment at fair value immediately after discontinuing the equity method.	An investor would recognize any retained interest at fair value, with any difference between the fair value of the retained interest and the carrying value of the equity method investment recognized in the income statement. As a result, under IFRS Accounting Standards, an entity will recognize a gain or loss as a result of losing significant influence, whereas under U.S. GAAP, the entity will record the interest at fair value or by applying the measurement alternative. Note, however, that depending on the classification of the retained interest (e.g., any equity security that is measured at fair value), changes in fair value may be immediately recognized under other U.S. GAAP. In those instances, the impact to the income statement of losing significant influence may be the same under U.S. GAAP and IFRS Accounting Standards. For further information, see A26.4.4.17 of Deloitte’s iGAAP publication.
Presentation: general and impairment	As discussed in Section 6.1, an equity method investment is presented as a single line item on the balance sheet and in the income statement. In addition, basis differences and investor-level impairments are typically recognized in the same line in the income statement as the equity in the investee’s earnings or losses.	An equity method investment is presented as a separate line item on the balance sheet and in the income statement. However, we generally believe that under IFRS Accounting Standards, investor-level impairments should not be offset against the share of profit or loss from an associate because this would conflict with the requirement to show that share of profit or loss as a separate line item. Therefore, differences may arise between IFRS Accounting Standards and U.S. GAAP regarding the classification of investor-level impairment charges in the income statement. For further information, see A26.7.1 of Deloitte’s iGAAP publication.
Presentation: proportionate consolidation	As discussed in Section 2.4.3, under U.S. GAAP, proportionate consolidation may be used to account for undivided interests in assets and liabilities as well as investments in unincorporated legal entities, such as partnerships, in certain industries (i.e., construction and extractive).	The use of proportionate consolidation is technically not prescribed under IFRS Accounting Standards. However, for a joint operation, an investor would recognize its share of assets, liabilities, revenues, and expenses instead of applying the equity method of accounting. A joint operation is defined in Appendix A of IFRS 11 as a “joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement.”
Presentation: held-for-sale classification	As described in Section 6.2.2.2, an equity method investment that does not qualify for discontinued operations reporting would not qualify for held-for-sale classification. An equity method investment that does qualify for discontinued operations would qualify for held-for-sale classification. However, equity method investments are not within the scope of the measurement guidance in ASC 360; rather, they must be assessed for impairment in accordance with ASC 323 even while classified as held for sale. In addition, ASC 323 does not provide specific guidance on disposals. Therefore, an investor should apply the equity method of accounting until the date on which significant influence is lost, which will usually not be before the date of disposal.	An equity method investment may be eligible for held-for-sale accounting if it satisfies certain criteria in paragraphs 6 through 12 of IFRS 5, including: The investment will be sold in a sale transaction. The investment is available for immediate sale. The sale is highly probable. The sale is expected to take place within one year. If the held-for-sale criteria are met, an investor should record the equity method investment at the lower of its (1) fair value less cost to sell or (2) carrying value on the date when the held-for-sale criteria are met. The investor would no longer apply the equity method of accounting and would instead remeasure the held-for-sale investment as of each subsequent reporting date. In addition, the investment may qualify for separate presentation in the investor’s discontinued operations if it qualifies as a component of the entity and meets certain other criteria under paragraphs 31 and 32 of IFRS 5. Therefore, differences may arise between IFRS Accounting Standards and U.S. GAAP related to when the equity method of accounting will no longer apply and the measurement of the held-for-sale equity method investment.
Disclosures	As described in Chapter 6, an investor’s disclosure of its equity method investments should include the following: The investee’s name. The investor’s percentage ownership of the investee’s common stock. Basis differences. The aggregate value of that investment based on the quoted market price, if available. Summarized information regarding the assets, liabilities, and results of operations of investees, either individually or in the aggregate, for material investments. The factors leading to an accounting conclusion that either (1) a 20 percent or greater interest does not provide significant influence or (2) a less than 20 percent interest does provide significant influence. Information regarding material impacts of any potential conversion of outstanding convertible securities, exercise of outstanding options and warrants, and other contingent issuances on the investor’s share of reported earnings or losses.	Under IFRS 12, an investor must disclose information largely similar to that required to be disclosed under U.S. GAAP (excluding the required disclosure under U.S. GAAP for possible conversions of convertible securities and exercise of options and warrants). In addition, an investor must disclose: The investee’s principal place of business. The reporting dates of investments recorded on a lag and the reasons the dates are different. Any restrictions on the associate to pay dividends or repay loans to the investor. The investor’s share of the associate’s contingent liabilities. The unrecognized share of losses if the equity method of accounting has been suspended. In addition, the summarized financial information must be provided separately for each material investment (whereas U.S. GAAP indicates the information should be provided individually or in the aggregate as appropriate). IFRS 12 also provides more prescriptive guidance regarding what specific information should be disclosed, including: Current assets. Noncurrent assets. Current liabilities. Noncurrent liabilities. Revenue. Profit or loss from continuing operations. Post-tax profit or loss from discontinued operations. OCI. Total comprehensive income. Therefore, IFRS Accounting Standards require additional disclosures beyond those required under U.S. GAAP.

Table B-2 Determining Whether to Apply Joint Venture Accounting

Subject	U.S. GAAP	IFRS Accounting Standards
Definition, scope, and type of joint venture	As discussed in Section 7.2, in accordance with the definition of a joint venture in ASC 323-10-20, a joint venture has all of the following characteristics: It is a separate legal entity. It is owned by a small group of entities. The operations are for the mutual benefit of the venturers. The purpose is to “share risks and rewards in developing a new market, product or technology; to combine complementary technological knowledge; or to pool resources in developing production or other facilities.” Each venturer can participate, directly or indirectly, in the overall management. The members have an interest or relationship other than passive investors. It is not a subsidiary of one of the members. ASC 323 addresses only separate legal entities. Other types of arrangements, such as collaborative arrangements, are addressed in other guidance.	A joint arrangement is an arrangement in which two or more parties have joint control. IFRS 11 requires an investor to follow the three-step process below when classifying a joint arrangement as either a joint operation (controlled by joint operators) or a joint venture (controlled by joint venturers). Step 1 — If the joint arrangement is not structured through a legal vehicle, it should always be classified as a joint operation. Step 2 — If the parties have rights to the assets and obligations for the liabilities either through legal form of the entity or by contract (i.e., the assets and liabilities held in the separate vehicle are the assets and liabilities of the parties), the joint arrangement should be classified as a joint operation. Conversely, if the parties have rights to the net assets of the arrangement, step 3 should be considered. Step 3 — Despite the parties’ having only rights to the net assets of the arrangement, if the parties have designed the arrangement in such a way that (1) its activities provide the parties with the output (i.e., the parties receive substantially all of the economic benefit of the assets in the vehicle) and (2) the vehicle relies on the parties for settling the liabilities, the arrangement is a joint operation. Otherwise, the arrangement is a joint venture.
Accounting for jointly controlled entities	Generally, the venturer should apply the equity method of accounting, except in certain industries (i.e., the construction and extractive industries), in which proportionate consolidation is permitted.	A joint venturer should recognize its interest in a joint venture as an investment and should account for that investment by using the equity method in accordance with IAS 28 unless the venturer is exempted from applying the equity method as specified in that standard.
Accounting for jointly controlled operations	ASC 323 does not address jointly controlled operations (since a jointly controlled operation does not have a legal entity). However, ASC 808-10 addresses the accounting for collaborative arrangements, which are jointly controlled operations that are not primarily conducted through a legal entity. To be within the scope of ASC 808-10, a participant must be (1) an active participant in the joint operations conducted primarily outside of a legal entity and (2) exposed to significant risks and rewards that depend on the joint activity’s success. As in IFRS 11, under ASC 808-10, a participant recognizes costs incurred and revenue generated from transactions with third parties (i.e., nonparticipants) in its income statement. However, ASC 808-10 also requires a participant to record such amounts on a gross or net basis in its income statement in accordance with ASC 606-10-55-36 through 55-40. That is, a participant would record the amounts gross if it was the principal on the sales transaction with the third party or net if it was an agent to the transaction with the third party.	IFRS 11 specifies that a joint operation “is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement. Those parties are called joint operators.” A joint operator recognizes the following attributes “in relation to its interest in a joint operation: its assets, including its share of any assets held jointly; its liabilities, including its share of any liabilities incurred jointly; its revenue from the sale of its share of the output of the joint operation; its share of the revenue from the sale of the output by the joint operation; and its expenses, including its share of any expenses incurred jointly.”
Initial contribution of nonmonetary assets that meet the definition of a business to a joint venture or joint operation	A gain or loss is recognized as the difference between the following: The sum of the fair value of any consideration received, the fair value of any retained noncontrolling investment in the net assets as of the date of contribution (the date control is lost), and the carrying amount of any noncontrolling interest in the net assets as of the date of contribution (the date control is lost). The carrying amount of the net assets contributed as of the date of contribution (the date control is lost).	An accounting policy election among the following three approaches may be taken (unless a venturer adopted the amendments proposed by the IASB in September 2014 before it indefinitely deferred them in December 2015): Approach A (based on the September 2014 amendments to IFRS 10 and IAS 28) — In a transaction involving a joint venture, the extent of gain or loss recognition by the venturer depends on whether the assets sold or contributed constitute a business. When an entity (1) sells or contributes assets that constitute a business to a joint venture or (2) loses control of a subsidiary that contains a business but retains joint control, the gain or loss resulting from that transaction is recognized in full. Approach B (based on the guidance in IAS 28 before the adoption of the September 2014 amendments) — Paragraph 28 of IAS 28 states that any gain or loss is recognized by the venturer “only to the extent of unrelated investors’ interests in the . . . joint venture.” Approach C (based on the guidance in IFRS 10 before the adoption of the September 2014 amendments) — Under IFRS 10, the venturer derecognizes all the net assets of the former subsidiary and recognizes at fair value any consideration received and any retained interest in the former subsidiary. Note that entities that cannot formally adopt the September 2014 amendments (e.g., because of a requirement for endorsement of changes to IFRS Accounting Standards in their jurisdiction) may adopt an accounting policy consistent with those amendments (i.e., distinguishing between transactions on the basis of whether the subsidiary being sold or contributed constitutes a business) provided that the requirements of paragraph 14(b) of IAS 8 are met (i.e., the change in policy results in the financial statements’ providing reliable and more relevant information). However, such a “voluntary” change in policy would have to be applied retrospectively in accordance with IAS 8; the transition provisions of the September 2014 amendments (which allow for prospective application to transactions occurring after a specified date) would not be available.
Initial contribution of nonmonetary assets that do not meet the definition of a business to a joint venture or joint operation	As discussed in Section 4.3.4, generally, venturers recognize the initial contributions of nonmonetary assets that do not meet the definition of a business at fair value and may recognize a gain if applicable.	An accounting policy election among the following three approaches may be taken (unless a venturer adopted the amendments proposed by the IASB in September 2014 before it indefinitely deferred them in December 2015): Approach A (based on the September 2014 amendments to IFRS 10 and IAS 28) — In a transaction involving a joint venture, when the venturer (1) sells or contributes assets that do not constitute a business to a joint venture or (2) loses control of a subsidiary that does not contain a business but retains joint control in a transaction involving a joint venture, the gain or loss resulting from that transaction is recognized only to the extent of the unrelated investors’ interests in the joint venture (i.e., the entity’s share of the gain or loss is eliminated). A new example added to IFRS 10 (see Appendix B, Example 17) illustrates the appropriate accounting in such circumstances. Approach B (based on the guidance in IAS 28 before the adoption of the September 2014 amendments) — Paragraph 28 of IAS 28 states that a gain or loss is recognized by the venturer “only to the extent of unrelated investors’ interests in the . . . joint venture.” Approach C (based on the guidance in IFRS 10 before the adoption of the September 2014 amendments) — Under IFRS 10 the venturer derecognizes all the net assets of the former subsidiary and recognizes at fair value any consideration received and any retained interest in the former subsidiary. Note that entities that cannot formally adopt the September 2014 amendments (e.g., because of a requirement for endorsement of changes to IFRS Accounting Standards in their jurisdiction) may adopt an accounting policy consistent with those amendments (i.e., distinguishing between transactions on the basis of whether the subsidiary being sold or contributed constitutes a business) provided that the requirements of paragraph 14(b) of IAS 8 are met (i.e., the change in policy results in the financial statements’ providing reliable and more relevant information). However, such a “voluntary” change in policy would have to be applied retrospectively in accordance with IAS 8; the transition provisions of the September 2014 amendments (which allow for prospective application to transactions occurring after a specified date) would not be available.

Footnotes

See paragraphs 18 and 19 of IAS 28.

See paragraph 6 of IAS 28.

See paragraphs 7 through 9 of IAS 28.

Quoted from paragraph 26 of IAS 28.

See paragraphs 35 and 36 of IAS 28.

Appendix C — ASC 323-740 Before the Adoption of ASU 2023-02

C.2 Introduction

C.2.1 QAHP Investments

A QAHP investment is a form of tax equity investment in which an investor invests in a QAHP through a limited liability entity for the purpose of obtaining low-income housing tax credits (LIHTCs) and other tax benefits generated by the QAHP. The LIHTCs generated are applied to the investor’s tax return each year over a 10-year period. These investments, which in practice are sometimes also referred to as LIHTC investments, are typically structured as “flow-through” entities for tax purposes. Therefore, the investor is entitled to directly receive tax benefits generated by the QAHP, typically in the form of tax credits and tax deductions from operating losses.

Investments in real estate, such as housing projects, should be accounted for in accordance with ASC 970-323. This guidance generally requires the use of the equity method of accounting for limited partnership real estate investments unless the limited partnership interest is so minor that it has essentially no influence over the investee. In such a case, the investment would typically be accounted for at fair value in accordance with ASC 3212 (unless the measurement alternative is elected). However, ASC 970-323-05-4 refers to ASC 323-740 for QAHP investments that satisfy the conditions in ASC 323-740.

ASC 323-740 permits an investor in a QAHP that meets certain scope criteria (see Section C.3) to make an accounting policy election to account for its QAHP investment by using either the effective yield method (for investments entered into before the adoption of ASU 2014-01 3) or the proportional amortization method (for investments entered into after the adoption of ASU 2014-01). If this policy election is made, it should be applied consistently to all QAHP investments that meet the scope criteria. Further, ASC 323-740 also provides incremental guidance for QAHP investments that do not qualify for, or do not elect to use, the proportional amortization method (see Section C.7). See Sections C.2.2, C.2.3, and C.2.4 for additional information on the impact of ASU 2014-01 and ASU 2023-02 on the guidance in ASC 323-740.

ASC 323-740

05-3 The following discussion refers to and describes a provision within the Revenue Reconciliation Act of 1993; however, it shall not be considered a definitive interpretation of any provision of the Act for any purpose. The Revenue Reconciliation Act of 1993, enacted in August 1993, retroactively extended and made permanent the affordable housing credit. Investors in entities that manage or invest in qualified affordable housing projects receive tax benefits in the form of tax deductions from operating losses and tax credits. The tax credits are allowable on the tax return each year over a 10-year period as a result of renting a sufficient number of units to qualifying tenants and are subject to restrictions on gross rentals paid by those tenants. These credits are subject to recapture over a 15-year period starting with the first year tax credits are earned. Corporate investors generally purchase an interest in a limited liability entity that manages or invests in the qualified affordable housing projects.

C.2.2 Before the Adoption of ASU 2014-01

Before the adoption of ASU 2014-01, an investor could have elected, if certain criteria were met, to account for its investment in a QAHP by using the effective yield method. Under this method, tax credits are applied to (recognized in) the investor’s tax return over a 10-year period and the investor’s initial cost of investment is amortized in a manner that provides a constant effective yield over the same 10-year period. An investor that used the effective yield method to account for QAHP investments it entered into before adopting ASU 2014-01 is permitted to continue applying this method to such investments until it transitions to the updated guidance in ASU 2023-02 (see Appendix D).

C.2.3 After the Adoption of ASU 2014-01

ASU 2014-01 replaced the effective yield method with the proportional amortization method. Under this ASU, an investor can elect to account for its investment in a QAHP by using the proportional amortization method, which requires that the investor’s initial cost of the investment be amortized in proportion to the tax credits and other tax benefits received. ASC 323-740-35-4 notes that “[a]s a practical expedient, an investor is permitted to amortize the initial cost of the investment in proportion to only the tax credits allocated to the investor if the investor reasonably expects that doing so would produce a measurement that is substantially similar to” the one that would have resulted if it had applied the full proportional amortization method.

Although the provisions of ASU 2014-01 were required to be applied retrospectively, an investor that used the effective yield method to account for its QAHP investments before adopting ASU 2014-01 may continue to apply that method for those prior investments.

C.2.4 Issuance of ASU 2023-02

In March 2023, the FASB issued ASU 2023-02, which further updates the guidance in ASC 323-740 and expands its applicability to investments other than QAHPs. See Appendix D for a discussion of ASC 323-740 after the adoption of ASU 2023-02.

The remainder of this appendix is applicable to investors who have not adopted ASU 2023-02.

Footnotes

See footnote 1.

For public entities, ASU 2014-01 became effective for fiscal years beginning after December 15, 2014, and interim periods therein. For nonpublic entities, the ASU became effective for fiscal years beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, 2015. Early adoption was permitted.

C.4 Applying the Proportional Amortization Method

C.4.1 Applicability of the Proportional Amortization Method to a QAHP Investment That Generates Other Tax Credits in Addition to Affordable Housing Credits

As discussed in more detail in Section C.2, ASC 323-740 can be applied to QAHP investments that generate LIHTC credits. In some situations, the QAHP generates other tax credits (e.g., alternative energy credits or credits related to restoring and rehabilitating historic buildings), which are also allocated to investors in the QAHP. Because the scope of ASC 323-740 is limited to QAHP investments, it is unclear whether a QAHP investment that generates other credits in addition to LIHTC credits would be automatically excluded from its scope. While we believe that an entity needs to carefully consider the nature of the investment, we do not think that a QAHP investment that generates tax benefits other than LIHTC credits would automatically be excluded from the scope of ASC 323-740.

To consider the nature of a QAHP investment, an investor would need to determine whether the LIHTC program is the predominant program through which the QAHP investment generates credits. This is not a bright-line determination; however, the greater the proportion of the benefits derived from other tax credits in relation to the proportion of the benefits derived from LIHTC credits and tax benefits from operating losses of the investment, the more difficult it becomes to conclude that the investment is within the scope of ASC 323-740. For example, we believe that if 45 percent of the tax credits generated by a QAHP investment are attributable to LIHTC credits and the remaining 55 percent are associated with other tax credits, it would be difficult to conclude that the investment is within the scope of ASC 323-740. Alternatively, we believe that if 92 percent of the projected benefits of a QAHP investment are related to LIHTC credits and only 8 percent are associated with other tax credits, it would generally be appropriate to conclude that the investment could be within the scope of ASC 323-740, provided that the other scope requirements are met.

In the determination of whether the “substantially all” condition is met (see Section C.3.3), tax credits that are accounted for outside the scope of ASC 740, such as refundable tax credits, are included in the computation of the total projected benefits (i.e., the denominator) but are not included in the computation of the projected benefits from tax credits and other income tax benefits (i.e., the numerator). If any of the underlying credits represent transferable credits, an investor will need to consider its accounting policy choice for such credits in determining whether to include them in the numerator when assessing the “substantially all” condition. See Section 12.2.2 of Deloitte’s Roadmap Income Taxes for additional information on accounting for transferable tax credits.

C.6 Subsequent Measurement

C.6.1 The Proportional Amortization Calculation

ASC 323-740

35-2 Under the proportional amortization method, the investor amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits allocated to the investor. The amortization amount shall be calculated as follows:

The initial investment balance less any expected residual value of the investment, multiplied by
The percentage of actual tax credits and other tax benefits allocated to the investor in the current period divided by the total estimated tax credits and other tax benefits expected to be received by the investor over the life of the investment.

35-5 Any expected residual value of the investment shall be excluded from the proportional amortization calculation. Cash received from operations of the limited liability entity shall be included in earnings when realized or realizable. Gains or losses on the sale of the investment, if any, shall be included in earnings at the time of sale.

35-6 An investment in a qualified affordable housing project through a limited liability entity shall be tested for impairment when events or changes in circumstances indicate that it is more likely than not that the carrying amount of the investment will not be realized. An impairment loss shall be measured as the amount by which the carrying amount of an investment exceeds its fair value. A previously recognized impairment loss shall not be reversed.

In each period after the initial investment in a QAHP accounted for under ASC 323-740, the investor amortizes the initial cost of the investment into the income tax benefit/expense line item in the investor’s income statement. The cost of the investment is amortized in proportion to the tax credits and other tax benefits expected to be received over the life of the underlying QAHP. The calculation is as follows:

Example C-2

On January 1, 20X1, Company A makes a $200,000 investment in a QAHP in exchange for a 10 percent limited partnership interest. Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to account for the investment by using the proportional amortization method.
Company A has not applied the practical expedient.
The partnership is financed entirely with equity.
Annual tax credits equal 9 percent of the original cost of the property each year for 10 years.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A’s statutory tax rate is 25 percent.
The estimated residual value of Company A’s investment is zero.

See table below.

C.6.2 Additional Investments Made After Initial Measurement

After making an initial investment, an entity may make an additional investment that was not included in the initial cost (e.g., the additional investment is not contractually required or is a contingent commitment that was previously determined to not be probable but subsequently became probable). If the investment continues to qualify for the proportional amortization method after the additional investment is made, the proportional amortization calculation should be adjusted to reflect the additional investment. In addition, the entity should adjust the calculation to reflect any additional tax credits and other tax benefits expected to be realized as a result of the additional investment.

There are two different ways that investors can adjust proportional amortization calculations to reflect additional investments that are not included in the initial cost of the investment:

They can create a separate amortization schedule for the additional investment and recognize the amortization calculated in this separate schedule in addition to the amortization calculated in the original schedule. (The schedule should be similar to that in Example C-2.)
The original amortization schedule can be adjusted prospectively to reflect the additional investment amount, tax credits, and other tax benefits expected to be received.

Both methods described above would result in the recognition of the same amortization amount in each period.

Example C-3

On January 1, 20X1, Company A makes a $200,000 investment in a QAHP in exchange for a 10 percent limited partnership interest. On January 1, 20X3, A makes an additional $100,000 investment in the QAHP in exchange for an additional 5 percent limited partnership interest that was not contemplated at the time of the initial investment.

Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to account for the investment by using the proportional amortization method.
Company A has not applied the practical expedient.
The $100,000 additional investment made in 20X3 resulted in a corresponding increase to the tax basis of the investment.
Company A will recognize (1) annual tax credits equal to 9 percent of the original cost of the property in each year for 10 years starting in 20X1 and (2) additional tax credits equal to 9 percent of the additional investment in each year for 10 years starting in 20X3.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A’s statutory tax rate is 25 percent.
The estimated residual value of A’s investment is zero.

See table below.

C.6.3 Practical Expedient

ASC 323-740

35-4 As a practical expedient, an investor is permitted to amortize the initial cost of the investment in proportion to only the tax credits allocated to the investor if the investor reasonably expects that doing so would produce a measurement that is substantially similar to the measurement that would result from applying the requirement in paragraph 323-740-35-2.

Under the proportional amortization method described in ASC 323-740, an investor amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received. As a practical expedient, an investor applying the proportional amortization method may choose to amortize the initial cost of the investment in proportion to only the tax credits allocated to the investor if the investor reasonably expects that doing so would produce a measurement that is substantially similar to the measurement that would result from applying the full proportional amortization method described in ASC 323-740-35-2 (as illustrated in Example C-2).

There is no bright-line test for determining whether the practical expedient can be applied. Instead, an investor will need to use significant judgment to determine whether use of the practical expedient would produce a measurement that is substantially similar to that of the proportional amortization method. Factors to consider include, but are not limited to, the net effect on income tax expense each period and the period over which the predominant portion of the investment would be amortized.

Below are some examples of when the use of the practical expedient would produce a measurement that is or is not substantially similar to the measurement produced by the proportional amortization method.

Substantially Similar	Not Substantially Similar
Application of the practical expedient would cause 100 percent of the investment to be amortized into the income tax line item over a period of 10 years (see Example C-4), while application of the proportional amortization method would cause 87 percent of the investment to be amortized into the income tax line item over the same 10-year period (see Example C-2). Application of the practical expedient would result in a net impact on income tax expense of $3,000 a year for 10 years, while application of the proportional amortization method would result in a net impact on income tax expense of $2,600 a year for 10 years and $267 a year for an additional 15 years.	Application of the practical expedient would cause 100 percent of the investment to be amortized into the income tax line item over a period of 10 years (see Example C-4), while application of the proportional amortization method would cause 50 percent of the investment to be amortized into the income tax line item over the same 10-year period. Application of the practical expedient would result in a net impact to income tax expense of $3,000 a year for 10 years, while application of the proportional amortization method would result in a net impact to income tax expense of $1,500 a year for 10 years and $1,000 a year for an additional 15 years.

Substantially Similar

Not Substantially Similar

Application of the practical expedient would cause 100 percent of the investment to be amortized into the income tax line item over a period of 10 years (see Example C-4), while application of the proportional amortization method would cause 87 percent of the investment to be amortized into the income tax line item over the same 10-year period (see Example C-2).
Application of the practical expedient would result in a net impact on income tax expense of $3,000 a year for 10 years, while application of the proportional amortization method would result in a net impact on income tax expense of $2,600 a year for 10 years and $267 a year for an additional 15 years.

Application of the practical expedient would cause 100 percent of the investment to be amortized into the income tax line item over a period of 10 years (see Example C-4), while application of the proportional amortization method would cause 50 percent of the investment to be amortized into the income tax line item over the same 10-year period.
Application of the practical expedient would result in a net impact to income tax expense of $3,000 a year for 10 years, while application of the proportional amortization method would result in a net impact to income tax expense of $1,500 a year for 10 years and $1,000 a year for an additional 15 years.

Below are examples of the application of the practical expedient.

Example C-4

On January 1, 20X1, Company A makes a $200,000 investment in a QAHP in exchange for a 10 percent limited partnership interest. Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to account for the investment by using the proportional amortization method.
Company A qualifies for, and elects to use, the practical expedient.
The partnership is financed entirely with equity.
Company A will recognize annual tax credits equal to 9 percent of the original cost of the property each year for 10 years starting in 20X1.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A’s statutory tax rate is 25 percent.
The estimated residual value of A’s investment is zero.

See table below.

Example C-5

On January 1, 20X1, Company A makes a $200,000 investment in a QAHP in exchange for a 10 percent limited partnership interest. On January 1, 20X3, A makes an additional $100,000 investment in the QAHP for an additional 5 percent limited partnership interest that was not contemplated at the time of the initial investment.

Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to account for the investment by using the proportional amortization method.
Company A qualifies for, and elects to use, the practical expedient.
The partnership is financed entirely with equity.
Company A will recognize (1) annual tax credits equal to 9 percent of the original cost of the property in each year for 10 years starting in 20X1 and (2) additional tax credits equal to 9 percent of the additional investment in each year for 10 years starting in 20X3.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A’s statutory tax rate is 25 percent.
The estimated residual value of A’s investment is zero.

See table below.

C.6.4 Reassessment

ASC 323-740

25-1C At the time of the initial investment, a reporting entity shall evaluate whether the conditions in paragraphs 323-740-25-1 through 25-1B have been met to elect to apply the proportional amortization method on the basis of facts and circumstances that exist at that time. A reporting entity shall subsequently reevaluate the conditions upon the occurrence of either of the following:

A change in the nature of the investment (for example, if the investment is no longer in a flow-through entity for tax purposes)
A change in the relationship with the limited liability entity that could result in the reporting entity no longer meeting the conditions in paragraphs 323-740-25-1 through 25-1B.

C.6.4.1 Changes in Circumstances After Initial Measurement

Under ASC 323-740-25-1C, an entity is required to reassess the applicability of the proportional amortization method when there is either a “change in the nature of the investment” or a “change in the relationship with the underlying [QAHP] that could result in the [investment] no longer meeting” the scope requirements for the application of ASC 323-740. Changes that would trigger the need for reassessment include, but are not limited to, (1) the investee is no longer a pass-through entity for tax purposes or (2) the investee no longer generates LIHTCs.

C.6.4.2 Changes in Laws or Rates

Questions have arisen regarding whether an entity needs to reevaluate whether a project yields an overall benefit (the criterion in ASC 323-740-25-1(b)) when a change in tax law is enacted. To determine whether a change in tax law represents a change in the nature of the investment or in the relationship with the investee, either of which would require reassessment of the applicability of the proportional amortization method, investors should evaluate the specific impact of the change in tax law. Such an assessment requires significant professional judgment.

Although a change in the tax rate may affect whether the criteria in ASC 323-740-25-1 are met after the initial investment, we do not believe that a change in tax rate represents either a change in the nature of the investment or a change in the relationship with the investee, as those terms are contemplated in ASC 323-740-25-1C. Therefore, an entity is not required to reassess whether it is still appropriate to apply the proportional amortization method solely because of a change in tax rates.

Alternatively, we believe that if a change in the tax law has a broader impact that affects more than just the tax rate, an entity should assess the nature of the change to determine whether it represents either a change in the nature of the investment or a change in the relationship with the investee. Examples of changes in tax laws that would generally trigger the need to reassess the applicability of the proportional amortization method include:

Changing a credit from nontransferable or nonrefundable to transferable or refundable.
Changing how a credit is generated (e.g., a change in the criteria that need to be met for a QAHP to generate credits).
Changing the rate at which the credits are generated (e.g., a change in the LIHTC rate from 9 percent each period to 5 percent each period).

If the total expected tax benefit changes because of a change in tax rates and the investment continues to be accounted for under the proportional amortization method, an investor must revise the amortization of the investment to ensure that cumulative amortization over the life of the investment equals the initial carrying amount (less any residual value). If the change in total expected tax benefits is the result of a change in tax rates and the investor has not elected to use the practical expedient, the proportion of benefits already allocated to the investor will increase in relation to the total expected tax credits and other tax benefits. As a result, we believe that there are two acceptable approaches for adjusting amortization.

Under the first approach, the investor would record a cumulative catch-up adjustment to the carrying amount of the investment on the basis of the amount of tax credits and other tax benefits that have been allocated to the investor in proportion to the revised amount of total expected tax benefits. This approach is consistent with the guidance in ASC 323-740, which requires that the initial cost of the investment be amortized in proportion to the tax credits and other benefits that have been allocated to the investor.

Under the second approach, the investor would adjust amortization prospectively. This treatment is consistent with accounting for a change in estimate that does not affect the carrying amount of an asset or liability but alters the subsequent accounting for existing or future assets or liabilities under ASC 250. See Example C-6 for an illustration of the prospective adjustment to the proportional amortization calculation in response to a change in tax rate.

In selecting an approach to adjust amortization, an investor should consider whether it has, in effect, made a policy election in prior periods when adjusting amortization to take into account changes in expected tax benefits that are due to factors other than changes in tax rates. If so, using a different approach to account for the change in tax rate would be a change in accounting principle that would need to be assessed for preferability.

If a significant portion of an investor’s yield is tied to tax benefits, as is expected with investments in QAHPs, the investor may need to test its investment for impairment when there is a change in the estimate or a change in tax law. More specifically, to evaluate whether it is more likely than not that the carrying amount of the QAHP investment will not be realized, the investor would need to compare (1) the carrying amount of the investment, after any cumulative catch-up is considered, with (2) the undiscounted amount of the remaining expected tax credits and other tax benefits.

C.6.4.3 Changes in Estimates After Initial Recognition

ASC 250-10-20 defines a change in accounting estimate, in part, as “[a] change that has the effect of adjusting the carrying amount of an existing asset or liability or altering the subsequent accounting for existing or future assets or liabilities.” Changes in accounting estimates occur when new information is obtained.

The accounting for a change in estimate is based on the cause of the change. Generally, changes in the amount or timing of anticipated tax benefits to be generated by a QAHP, or changes in the residual value of a QAHP investment, are accounted for prospectively and typically would not be considered a change in circumstances that would trigger the need to reassess the applicability of the proportional amortization method. Investors should carefully consider whether adjustments made to the proportional amortization calculation are the result of a change in estimate or the correction of an error.

C.6.5 Impairment Considerations

QAHP investors are required to assess their investment for impairment if the occurrence of an event or a change in circumstances indicates that it is more likely than not that the carrying amount of the investment will not be realized. ASC 323-740-35-6 states, in part, that an “impairment loss shall be measured as the amount by which the carrying amount of an investment exceeds its fair value.”

Events or changes in circumstances that may indicate that a QAHP investment is impaired include, but are not limited to, (1) changes in income tax rates and (2) changes in the income tax credits and other tax benefits to be generated by the QAHP. See Section C.6.4 for additional guidance on the potential need for reassessment if an investment in a QAHP qualifies for ASC 323-740 when such changes occur.

C.6.5.1 Presentationof Impairment Expense

ASC 323-740 does not specify where in the income statement an impairment charge related to a QAHP investment should be recorded. Under the proportional amortization method, the amortization of the cost of the investment is netted against the tax benefits received within the income tax expense line. An impairment is a recognition of the fact that the unamortized cost of acquiring the benefits exceeds the remaining expected benefits, but it does not change the nature of the initial investment as an investment in tax credits and other tax benefits. Accordingly, we believe that the impairment of an investment accounted for by using the proportional amortization method would be recorded as a component of income tax expense. However, such presentation would not be appropriate for QAHP investments within the scope of ASC 323-740 that are not accounted for by using the proportional amortization method.

Since investments in QAHPs are usually recovered through income tax credits and other tax benefits, the impairment assessments of such investments often focus on these benefits. However, secondary markets for such investments exist, and therefore recoveries may occur through sales. When developing the guidance in ASU 2014-01, the EITF was cognizant of the various methods of recovery and referred to “fair value” in the guidance.

See the example below of a possible impairment assessment, including an undiscounted cash flow assessment, for a QAHP investment accounted for in accordance with ASC 323-740.

Example C-6

On January 1, 20X1, Company A makes a $200,000 investment in a QAHP in exchange for a 10 percent limited partnership interest. Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to account for the investment by using the proportional amortization method.
Company A has not applied the practical expedient.
The partnership is financed entirely with equity.
Company A recognizes annual tax credits equal to 9 percent of the original cost of the property in each year for 10 years starting in 20X1.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A’s statutory tax rate is 25 percent.
On January 1, 20X4, a new tax law was passed that reduced A’s statutory tax rate to 12 percent.
The estimated residual value of A’s investment is zero.

See table below.

Because of the new tax law enacted in 20X4 that decreased A’s statutory tax rate from 25 percent to 12 percent, the total other tax benefits expected to be generated by the QAHP decreased. As a result, on January 1, 20X4 (the date the new tax law was enacted), the total undiscounted cash flows (i.e., the sum of anticipated tax credits plus other tax benefits) was less than the investment balance. Accordingly, A recorded an impairment of $706, which was the difference between the investment balance on January 1, 20X4, and the expected future tax credit and other tax benefits after adjusting for the change in tax rates.

Note that as discussed in Section C.6.4.3, there are two acceptable approaches for adjusting the amortization calculation in response to a change in tax rates. This example illustrates the prospective adjustment approach.

C.6.5.2 Impairment of Investment in QAHPs Accounted for Under the Equity Method

ASC 323-740 historically included an example illustrating the accounting for an investment in a QAHP accounted for under the equity method. This guidance was solely applicable to QAHP investments that qualify for, and are accounted for under, the equity method and should not be used by analogy for any other investments not within the scope of ASC 323-740. Although this example was removed from the Codification, we believe that it is still acceptable to use the method for assessing for impairment of an equity method investment within the scope of ASC 323-740 that was illustrated in this example.

See the example below for a possible impairment assessment, including the undiscounted cash flow method, for a QAHP investment accounted for in accordance with ASC 323 (i.e., the traditional equity method of accounting for all purposes other than impairment).

Example C-7

On January 1, 20X1, Company A makes a $200,000 QAHP investment in exchange for a 10 percent limited partnership interest. Further assume that:

Company A accounts for its investment as a traditional equity method investment in accordance with ASC 323.
The partnership is financed entirely with equity.
Company A will recognize annual tax credits equal to 9 percent of the original cost of the property in each year for 10 years starting in 20X1.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A’s statutory tax rate is 25 percent.
The estimated residual value of A’s investment is zero.

See table below.

In 20X3, the total undiscounted cash flows (i.e., the sum of anticipated tax credits plus other tax benefits) dropped below the investment balance. Accordingly, A recorded an impairment of $32,000, which was the difference between the investment balance at the end of 20X3 and the anticipated future tax credit and other tax benefits.

Footnotes

Appendix D — ASC 323-740 After the Adoption of ASU 2023-02

D.2 Introduction

D.2.1 Tax Equity Investments

ASC 323-740

05-1 This Subtopic contains standalone guidance on the use of the proportional amortization method to investments made primarily for the purpose of receiving income tax credits and other income tax benefits. Income tax accounting guidance on other types of equity method investments and joint ventures is contained in Subtopics 740-10 and 740-30.

Tax equity investments, including investments in QAHPs, are a subset of investments that are made through limited liability entities for the purpose of obtaining income tax credits and other income tax benefits generated by the investee. Because these types of investments are typically structured as “flow-through” entities for tax purposes, the investors are entitled to directly receive income tax benefits generated by the investee, typically in the form of income tax credits and income tax deductions from operating losses.

ASC 323-740 permits investments that meet certain scope criteria (see Section D.3) to be accounted for by using the proportional amortization method at the election of the investor. The sections below provide additional information on the impact of ASU 2014-01 and ASU 2023-02 on the guidance in ASC 323-740.

In March 2023, the FASB issued ASU 2023-02. Before adoption of ASU 2023-02, tax equity investments are typically accounted for in accordance with ASC 323, or industry specific guidance such as ASC 970-323. In that regard, ASC 970-323-05-4 specifies that QAHP investments should be accounted for in accordance with ASC 323-740. That is, only QAHP investments that meet certain criteria are eligible to be accounted for by using the proportional amortization method. However, if those criteria are not met, or if the tax equity investor did not elect to apply the proportional amortization method, other guidance in ASC 323-740 would apply to those QAHP investments. After the adoption of ASU 2023-02, any tax equity investments that meet certain criteria can be accounted for by using the proportional amortization method in accordance with ASC 323-740. As a result, the scope of the investments to be accounted for under ASC 323-740 changes after the adoption of ASU 2023-02.

D.2.2 Before the Adoption of ASU 2014-01

Before the adoption of ASU 2014-01, a tax equity investor could have elected, if certain criteria were met, to account for its QAHP investments by using the effective yield method. Under this method, tax credits are applied to (recognized in) the investor’s tax return over a 10-year period and the investor’s initial cost of investment is amortized in a way that provides a constant effective yield over the same 10-year period. An investor that used the effective yield method to account for QAHP investments it entered into before adopting ASU 2014-01 is permitted to continue applying this method to such investments until it transitions to the updated guidance in ASU 2023-02.

D.2.3 After the Adoption of ASU 2014-01

ASU 2014-01 replaced the effective yield method with the proportional amortization method. Under this ASU, a tax equity investor can elect to account for its investment in a QAHP by using the proportional amortization method, which required that the investor’s initial cost of the investment be amortized in proportion to the tax credits and other tax benefits received. ASC 323-740-35-4 notes that “[a]s a practical expedient, an investor is permitted to amortize the initial cost of the investment in proportion to only the tax credits allocated to the investor if the investor reasonably expects that doing so would produce a measurement that is substantially similar to” the one that would have resulted if it had applied the full proportional amortization method.

Although the provisions of ASU 2014-01 were required to be applied retrospectively, an investor that used the effective yield method to account for its QAHP investments before adopting ASU 2014-01 could continue to apply that method for those prior investments.

D.2.4 Issuance of ASU 2023-02

In March 2023, the FASB issued ASU 2023-02, which further updates the guidance in ASC 323-740 and expands its applicability to investments other than QAHPs. Specifically, this ASU expands the use of the proportional amortization method, which was previously limited to tax equity investments in QAHPs, to all tax equity investments regardless of the program from which the income tax credits are received, if certain conditions are met.

Under ASU 2023-02, an investor must make an accounting policy election to apply the proportional amortization method on a tax-credit-program-by-tax-credit-program basis. For all tax equity investments accounted for under the proportional amortization method, an entity must use the flow-through method to account for ITCs received through the tax equity investments, even if the entity uses the deferral method for other ITCs it received. Further, ASU 2023-02 removes the guidance in ASC 323-740 that was specific to QAHP investments that were accounted for by using the equity method or cost method (rather than proportional amortization).

The remainder of this appendix is applicable to investors who have adopted ASU 2023-02. For additional guidance on the application of ASC 323-740 for investors who have not yet adopted the ASU, see Appendix C.

D.6 Subsequent Measurement

ASC 323-740

35-2 Under the proportional amortization method, the investor amortizes the initial cost of the investment in proportion to the income tax credits and other income tax benefits allocated to the investor. The amortization amount shall be calculated as follows:

The initial investment balance less any expected residual value of the investment, multiplied by
The percentage of actual income tax credits and other income tax benefits allocated to the investor in the current period divided by the total estimated income tax credits and other income tax benefits expected to be received by the investor over the life of the investment.

35-5 Any expected residual value of the investment shall be excluded from the proportional amortization calculation. Non-income-tax-related benefits received from operations of the limited liability entity shall be included in pre-tax earnings when realized or realizable. Gains or losses on the sale of the investment, if any, shall be included in pre-tax earnings at the time of sale.

35-6 An investment shall be tested for impairment when events or changes in circumstances indicate that it is more likely than not that the carrying amount of the investment will not be realized. An impairment loss shall be measured as the amount by which the carrying amount of an investment exceeds its fair value. A previously recognized impairment loss shall not be reversed.

D.6.1 The Proportional Amortization Calculation

In each period after the initial investment in a tax equity structure accounted for by using the proportional amortization method, the investor amortizes the initial cost of the investment, less any expected residual value, into the income tax benefit/expense line item in the investor’s income statement.

The ASC master glossary defines residual value as the “estimated fair value of an intangible asset at the end of its useful life to an entity, less any disposal costs.” While that definition includes a reference to an intangible asset, we believe that the definition is applicable to the proportionate amortization method. In the determination of the expected residual value of a tax equity investment, the exit call/put option price should generally be considered the expected residual value. When calculating proportional amortization each period, investors are not required to discount, and subsequently accrete, to the expected residual return.

The cost of the investment is amortized in proportion to the income tax credits and other income tax benefits expected to be received over the life of the underlying tax equity project. The calculation is as follows:

This includes (1) any unconditional and legally binding future contributions to be made and (2) the cost of any future contributions that are contingent on a future event that is determined to be probable. These deferred equity contributions should be discounted and recognized as part of the initial investment balance.

Example D-2

On January 1, 20X1, Company A makes a $200,000 tax equity investment2 in an LLC holding a wind project in exchange for a 5 percent limited partnership interest. Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to use the proportional amortization method to account for its tax equity investments in this tax credit program in accordance with ASC 323-740-25-4.
Company A has not applied the practical expedient.
PTCs will be received annually for a period of 10 years on the basis of the total kilowatt-hours of energy generated by the underlying wind project each year.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A will receive cash proceeds based on a fixed percentage of the project’s cash generated during the life of the project.
Company A’s statutory tax rate is 25 percent.
The estimated residual value of A’s investment is zero.
All cash flows (except the initial investment) occur at the end of each year.

See table below.

D.6.2 Additional Investments Made After Initial Measurement

After making the initial investment, an entity may make an additional investment that was not included in the initial cost (i.e., it was not contractually required, or a contingent commitment that was previously determined to not be probable became probable). If the investment continues to qualify for the proportional amortization method after the additional investment is made, the proportional amortization calculation should be adjusted to reflect the additional investment. In addition, the entity should adjust the calculation to reflect any additional income tax credits and other income tax benefits expected to be realized as a result of the additional investment. See Section D.6.3 for additional guidance on when an investor is required to reassess whether an investment continues to qualify for the proportional amortization method.

There are two different ways that investors can adjust proportional amortization calculations to reflect additional investments that are not included in the initial cost of the investment:

They can create a separate amortization schedule for the additional investment and recognize the amortization calculated in this separate schedule in addition to the amortization calculated on the original schedule. (The schedule should be similar to that in Example D-2.)
The original amortization schedule can be adjusted prospectively to reflect the additional investment amount, income tax credits, and other income tax benefits expected to be received.

Both methods described above would result in recognition of the same amortization in each period.

Example D-3

On January 1, 20X1, Company A makes a $200,000 tax equity investment3 in an LLC holding a wind project in exchange for a 5 percent limited partnership interest. On January 1, 20X3, A makes an additional $100,000 investment in the LLC holding the wind project in exchange for an additional 5 percent limited partnership interest that was not contemplated at the time of the initial investment.

Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to use the proportional amortization method to account for its tax equity investments in this tax credit program in accordance with ASC 323-740-25-4.
Company A has not applied the practical expedient.
The $100,000 additional investment made in 20X3 resulted in a corresponding increase to the tax basis of the investment.
PTCs will be received annually for a period of 10 years on the basis of the total kilowatt-hours of energy generated by the underlying wind project each year.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A will receive cash proceeds on the basis of a fixed percentage of the project’s cash generated during the life of the project.
Company A’s statutory tax rate is 25 percent.
The estimated residual value of A’s investment is zero.
All cash flows (except the initial investment) occur at the end of each year.

See table below.

D.6.3 Practical Expedient

ASC 323-740

35-4 As a practical expedient, an investor is permitted to amortize the initial cost of the investment in proportion to only the income tax credits allocated to the investor if the investor reasonably expects that doing so would produce a measurement that is substantially similar to the measurement that would result from applying the requirement in paragraph 323-740-35-2.

Under the proportional amortization method as described in ASC 323-740, an investor amortizes the initial cost of the investment in proportion to the income tax credits and other income tax benefits received. As a practical expedient, an investor applying the proportional amortization method may choose to amortize the initial cost of the investment in proportion to only the income tax credits allocated to the investor if the investor reasonably expects that doing so would produce a measurement that is substantially similar to the measurement that would result from applying the full proportional amortization method described in ASC 323-740-35-2 (as illustrated in Example D-2).

There is no bright line test for determining whether the practical expedient can be applied. Instead, an investor will need to use significant judgment to determine whether the practical expedient would produce a measurement that is substantially similar to that of the proportional amortization method. Factors to consider include, but are not limited to, the net effect on income tax expense each period and the period over which the predominant portion of the investment would be amortized.

Substantially Similar	Not Substantially Similar
Application of the practical expedient would cause 100 percent of the investment to be amortized into the income tax line item over a period of 10 years (see Example D-4), while application of the proportional amortization method would cause 86 percent of the investment to be amortized into the income tax line item over the same 10-year period (see Example D-2). Application of the practical expedient would result in a net impact to income tax expense of $500 a year for 10 years, while application of the proportional amortization method would result in a net impact on income tax expense of $450 a year for 10 years and $33 a year for an additional 15 years.	Application of the practical expedient would cause 100 percent of the investment to be amortized into the income tax line item over a period of 10 years (see Example D-4), while application of the proportional amortization method would cause 50 percent of the investment to be amortized into the income tax line item over the same 10-year period. Application of the practical expedient would result in a net impact to income tax expense of $500 a year for 10 years, while application of the proportional amortization method would result in a net impact to income tax expense of $2,000 a year for 10 years and $(1,000) a year for an additional 15 years.

Substantially Similar

Not Substantially Similar

Application of the practical expedient would cause 100 percent of the investment to be amortized into the income tax line item over a period of 10 years (see Example D-4), while application of the proportional amortization method would cause 86 percent of the investment to be amortized into the income tax line item over the same 10-year period (see Example D-2).
Application of the practical expedient would result in a net impact to income tax expense of $500 a year for 10 years, while application of the proportional amortization method would result in a net impact on income tax expense of $450 a year for 10 years and $33 a year for an additional 15 years.

Application of the practical expedient would cause 100 percent of the investment to be amortized into the income tax line item over a period of 10 years (see Example D-4), while application of the proportional amortization method would cause 50 percent of the investment to be amortized into the income tax line item over the same 10-year period.
Application of the practical expedient would result in a net impact to income tax expense of $500 a year for 10 years, while application of the proportional amortization method would result in a net impact to income tax expense of $2,000 a year for 10 years and $(1,000) a year for an additional 15 years.

Below are examples of the application of the practical expedient.

Example D-4

On January 1, 20X1, Company A makes a $200,000 tax equity investment4 in an LLC holding a wind project in exchange for a 5 percent limited partnership interest. Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to use the proportional amortization method to account for its tax equity investments in this tax credit program in accordance with ASC 323-740-25-4.
Company A qualifies for, and elects to use, the practical expedient.
PTCs will be received annually for a period of 10 years on the basis of the total kilowatt-hours of energy generated by the underlying wind project each year.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A will receive cash proceeds on the basis of a fixed percentage of the project’s cash generated during the life of the project.
Company A’s statutory tax rate is 25 percent.
The estimated residual value of A’s investment is zero.
All cash flows (except the initial investment) occur at the end of each year.

See table below.

Example D-5

On January 1, 20X1, Company A makes a $200,000 tax equity investment5 in an LLC holding a wind project in exchange for a 5 percent limited partnership interest. On January 1, 20X3, A makes an additional $100,000 investment in the LLC holding the wind project in exchange for an additional 5 percent limited partnership interest that was not contemplated at the time of the initial investment.

Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to use the proportional amortization method to account for its tax equity investments in this tax credit program in accordance with ASC 323-740-25-4.
Company A qualifies for, and elects to use, the practical expedient.
The $100,000 additional investment made in 20X3 resulted in a corresponding increase to the tax basis of the investment.
PTCs will be received annually for a period of 10 years on the basis of the total kilowatt-hours of energy generated by the underlying wind project each year.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A will receive cash proceeds on the basis of a fixed percentage of the project’s cash generated during the life of the project.
Company A’s statutory tax rate is 25 percent.
The estimated residual value of A’s investment is zero.
All cash flows (except the initial investment) occur at the end of each year.

See table below.

D.6.4 Reassessment

ASC 323-740

A change in the nature of the investment (for example, if the investment is no longer in a flow-through entity for tax purposes)
A change in the relationship with the underlying project that could result in the reporting entity no longer meeting the conditions in paragraphs 323-740-25-1 through 25-1B.

D.6.4.1 Changes in Circumstances After Initial Measurement

Under ASC 323-740-25-1C, an entity is required to reassess the applicability of the proportional amortization method when there is either a “change in the nature of the investment” or a “change in the relationship with the underlying [tax equity] project that could result in the [investment] no longer meeting” the scope requirements for the application of ASC 323-740. Changes that would trigger the need for reassessment include, but are not limited to, (1) the investee is no longer a pass-through entity for tax purposes, (2) the investee no longer generates income tax credits, or (3) an additional investment is made that was not contractually required or a contingent commitment that was previously determined to not be probable became probable.

However, there is an exception to this third trigger. Investments in wind projects are commonly structured so that the initial investment amount includes the majority (but not all) of the total investment expected to be received. Each year after the initial investment, each investor is required to make a small additional investment (a “pay-go” payment), which is calculated on the basis of the actual amount of PTCs generated by the wind project. Because these pay-go amounts are calculated on the basis of PTCs generated, they could be viewed as contingent and not probable as of the date of the initial investment. We believe that these regular pay-go payments would not constitute a change in the nature of the investment or a change in the relationship with the underlying project and, therefore, do not trigger the need for reassessment of the applicability of the proportional amortization method.

D.6.4.2 Changes in Laws or Rates

Questions have arisen regarding whether an entity needs to reevaluate whether a tax equity project yields an overall benefit (the criterion in ASC 323-740-25-1(b)) when a change in tax law is enacted. To determine whether a change in tax law represents a change in the nature of the investment or in the relationship with the investee, either of which would require reassessment of the applicability of ASC 323-740, investors should evaluate the specific impact of the change in tax law. Such an assessment requires significant professional judgment.

Although a change in tax rate may affect whether the criteria in ASC 323-740-25-1 are met after the initial investment, we do not believe that a change in tax rate represents either a change in the nature of the investment or a change in the relationship with the investee as those terms are contemplated in ASC 323-740-25-1C. Therefore, an entity is not required to reassess whether it is still appropriate to apply the proportional amortization method solely because of the change in tax rates.

We believe that, alternatively, if the change in the tax law has a broader impact that affects more than just the tax rate, an entity should assess the nature of the change to determine whether it represents either a change in the nature of the investment or a change in the relationship with the investee. Examples of changes in tax laws that would generally trigger the need to reassess the applicability of the proportional amortization method include:

Changing a credit from nontransferable or nonrefundable to transferrable or refundable.
Changing how a credit is generated (e.g., a change in the criteria that need to be met for a tax equity project to generate credits).
Changing the rate at which the credits are generated (e.g., a change in the LIHTC rate from 9 percent each period to 5 percent each period).

If the total expected tax benefit changes because of a change in tax rates and the investment continues to be accounted for under the proportional amortization method, an investor must revise the amortization of the investment to ensure that cumulative amortization over the life of the investment equals the initial carrying amount (less any residual value). If the change in total expected income tax benefits is the result of a change in tax rates and the investor has not elected to use the practical expedient, the proportion of benefits already allocated to the investor will increase in relation to the total expected income tax credits and other income tax benefits. As a result, we believe that there are two acceptable approaches for adjusting amortization.

Under the first approach, the investor would record a cumulative catch-up adjustment to the carrying amount of the investment on the basis of the amount of income tax credits and other income tax benefits that have been allocated to the investor in proportion to the revised amount of total expected income tax benefits. This approach is consistent with the guidance in ASC 323-740, which requires that the initial cost of the investment be amortized in proportion to the income tax credits and other income tax benefits that have been allocated to the investor.

Under the second approach, the investor would adjust amortization prospectively. This treatment is consistent with accounting for a change in estimate that does not affect the carrying amount of an asset or liability but alters the subsequent accounting for existing or future assets or liabilities under ASC 250. See Example D-6 for an illustration of the prospective adjustment to the proportional amortization calculation in response to a change in tax rate.

In selecting an approach to adjust amortization, an investor should consider whether it has, in effect, made a policy election in prior periods when adjusting amortization to take into account changes in expected income tax benefits that are due to factors other than changes in tax rates. If so, using a different approach to account for the change in tax rate would be a change in accounting principle that would need to be assessed for preferability.

If a significant portion of an investor’s yield is tied to income tax benefits, as is expected with tax equity investments, the investor may need to test its investment for impairment when there is a change in estimate or a change in tax law. More specifically, to evaluate whether it is more likely than not that the carrying amount of the tax equity investment will not be realized, the investor would need to compare (1) the carrying amount of the investment, after any cumulative catch-up is considered, with (2) the undiscounted amount of the remaining expected income tax credits and other income tax benefits.

D.6.4.3 Changes in Estimates After Initial Recognition

The accounting for a change in estimate is based on the cause of the change. Generally, changes in the amount or timing of anticipated income tax benefits to be generated by a tax equity investment, or the residual value of a tax equity investment, are accounted for prospectively and typically would not be considered a change in circumstances that would trigger the need to reassess the applicability of the proportional amortization method. Investors should carefully consider whether adjustments made to the proportional amortization calculation are the result of a change in estimate or the correction of an error.

D.6.5 Impairment Considerations

Investors are required to assess their investment for impairment if the occurrence of an event or a change in circumstances indicates that it is more likely than not that the carrying amount of the investment will not be realized. ASC 323-740-35-6 states, in part, that an “impairment loss shall be measured as the amount by which the carrying amount of an investment exceeds its fair value.”

Events or changes in circumstances that may indicate that a tax equity investment is impaired include, but are not limited to, (1) changes in income tax rates, (2) material changes in the residual value, and (3) changes in the income tax credits and other income tax benefits to be generated by the investment. See Section D.6.4 for additional guidance on the potential need to reassess whether a tax equity investment qualifies for ASC 323-740 when these changes occur.

We believe that, in a manner consistent with the requirements of ASC 360 for long-lived assets, an investor should use undiscounted amounts when determining whether an impairment of a tax equity investment is necessary. However, on the basis of the guidance in ASC 323-740-35-6, we believe that impairment should be calculated by using discounted amounts since that is what would be required in a fair value measurement of the investment.

D.6.5.1 Presentation of Impairment Expense

ASC 323-740 does not specify where in the income statement an impairment charge related to a tax equity investment should be recorded. Under the proportional amortization method, the amortization of the cost of the investment is netted against the income tax benefits received within the income tax expense line. An impairment is a recognition of the fact that the unamortized cost of acquiring the benefits exceeds the remaining expected benefits, but it does not change the nature of the initial investment as an investment in income tax credits and other income tax benefits. Accordingly, we believe that the impairment of an investment accounted for by using the proportional amortization method would be recorded as a component of income tax expense.

Since tax equity investments are usually recovered through income tax credits and other income tax benefits, the impairment assessment of such investments often focuses on these benefits. However, secondary markets for such investments exist and, therefore, recovery may occur through sale. When developing the guidance in ASU 2023-02, the EITF was cognizant of the various methods of recovery and referred to “fair value” in the guidance.

The example below illustrates a possible impairment assessment, including the undiscounted cash flow assessment, for a tax equity investment accounted for in accordance with ASC 323-740.

Example D-6
On January 1, 20X1, Company A makes a $200,000 tax equity investment6 in an LLC holding a wind project in exchange for a 5 percent limited partnership interest. Further assume that: Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to use the proportional amortization method to account for its tax equity investments in this tax credit program in accordance with ASC 323-740-25-4. Company A has not applied the practical expedient. PTCs will be received annually for a period of 10 years on the basis of the total kilowatt-hours of energy generated by the underlying wind project each year. Book and tax depreciation are determined by using a straight-line method over 25 years. Company A’s initial statutory tax rate is 25 percent. On January 1, 20X4, a new tax law was passed that reduced A’s statutory tax rate to 12 percent. The estimated residual value of A’s investment is zero. All cash flows (except the initial investment) occur at the end of each year. See table below. Because of the new tax law enacted in 20X4 that decreased A’s statutory tax rate from 25 percent to 12 percent, the total benefits expected to be generated by the tax equity investee decreased. As a result, on January 1, 20X4 (the date the new tax law was enacted), the total undiscounted cash flows (i.e., the sum of anticipated income tax credits, other income tax benefits, plus non-income tax benefits) was less than the investment balance. Accordingly, A recorded an impairment of $8,505, which was the difference between the investment balance on January 1, 20X4, and the expected future benefits after adjusting for the change in tax rates. Note that as discussed in Section D.6.4.2, there are two acceptable approaches for adjusting the amortization calculation in response to a change in tax rates. This example illustrates the prospective adjustment approach.

Example D-6

On January 1, 20X1, Company A makes a $200,000 tax equity investment6 in an LLC holding a wind project in exchange for a 5 percent limited partnership interest. Further assume that:

Company A determines that its investment has met the scope criteria in ASC 323-740 and elects to use the proportional amortization method to account for its tax equity investments in this tax credit program in accordance with ASC 323-740-25-4.
Company A has not applied the practical expedient.
PTCs will be received annually for a period of 10 years on the basis of the total kilowatt-hours of energy generated by the underlying wind project each year.
Book and tax depreciation are determined by using a straight-line method over 25 years.
Company A’s initial statutory tax rate is 25 percent.
On January 1, 20X4, a new tax law was passed that reduced A’s statutory tax rate to 12 percent.
The estimated residual value of A’s investment is zero.
All cash flows (except the initial investment) occur at the end of each year.

See table below.

Because of the new tax law enacted in 20X4 that decreased A’s statutory tax rate from 25 percent to 12 percent, the total benefits expected to be generated by the tax equity investee decreased. As a result, on January 1, 20X4 (the date the new tax law was enacted), the total undiscounted cash flows (i.e., the sum of anticipated income tax credits, other income tax benefits, plus non-income tax benefits) was less than the investment balance. Accordingly, A recorded an impairment of $8,505, which was the difference between the investment balance on January 1, 20X4, and the expected future benefits after adjusting for the change in tax rates.

Note that as discussed in Section D.6.4.2, there are two acceptable approaches for adjusting the amortization calculation in response to a change in tax rates. This example illustrates the prospective adjustment approach.

Footnotes

For simplicity, assume that the investment balance does not reflect any deferred equity contributions.

See footnote 2.

D.7 Presentation and Disclosure

D.7.1 Presentation

ASC 323-740

45-2 Under the proportional amortization method, the amortization of the investment in the limited liability entity is recognized in the income statement as a component of income tax expense (or benefit). The current tax expense (or benefit) shall be accounted for pursuant to the general requirements of Topic 740.

ASC 323-740 requires the amortization of investments accounted for under the proportional amortization method to be recognized as a component of income tax expense (benefit). However, it does not address the balance sheet presentation of such investments. EITF Issue 13-B, which resulted in the issuance of ASU 2014-01, stated that QAHP “investments do not have the characteristics of deferred tax assets and [that the EITF] agrees with the stakeholders that deferred tax asset classification could have significant and adverse consequences for both financial reporting and regulatory capital purposes.” It further noted:

The FASB staff does not believe that the Task Force needs to prescribe a balance sheet classification for the purpose of achieving symmetry with the income statement classification. The FASB staff believes that the presentation of those tax credit investments as investments is reasonable and appropriate but, because reporting entities often include such investments in other asset captions, the staff recommends not prescribing a specific balance sheet presentation.

As a result, in deliberating ASU 2014-01 and ASU 2023-02, the EITF did not prescribe specific balance sheet presentation for investments accounted for by using the proportional amortization method. On the basis of this lack of guidance, there is diversity in practice in the balance sheet presentation of these investments. While such an investment should not be presented as a DTA, it may be appropriate to present it as an investment asset or as a component of other assets.

D.7.2 Disclosure

ASC 323-740

50-1 A reporting entity shall disclose information in annual and interim periods that enables users of its financial statements to understand the following information about its investments that generate income tax credits and other income tax benefits from a tax credit program for which it has elected on a tax-credit-program-by-tax-credit-program basis to apply the proportional amortization method, including investments within that elected tax credit program that do not meet the conditions in paragraph 323-740-25-1:

The nature of its investments
The effect of the recognition and measurement of its investments and the related income tax credits and other income tax benefits on its financial position and results of operations.

50-1A To meet the objectives in paragraph 323-740-50-1, a reporting entity shall disclose the following information about its investments that generate income tax credits and other income tax benefits from a tax credit program for which it has elected on a tax-credit-program-by-tax-credit-program basis to apply the proportional amortization method, including investments within that elected tax credit program that do not meet the conditions in paragraph 323-740-25-1:

The amount of income tax credits and other income tax benefits recognized during the period, including the line item in the statement of operations and statement of cash flows in which it has been recognized
The amount of investments and the line item in which the investments are recognized in the statement of financial position
For investments accounted for using the proportional amortization method, the amount of investment amortization recognized as a component of income tax expense (benefit)
For investments accounted for using the proportional amortization method, the amount of non-income-tax-related activity and other returns received that is recognized outside of income tax expense (benefit) and the line item in the statement of operations and statement of cash flows in which it has been recognized
For investments accounted for using the proportional amortization method, significant modifications or events that resulted in a change in the nature of the investment or a change in the relationship with the underlying project.

50-2 To meet the objectives in paragraph 323-740-50-1, a reporting entity may consider disclosing the following about its investments that generate income tax credits and other income tax benefits from a tax credit program for which it has elected on a tax-credit-program-by-tax-credit-program basis to apply the proportional amortization method, including investments within that elected tax credit program that do not meet the conditions in paragraph 323-740-25-1:

Subparagraph superseded by Accounting Standards Update No. 2023-02.
Subparagraph superseded by Accounting Standards Update No. 2023-02.
Subparagraph superseded by Accounting Standards Update No. 2023-02.
For investments accounted for using the equity method, the amount of investment income or loss included in pretax income
Any commitments or contingent commitments (for example, guarantees or commitments to provide additional capital contributions), including the amount of delayed equity contributions and the year or years in which contingent commitments are expected to be paid
The amount and nature of impairment losses during the year resulting from the forfeiture or ineligibility of income tax credits or other circumstances. For example, in a qualified affordable housing project investment, those impairment losses may be based on actual property-level foreclosures, loss of qualification due to occupancy levels, compliance issues with tax code provisions, or other issues.

If an investor has a tax equity investment accounted for by using the proportional amortization method, certain additional disclosures may be necessary owing to the unique nature of the investment. ASC 323-740-50-1 addresses the overall disclosure objectives for investments in tax equity structures, which include (1) the nature of the tax equity investment and (2) the effect of the investment on the investor’s financial position and results of operations. ASC 323-740-50-1A specifies the information that entities must disclose to meet the objectives outlined in ASC 323-740-50-1. By contrast, ASC 323-740-50-2 provides example disclosures that can be made to meet the objectives in ASC 323-740-50-1.

Note that the guidance in ASC 323-740-50 is applicable to investments that generate income tax credits and other income tax benefits from a tax credit program to which the investor has elected to apply the proportional amortization method regardless of whether the proportional amortization method has actually been applied.

D.8 Transition

D.8.1 Transition Guidance

ASC 323-740

65-2 The following represents the transition and effective date information related to Accounting Standards Update No. 2023-02, Investments — Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method:

A public business entity shall apply the pending content that links to this paragraph for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years.
All other entities shall apply the pending content that links to this paragraph for fiscal years beginning after December 15, 2024, including interim periods within those fiscal years.
For all entities, early adoption, including adoption in an interim period, is permitted. If an entity adopts in an interim period, it shall adopt as of the beginning of the fiscal year that includes that interim period.
Except for the transition adjustment types described in (e), an entity shall apply the pending content that links to this paragraph using either a modified retrospective approach or a retrospective approach. Under both a modified retrospective approach and a retrospective approach, an entity that elects to apply the proportional amortization method shall determine as of the date that an investment was entered into, and considering the effect of any modifications, including those that may require reassessment as discussed in paragraph 323-740-25-1C, whether the investment qualifies for the proportional amortization method on the basis of the following:
1. Under a modified retrospective approach, that evaluation shall be performed for all investments that are still expected to generate either income tax credits or other income tax benefits from a tax credit program as of the date of adoption. To make that determination, the entity shall use actual income tax credits and other income tax benefits received and remaining benefits expected as of the date of adoption. A cumulative-effect adjustment shall be recognized to the opening balance of retained earnings at the beginning of the fiscal year of adoption for the difference between the previous accounting and the new method of accounting since the investment was entered into.
2. Under a retrospective approach, that evaluation shall be performed for all investments that are still expected to generate either income tax credits or other income tax benefits from a tax credit program as of the beginning of the earliest period presented. To make that determination, the entity shall use actual income tax credits and other income tax benefits received and remaining benefits expected as of the beginning of the earliest period presented. A cumulative-effect adjustment shall be recognized to the opening balance of retained earnings at the beginning of the earliest period presented for the difference between the previous accounting and the new method of accounting since the investment was entered into.
3. Under both a modified retrospective approach and a retrospective approach, an entity shall use actual equity contributions made and remaining equity contributions expected to be made as of the date at which an entity first applies the pending content that links to this paragraph in applying the guidance in paragraph 323-740-25-3.
An entity that holds investments in limited liability entities that manage or invest in qualified affordable housing projects and are flow-through entities for tax purposes that no longer are permitted to apply the cost method guidance, the impairment guidance in the equity method Example, or the delayed equity contribution guidance shall apply the pending content that links to this paragraph using the transition method elected in (d) or a prospective approach. Under a prospective approach, an adjustment as a result of applying the pending content that links to this paragraph to investments in qualified affordable housing projects held at the date of adoption shall be recognized in current-period earnings, the balance sheet, or both on the date of adoption. An entity may elect to apply its transition method in (d) or a prospective approach separately for each of the three transition adjustment types in this subparagraph. An entity shall apply a consistent transition method for each transition adjustment type.
Investments for which the proportional amortization method is used shall follow the flow-through method described in paragraph 740-10-25-46. An entity may have previously elected to apply the deferral method. That election is not applicable to investments that are accounted for using the proportional amortization method.
An entity shall provide the following transition disclosures consistent with Topic 250 on accounting changes and error corrections:
1. The nature of and reason for the change in accounting principle
2. The transition method and a description of prior-period information that has been retrospectively adjusted, if any
3. The effect of the change on income from continuing operations, net income, and any affected per-share amounts for the prior periods retrospectively adjusted
4. The cumulative effect of the change on retained earnings
5. A qualitative description of the financial statement line items affected by the change.
An entity that issues interim financial statements shall provide the disclosures in (g) in the financial statements of both the interim period of the change and the fiscal year of the change.

D.8.1.1 Effective Date

The amendments in ASU 2023-02 are required to be implemented by PBEs for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. All other entities are required to implement the amendments in ASU 2023-02 for fiscal years beginning after December 15, 2024, including interim periods within those fiscal years. For all investors, early adoption is permitted, including adoption in an interim period. If an entity adopts in an interim period, it should adopt as of the beginning of the fiscal year that includes that interim period. For example, if a calendar year-end non-PBE tax equity investor elects to adopt the amendments in ASU 2023-02 in the quarter ending on June 30, 2024, it would adopt the amendments as of January 1, 2024.

D.8.1.2 Transition Approach

Entities have the option to implement the amendments in ASU 2023-02 by using either the retrospective approach or the modified retrospective approach (the general transition approach). If the retrospective approach is elected, an entity would record a cumulative-effect adjustment to the opening balance of retained earnings as of the beginning of the earliest reporting period presented. If electing the modified retrospective approach, an entity would record a cumulative-effect adjustment to the opening balance of retained earnings as of the beginning of the first reporting period in which the guidance is effective.

D.8.1.2.1 Investments Previously Accounted for Under the Proportional Amortization Method in ASC 323-740

After ASU 2023-02 is adopted, investments previously accounted for under the proportional amortization method in ASC 323-740 should continue to be accounted for under that method. We generally believe that any investments that were previously accounted for under the proportional amortization method would continue to qualify for that accounting after adoption of ASU 2023-02.

If the investor decides to change its election so that it no longer elects to apply the proportional amortization method, this would be considered a change in accounting principle, and the investor would need to apply the guidance in ASC 250-10.

D.8.1.2.2 Investments, Other Than QAHPs, Not Previously Accounted for Under the Proportional Amortization Method in ASC 323-740

Regardless of the general transition approach selected, if an entity has an investment other than a QAHP that was not previously accounted for under the proportional amortization method in accordance with ASC 323-740, it should determine whether the investment is still expected to generate either income tax credits or other income tax benefits from a tax credit program. Such a determination must be made as of either (1) the beginning of the earliest period presented if the retrospective transition approach is being applied or (2) the period of adoption if the modified retrospective transition approach is being applied.

If an entity determines that its investment other than a QAHP that was not previously accounted for under the proportional amortization method is still expected to generate income tax credits or other income tax benefits from a tax credit program, it should consider the effect of any subsequent modifications and determine, as of the date that the investment was entered into, whether the investment qualifies for the proportional amortization method (see Section D.3). This determination should incorporate actual income tax credits and other tax benefits earned to date as well as an estimate of the remaining income tax credits and other income tax benefits to be earned from the investment.

If such an investment qualifies for use of the proportional amortization method and the tax equity investor has elected to apply such method to investments that earn income tax credits through that program, the tax equity investor should account for the investment by using the proportional amortization method in accordance with the guidance in ASC 323-740, as amended by ASU 2023-02.

D.8.1.2.3 Select QAHP Not Previously Accounted for Under the Proportional Amortization Method in ASC 323-740

Before adoption of ASU 2023-02, the guidance in ASC 323-740 is applicable to all equity investments in a QAHP regardless of whether they were accounted for under the proportional amortization method. After adoption of ASU 2023-02, the guidance in ASC 323-740 is applicable only to those tax equity investments that are accounted for under the proportional amortization method (except for disclosure requirements as described in Section D.7.2). As a result, there are certain provisions in ASC 323-740 that no longer apply to QAHP investments that are not accounted for under the proportional amortization method. Therefore, the EITF determined that special transition guidance should be provided for these investments.

As described in Section D.8.1.2, the amendments in ASU 2023-02 can generally be implemented by using the retrospective or modified retrospective approach. However, ASU 2023-02 provides three exceptions from the general transition approach in which the amendments can be implemented by using the prospective approach. For investments in QAHPs that did not previously qualify for the proportional amortization method, or for which the proportional amortization method was not previously elected, the prospective transition method can be used to account for the following:

Transitioning from the cost method to another acceptable method of accounting for QAHP investments that are not accounted for under the proportional amortization method and that do not qualify for use of the equity method of accounting (see Section D.8.1.2.3.1).
Transitioning from the impairment guidance for equity method investments as illustrated in the example in ASC 323-740-55-8 and 55-9 to the impairment guidance in ASC 323-107 (see Section D.8.1.2.3.2).
Transitioning from the delayed equity contribution guidance in ASC 323-740-25-3, since this guidance is no longer applicable for QAHP investments that are not accounted for under the proportional amortization method (see Section D.8.1.2.3.3).

The prospective transition approach can be elected for each of these three exceptions independently (i.e., the same transition approach does not have to be selected for each of the three provisions mentioned above). However, if the prospective approach is not elected, the investor should use the “general transition” approach described above to implement the amendments in ASU 2023-02.

D.8.1.2.3.1 Transition From Cost Method

Before the adoption of ASU 2023-02, ASC 323-740 allows entities to use the modified cost method8 for investments in QAHPs that do not qualify for or are not accounted for under the proportional amortization method and do not qualify to be accounted for as equity method investments. After the adoption of ASU 2023-02, investments may no longer be accounted for under the modified cost method and, as a result, would transition to being accounted for either (1) at fair value in accordance with ASC 321 or (2) under the measurement alternative provided by ASC 321.9 In this scenario, the entity would record, to the opening balance of retained earnings, a cumulative-effect adjustment equal to the difference between the historical carrying amount of the investment and the carrying amount of the investment after applying ASC 321 as follows, depending on the transition approach selected:

Retrospective transition approach — A cumulative-effect adjustment would be recorded as of the beginning of the earliest period presented for the difference between (1) the historical investment balance on that date and (2) what the investment balance would have been had the investment historically been accounted for in accordance with ASC 321.
Modified retrospective transition approach — A cumulative-effect adjustment would be recorded as of the beginning of the period of adoption for the difference between (1) the historical investment balance on that date and (2) what the investment balance would have been had the investment historically been accounted for in accordance with ASC 321.
Prospective transition approach — No cumulative-effect adjustment would be recorded. Instead, the investment balance would be adjusted for the difference between (1) the balance as accounted for under the cost method as of the date of adoption and (2) what the investment balance would have been had the investment historically been accounted for in accordance with ASC 321, with an offsetting adjustment recognized in current-period earnings.

ASC 321 typically requires entities to measure equity investments at fair value but permits a measurement alternative for equity investments without a readily determinable fair value. If the investor elects the measurement alternative provided in ASC 321 (in which the investment is accounted for at initial cost, less impairment) while also considering observable price changes, the investor would need to assess whether there were any impairments that would have been identified under ASC 321. This is because the investment was initially acquired and recognized by using the cost method. In addition, the investor would need to assess whether there were any observable price changes in orderly transactions for the identical or a similar investment and measure the investment at fair value as of the date that the observable transaction occurred. In effect, the investor should determine what the investment balance would have been if it had been measured in accordance with ASC 321 since the date the cost method was applied (usually inception) and then record a cumulative-effect adjustment as described above.

Note that ASC 321 was codified as a result of the issuance of ASU 2016-01. The guidance in ASU 2016-01 was effective for PBEs for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For all other entities, the guidance in ASU 2016-01 was effective for fiscal years beginning after December 15, 2018, and interim periods with fiscal years beginning after December 15, 2019. Therefore, some entities may have existing QAHP investments that were entered into before the adoption of ASU 2016-01. For such entities, we believe the tax equity investments should have been accounted for as though the modified cost method in ASC 323-740 was applied before the tax equity investor’s adoption of ASU 2016-01; therefore, the cumulative-effect adjustment recorded would incorporate some periods in which the investment was accounted for under the modified cost method and some in which ASC 321 was applied.

The timeline below illustrates various impairment considerations related to the accounting for investments during the following three periods: (A) before the adoption of ASU 2016-01, (B) after the adoption of ASU 2016-01 but before the adoption of ASU 2023-02, and (C) after the adoption of ASU 2023-02.

During period A, an entity should assess investments in QAHPs that did not qualify for (or did not elect to use) the proportional amortization method or equity method of accounting for impairment by using the modified cost method in ASC 323-740.
During period B, an entity should assess these QAHP investments by using ASC 321 (fair value or the measurement alternative).
During period C, if the measurement alternative was selected and an impairment was identified in historical periods by using the guidance outlined for periods A and B above, an entity should record the difference between that impairment and any actual historical impairment recognized as part of the cumulative-effect adjustment. The entity should assess tax equity investments accounted for by using ASC 321 for impairment on the basis of the guidance in ASC 321.

D.8.1.2.3.2 Transition From Equity Method Impairment Guidance

Before the adoption of ASU 2023-02, ASC 323-740 includes an example illustrating how a QAHP investment accounted for under the equity method should be assessed for impairment. After the adoption of ASU 2023-02, ASC 323-740 no longer includes this equity method impairment example, and it is now only applicable to investments accounted for by using the proportional amortization method. (However, note that the example that was included in ASC 323-740-55-8 and 55-9 diverged from how impairment of typical equity method investments is calculated.) After the adoption of ASU 2023-02, investors applying the equity method to account for an investment in a QAHP should apply the guidance in ASC 323-10 to determine whether the equity method investment is impaired. That is, after the adoption of ASU 2023-02, there should be no difference between how a QAHP investment accounted for under the equity method should be assessed for impairment and how other equity method investments accounted for in accordance with ASC 323-10 are assessed.

Regardless of the transition approach elected, we believe that the tax equity investor should assess, on the basis of the guidance in ASC 323-10, whether there were any impairments since the initial recognition of the QAHP investment. If an impairment is identified on the basis of the guidance in ASC 323-10 or an impairment was previously recognized on the basis of the superseded guidance in ASC 323-740, an entity should do the following, depending on the transition approach elected:

Retrospective transition approach — A cumulative-effect adjustment should be recorded as of the beginning of the earliest period presented to (1) give effect to the impairment being recognized in accordance with ASC 323-10 and (2) reverse the impact of any impairment that was recognized in accordance with the example in ASC 323-740.
Modified retrospective transition approach — A cumulative-effect adjustment should be recorded as of the beginning of the period of adoption to (1) give effect to the impairment being recognized in accordance with ASC 323-10 and (2) reverse the impact of any impairment that was recognized in accordance with the example in ASC 323-740.
Prospective transition approach — No cumulative-effect adjustment should be recorded. Instead, the impact of recognizing the impairment in accordance with ASC 323-10 and reversing the impairment (if any) that was previously recognized by using the example in ASC 323-740 should be recorded in the period of adoption as an adjustment to the investment balance, with an offsetting impairment charge recognized in current-period earnings.

D.8.1.2.3.3 Transition From Delayed Equity Contribution Guidance

Before the adoption of ASU 2023-02, ASC 323-740 includes guidance that requires investors in QAHPs to gross-up their investment balance for the amount of any unconditional and legally binding future contributions to be made, as well as future contributions that are contingent on a future event that is determined to be probable. An offsetting liability would then be recorded for the amount of the future contributions included in the investment balance. While that guidance continues to exist in ASC 323-740-25-3 after the adoption of ASU 2023-02, because the scope of investments subject to ASC 323-740 has changed, it should no longer be applied to investments for which the proportional amortization method is not applied. If an investor has QAHP investments accounted for in accordance with the cost method, ASC 321, or the equity method that have been grossed up for delayed equity contributions, this transition guidance would apply upon adoption of ASU 2023-02 as follows, depending on the transition approach elected:

Retrospective transition approach — The investment balance and offsetting liability for the delayed equity contribution would be netted down as of the beginning of the earliest period presented. Said differently, the balance sheet would no longer reflect the increased investment balance or corresponding liability for the portion of the tax equity investment not yet funded.
Modified retrospective and prospective transition approaches — The investment balance and offsetting liability for the delayed equity contribution should be netted down as of the beginning of the period of adoption. Because there should be no difference between the amount of the investment balance and the liability being netted down, there is no cumulative effect adjustment or income statement impact, and these two transition approaches are effectively the same.

We believe that if an entity elects the retrospective or modified retrospective transition approach, a tax equity investment that was previously impaired but for which a delayed equity contribution has been recorded should be reassessed for impairment under the applicable accounting framework. If the reduction of the investment balance that results from applying this transition guidance would cause an impairment to no longer be identified, the reversal or adjustment of that impairment should be recognized as part of the cumulative-effect adjustment.

D.8.1.3 Transition Illustrative Example — ASC 323 to Proportional Amortization

Example D-7

On June 30, 2022, Investor A made an initial investment in Facility W, which generates income tax credits through onshore wind production, and has historically accounted for this investment as an equity method investment. Because A is a PBE, it is required to adopt ASU 2023-02 for its fiscal year beginning January 1, 2024.

On January 1, 2024, A adopts ASU 2023-02 by using the modified retrospective transition approach and elects to apply the proportional amortization method for qualifying tax equity investments that generate income tax credits through onshore wind production. Investor A determines that (1) as of the date of adoption, the investment is still expected to generate either income tax credits or other income tax benefits from a tax credit program and (2) as of the investment date (June 30, 2022), the investment still qualifies for use of the proportional amortization method and is eligible for such accounting under ASC 323-740-25-1.

On the basis of the assessment of these two factors, A determines that its investment in W meets the new requirements to be accounted for under the proportional amortization method and calculates the cumulative-effect adjustment to the opening balance of retained earnings as follows:

The subsequent accounting for A’s investment in W will be no different from the subsequent accounting for an investment accounted for by using the proportional amortization method since inception. The amortization of the investment in W recognized each period will be based on the proportional amortization calculation used to determine the initial cumulative-effect adjustment.10

D.8.2 Summary of Differences in ASC 323-740 Before and After the Implementation of ASU 2023-02

ASC 323-740 (Before Implementing ASU 2023-02)	ASC 323-740 (After Implementing ASU 2023-02)
Scope
The guidance applies to qualified11 investments in limited liability entities that manage or invest in QAHPs and are flow-through entities for tax purposes. See Section C.1.	The guidance applies to qualified12 investments in limited liability entities that are made primarily for receiving income tax credits and other income tax benefits and are flow-through entities for tax purposes. It is no longer limited to investments in QAHPs. See Section D.1.
If the proportional amortization method is elected, it must be applied to all investments that qualify for the proportional amortization method. See Section C.1.	The proportional amortization method is elected on a tax-credit-program by tax-credit-program basis. It is not required to be applied to all investments that qualify for the proportional amortization method. See Section D.1.
The scope criterion in ASC 323-740-25-1(aaa), which requires substantially all projected benefits from the investment to be from income tax credits or other tax benefits, does not specify how refundable income tax credits should be considered in this assessment. See Section C.3.1.	The scope criterion in ASC 323-740-25-1(aaa), which requires substantially all projected benefits from the investment to be from income tax credits or other income tax benefits, clarifies that in the evaluation of this condition, income tax credits accounted for outside of the scope of ASC 740 (e.g., refundable income tax credits) should be included in total projected benefits but not in income tax credits and other income tax benefits. See Section D.3.
The scope criterion in ASC 323-740-25-1(aaa), which requires substantially all projected benefits from the investment to be from income tax credits or other income tax benefits, does not specify whether this should be assessed on a discounted basis. There is significant diversity in practice in how this assessment is performed.	The scope criterion in ASC 323-740-25-1(aaa), which requires substantially all projected benefits from the investment to be from income tax credits or other income tax benefits, clarifies that this condition should be determined on a discounted basis by using a discount rate that is consistent with the cash flow assumptions used by the investor when determining whether it would invest in the underlying project. See Section D.3.
If Proportional Amortization Is Not Elected or Does Not Apply
Investments that do not qualify to be accounted for in accordance with the proportional amortization method (ASC 323-740) or the equity method (ASC 323) can be accounted for in accordance with either the modified cost method as illustrated in ASC 323-740-55 or in accordance with ASC 321. See Section C.7.	Investments that do not qualify to be accounted for in accordance with the proportional amortization method (ASC 323-740) or the equity method (ASC 323) should be accounted for in accordance with ASC 321. The cost method that was illustrated in an example in ASC 323-740 is no longer an acceptable option. See Section D.1.
Specific illustrative guidance is available addressing how investments in QAHPs that are accounted for in accordance with the equity method can be assessed for impairment. See Section C.6.5.2.	There is no unique guidance on how to assess tax equity investments accounted for by using the equity method for impairment. Instead, investors should refer to the guidance in ASC 323-10 or ASC 323-30, depending on the scope of the guidance applicable to that investment. See Section D.6.5.
Specific guidance for QAHPs not accounted for by using the proportional amortization method allows investors to gross up their initial investment balance for the amount of any unconditional and legally binding future contributions to be made, as well as future contributions that are contingent on a future event that is determined to be probable. An offsetting liability is then recorded for the amount of the future contributions included in the investment balance. See Section C.5.1.	While similar guidance continues to exist in ASC 323-740-25-3 that allows investors to gross up their initial investment balance, such guidance should no longer be applied to investments that do not apply the proportional amortization method. See Section D.8.1.2.3.3.

Footnotes

See the guidance in AC 323-10-35-31 through 35-32A.

Note that the cost method previously referenced in ASC 323-740 was a modified form of the cost method previously codified in ASC 325-20. See Section C.6 for more information.

The measurement alternative provided in ASC 321 allows an equity security without a readily determinable fair value to be subsequently measured at cost, less impairment, factoring in observable price changes (see ASC 321-10-35-2).

To determine this amount, the investor needs to create a proportional amortization calculation as if the investment were accounted for by using the proportional amortization method since June 30, 2022, the date of the initial investment. This amount would equal the investment balance as of January 1, 2024.

To qualify for the proportional amortization method, investments would need to meet the criteria outlined in ASC 323-740-25-1, as discussed in more detail in Sections D.3 and D.4.

See footnote 11.

Appendix E — Titles of Standards and Other Literature

Appendix F — Abbreviations

Abbreviation	Description
AcSEC	Accounting Standards Executive Committee
AFS	available for sale
AICPA	American Institute of Certified Public Accountants
AOCI	accumulated other comprehensive income
APB	Accounting Principles Board
APIC	additional paid-in capital
ASC	FASB Accounting Standards Codification
ASU	FASB Accounting Standards Update
CECL	current expected credit loss
CEO	chief executive officer
CFO	chief financial officer
CFR	U.S. Code of Federal Regulations
COO	chief operating officer
CTA	cumulative translation adjustment
DRO	deficit restoration obligation
DTA	deferred tax asset
DTL	deferred tax liability
EITF	FASB Emerging Issues Task Force
EPS	earnings per share
FASB	Financial Accounting Standards Board
FVTPL	fair value through profit or loss
GAAP	generally accepted accounting principles
GP	general partner
HLBV	hypothetical liquidation at book value
IAS	International Accounting Standard
IASB	International Accounting Standards Board
IFRS	International Financial Reporting Standard
IP	intellectual property
IPR&D	in-process research and development
IRC	Internal Revenue Code
IRR	internal rate of return
ITC	investment tax credit
LLC	limited liability company
LLP	limited liability partnership
LOC	line of credit
NFP	not-for-profit entity
NMTC	New Markets Tax Credit (program)
OCA	SEC’s Office of the Chief Accountant
OCI	other comprehensive income
OTTI	other-than-temporary impairment
PBE	public business entity
PCAOB	Public Company Accounting Oversight Board
PCC	Private Company Council
PP&E	property, plant, and equipment
PTC	production tax credit
QAHP	qualified affordable housing project
REIT	real estate investment trust
SAB	SEC Staff Accounting Bulletin
SEC	U.S. Securities and Exchange Commission
SOP	Statement of Position
VIE	variable interest entity

Appendix G — Roadmap Updates for 2023

The tables below summarize the substantive changes made in the 2023 edition of this Roadmap.

New Content

Section	Title	Description
5.1.1.1	Impact of Accretion of Temporary Equity	Added a new section on the impact of the accretion of temporary equity to the recognition of equity method earnings.
5.1.7.3	Earnings or Losses of a Consolidated Subsidiary’s Investee	Added a new section, including new Example 5-20, on the accounting for investments held by one or more consolidated subsidiaries.
5.6.7	Decrease in Level of Ownership Interest Results in Loss of Control Over the Investee (Consolidation to Equity Method)	Added a new section discussing the accounting for a decrease in the level of ownership interest resulting in a loss of control over the investee.
5.6.8.1	Other Considerations — Dissolution	Added a new section on the accounting by an investor upon a dissolution of the investee.
5.6.8.2	Other Considerations — Spin-Off Transactions	Added a new section discussing the investor’s accounting for an investee spin-off transaction.
5.6.8.3	Other Considerations — Common-Control Contributions	Added a new section on the accounting by a third-party investor when there is a common-control transaction between the investee and its parent or an associate in exchange for additional shares.
5.9	Investor’s Recognition of ITCs Generated by an Investee	Added a new section to provide reference to Section 12.3.4 of Deloitte’s Roadmap Income Taxes for guidance on how an investor accounting for its investment in a pass-through entity under the equity method should account for the tax benefits received in the form of ITCs.
Chapter 9	Accounting by the Joint Venture After Adopting ASU 2023-05	Added a new chapter on the accounting by joint ventures after the adoption of ASU 2023-05. Chapter 9 in the 2022 version (“Accounting by the Venturer”) was moved to Chapter 10.
Appendix C	ASC 323-740 Before the Adoption of ASU 2023-02	Added a new appendix discussing how to account for LIHTC investments in accordance with ASC 323-740 before the adoption of ASC 2023-02.
Appendix D	ASC 323-740 After the Adoption of ASU 2023-02	Added a new appendix discussing how to account for tax equity investments in accordance with ASC 323-740 after the adoption of ASC 2023-02.

Amended or Deleted Content

Section	Title	Description
Chapter 1	Overview	Added a table highlighting the different accounting models that can be relevant to equity investments.
3.4.2	Investment in an Entity That Invests in QAHPs	Deleted the discussion on accounting for a QAHP. Content pertaining to the application of the proportional amortization method has been included in new Appendixes C and D.
4.3.4	Contribution of Nonfinancial Assets or In-Substance Nonfinancial Assets That Do Not Constitute a Business or Nonprofit Activity	Added Example 4-5 to address the accounting for a contribution to an equity method investment upon formation. Renumbered all subsequent examples in Chapter 4.
4.5	Basis Differences	Updated to include additional discussion related to accounting for intangible assets as part of the initial measurement of an equity method investment.
5.1.2	Disproportionate Allocation of an Investee’s Earnings or Losses in Relation to an Investor’s Ownership Interest	Updated discussion of the selection of an allocation method when there is significant risk that an allocation will be unwound in subsequent periods.
5.1.3.3	Investee Applies Different Accounting Policies Under U.S. GAAP	Updated discussion of the impact of an equity method investee applying different accounting policies than the investor. Specifically addressed the situation in which an investor and an equity method investee enter into a sales contract that the investor determines is a derivative, and the investor applies the normal purchases and normal sales scope exception and the equity method investee does not.
5.1.3.4	Investee Adopts a New Accounting Standard on a Different Date	Added discussion of the impact of an equity method investee’s adoption of a new accounting standard before an investor. Removed Example 5-7, which addressed specific transition considerations for an equity method investee’s adoption of ASC 842 and ASC 606. Renumbered Examples 5-8 through 5-20.
5.1.4	Accounting for an Investor’s Share of Earnings on a Time Lag	Updated to discuss the requirements in situations in which (1) an investor that did not previously account for an equity method investee on a lag determines that it should be reporting equity method earnings on a lag or (2) an investor accounts for an equity method investment on a lag but wants to extend the length of the lag period.
5.1.5.1	Intra-Entity Profits and Losses	Added discussion of the inconsistency in the elimination of intra-entity profits recognized under ASC 610-20 compared with the treatment of intra-entity revenue in the scope of ASC 606. Also added discussion of factors to consider in the determination of whether intra-entity transactions are at arm’s length.
5.1.5.2	Amortization or Accretion of Basis Differences	Updated to discuss the impact of equity method basis differences on the calculation of gain or loss recognized when an equity method investment is disposed of.
5.2	Equity Method Losses That Exceed the Investor’s Equity Method Investment Carrying Amount	Added discussion of the accounting when an imminent return to profitability was initially assured but subsequently is no longer assured.
5.2.2	Collateral of the Investee Held by the Investor When Equity Losses Exceed the Investor’s Investment	Added discussion of the accounting when the investee extinguishes or settles the loan guaranteed by the investor.
5.5.5	Qualified Affordable Housing Project Investments	Deleted the discussion on accounting for a QAHP. Content pertaining to the application of the proportional amortization method has been included in new Appendixes C and D.
5.6.1	Increase in Level of Ownership or Degree of Influence — Control Initially Obtained (From Equity Method to Consolidation Accounting)	Added discussion of the accounting considerations when the investee and investors are not under common control and the investee is a business as defined in ASC 805-10 or a VIE as defined in ASC 810-10 or is an asset acquisition. Also updated to discuss the accounting considerations when the investor and investee are under common control.
5.6.2	Increase in Level of Ownership or Degree of Influence — Significant Influence Initially Obtained (ASC 321 to Equity Method)	Added discussion of the requirement to remeasure equity investments under ASC 321 before the application of ASC 323.
7.2.7	Reassessment of the Joint Venture Determination	Added a Changing Lanes discussing the issuance of ASU 2023-05.
Chapter 8	Accounting by the Joint Venture Before Adopting ASU 2023-05	Revised content to reflect the options for a joint venture accounting for its net assets at formation (i.e., the carry-over approach or early adoption of ASU 2023-05).

	Andrew Winters Audit & Assurance Partner Deloitte & Touche LLP +1 203 761 3355 anwinters@deloitte.com		Derek Bradfield Audit & Assurance Partner Deloitte & Touche LLP +1 303 305 3878 dbradfield@deloitte.com
	Ashley Carpenter Audit & Assurance Partner Deloitte & Touche LLP +1 203 761 3197 ascarpenter@deloitte.com		Brandon Coleman Audit & Assurance Partner Deloitte & Touche LLP +1 312 486 0259 brcoleman@deloitte.com
	Christopher Cryderman Audit & Assurance Partner Deloitte & Touche LLP +1 212 313 2652 chcryderman@deloitte.com		Marla Lewis Audit & Assurance Partner Deloitte & Touche LLP +1 203 708 4245 marlalewis@deloitte.com
	Sean May Audit & Assurance Partner Deloitte & Touche LLP +1 415 783 6930 semay@deloitte.com		Morgan Miles Audit & Assurance Partner Deloitte & Touche LLP +1 617 585 4832 momiles@deloitte.com
	Andrew Pidgeon Audit & Assurance Partner Deloitte & Touche LLP +1 415 783 6426 apidgeon@deloitte.com		Shekhar Sanwaria Audit & Assurance Managing Director Deloitte & Touche Assurance & Enterprise Risk Services India Private Limited +1 404 487 7526 ssanwaria@deloitte.com
	James Webb Audit & Assurance Partner Deloitte & Touche LLP +1 415 783 4586 jwebb@deloitte.com		John Wilde Audit & Assurance Partner Deloitte & Touche LLP +1 415 783 6613 johnwilde@deloitte.com

Internal legal costs for preparation of the investment acquisition agreement	$ 2,000
Broker fee for identifying the acquisition opportunity	10,000
Fee paid to external valuation specialist to determine the fair value of the investment	10,000
Employee travel costs directly related to the acquisition	1,000

Deloitte's Roadmap: Equity Method Investments and Joint Ventures

7.2.6.1.3.1.1 VIE Model

7.2.6.1.3.1.2 Voting Model

7.2.6.1.3.2.1 VIE Model

7.2.6.1.3.2.2 Voting Model