November 2019

Affects: Entities that hold equity securities accounted for under ASC 3211 or equity method investments accounted for under ASC 323.

Background: In 2016, the FASB issued ASU 2016-01 (codified in ASC 321). ASC 321 provides a measurement alternative for certain equity securities without a readily determinable fair value. The measurement alternative allows an entity to elect to measure an equity security at its cost minus impairment and adjusted for the price within observable transactions. Upon adopting the guidance in ASU 2016-01, stakeholders identified several instances in which the interaction between ASC 321 and ASC 323 was unclear, particularly related to the application of the measurement alternative provided under ASC 321.

Stakeholders indicated that there is diversity in practice related to the interaction between ASC 321 and ASC 323 associated with an entity’s accounting for (1) its equity interest under the measurement alternative if the interest subsequently qualifies for the equity method of accounting under ASC 323 (e.g., if an additional purchase causes the investment to qualify for the equity method, whether an entity must adjust any previously held interest to the observable price before applying the equity method) and (2) its equity method investment under ASC 323 if it no longer qualifies for application of the equity method and instead applies the ASC 321 measurement alternative to its remaining equity interest (e.g., if a portion of the investment is sold, whether an entity must adjust the retained portion to the observable price).

In addition, ASC 323 provides guidance on recognizing an investor’s share of equity method losses in situations in which the investor has other investments in the investee that do not qualify for the equity method of accounting (e.g., they are accounted for under ASC 321). Stakeholders have asked the FASB to clarify the application of this guidance in circumstances in which an investor has other investments in the investee that do not qualify for the equity method of accounting and to which it applies the measurement alternative in ASC 321. Specifically, stakeholders have asked the Board to clarify the order in which to apply the guidance when, within an accounting period, there is an observable transaction that will result in an adjustment to the carrying value of the investment and allocable equity method losses.

Lastly, stakeholders have indicated that there are diverse views about whether ASC 323 or ASC 321 should be used to account for certain forward contracts and purchased options to acquire an equity instrument that do not meet the definition of a derivative under ASC 815 if an investee currently holds an investment that is accounted for under the equity method or the equity instruments that will be acquired under the forward or option will be accounted for under the equity method.

At its May 8, 2019, meeting, the FASB decided to add to the EITF’s technical agenda a project on clarifying the interaction between ASC 321 and ASC 323.

At its June 13, 2019, meeting, the Task Force reached a consensus-for-exposure on the accounting for (1) an equity security under the measurement alternative before application or after discontinuation of the equity method of accounting and (2) forward contracts and purchased options to acquire an equity instrument that will be accounted for under ASC 323.

In July 2019, the FASB issued a proposed ASU based on the consensus-for-exposure that the EITF reached at its June 2019 meeting.

The Task Force did not reach a tentative decision on how to account for equity method investee losses in circumstances in which an investor has other investments in the investee to which it applies the measurement alternative in ASC 321. The Task Force asked the FASB staff to perform additional research on this matter before it begins redeliberations.

Summary: At its November 7, 2019, meeting, the Task Force discussed the comment letters received on the proposed ASU. It reaffirmed the proposed guidance in its consensus-for-exposure and made minor revisions as necessary. Specifically, the Task Force reaffirmed the following:

• An entity that applies the ASC 321 measurement alternative should consider observable transactions that require it to either apply or discontinue applying the equity method immediately before applying or after discontinuing the application of ASC 323.
• An entity should apply ASC 321 to account for forward contracts and purchased options to acquire an equity instrument that do not meet the definition of a derivative under ASC 815. That is, these instruments would be within the scope of ASC 321 even if the underlying equity securities to be received will be accounted for under ASC 323.

The Task Force discussed how to account for equity method investee losses in circumstances in which an investor has other investments in the investee to which it applies the measurement alternative in ASC 321. It recommended that the Board and Private Company Council determine the issue’s pervasiveness and consider whether to include the issue in their respective simplification projects.

Effective Date and Transition: The Task Force reached a consensus that the effective date of the amendments resulting from this Issue will be as follows:

• Public business entities — Fiscal years beginning after December 15, 2020, and interim periods within those fiscal years beginning after December 15, 2020.
• All other entities — Fiscal years beginning after December 15, 2021, and interim periods within those fiscal years beginning after December 15, 2021.

An entity may early adopt the guidance in any annual or interim period after the final ASU is issued.

The Task Force reaffirmed its consensus-for-exposure that an entity would apply a prospective transition method. The Task Force also reaffirmed that upon transition, an entity will be required to disclose the nature of and reasons for the change in accounting principle, the transition method elected, and a qualitative description of the financial statement line items affected by the change.

Next Steps: FASB ratification is expected at the Board’s November 20, 2019, meeting, after which a final ASU will be issued.

Affects: Entities that recognize revenue from licenses of functional intellectual property with contracts that have been modified.

Background: Under ASC 606, entities that license functional intellectual property (e.g., software providers) generally recognize revenue at a point in time (provided that the conditions for such recognition have been met) instead of over the license term. The “use and benefit” guidance in ASC 606 indicates that revenue should not be recognized until the customer has a copy of the intellectual property and the license period has commenced. That guidance also requires an entity to recognize revenue for license renewals no earlier than the beginning of the renewal period. A contract modification, which is a change in price or scope, must be accounted for as a separate contract if (1) the additional goods and services are distinct and (2) an increase in the price of the contract reflects the entity’s stand-alone selling price (SSP) of those additional goods or services, adjusted to reflect the circumstances of the contract. If the contract modification does not result in a separate contract, the entity must determine whether the modification constitutes (1) the termination of the existing contract and the creation of a new contract, (2) a part of the existing contract, or (3) a combination of both.

A modification of a license of intellectual property may include an extension of the term of the original license along with other changes to the rights in the contract. Views differ on whether to apply the guidance on license renewals or the guidance on modifications when modifications of licensing arrangements include an extension to the term of the license along with other changes (e.g., those that grant or revoke additional rights).

An additional issue is emerging in the software industry related to contracts that include (or are modified to include) an option that allows the customer to convert from a license arrangement to an arrangement in which the software is hosted as a service (i.e., software as a service or SaaS). Views differ on how to account for the revocation of licensing rights and the conversion to a SaaS arrangement.

At its May 8, 2019, meeting, the FASB decided to add to the EITF’s technical agenda a project on contract modifications of licenses of intellectual property. The scope of the project includes:

• Accounting for contract modifications in which another right is added to the existing rights, and the contract term is extended.
• Accounting for situations in which licensing rights are revoked, “including conversion of term software licenses to software as a service (SaaS) arrangements.”2

At its June 13, 2019, meeting, the FASB staff held an educational session on this Issue. No formal votes were taken, and no decisions were made. In addition, the FASB staff’s industry working group met on July 16, 2019, to discuss the Issue.

Summary: At its November 7, 2019, meeting, the Task Force deliberated potential accounting alternatives for contract modifications that include both an extension of the contract term for existing rights and the addition of new rights.

Some Task Force members expressed concerns about alternatives that could override the existing contract modification guidance in ASC 606. Under that guidance, an entity determines whether a contract modification is (1) a separate contract (i.e., the additional rights are distinct and reflect the SSP) or (2) the termination of an existing contract and the creation of a new contract (i.e., the additional rights do not reflect the SSP). However, the Task Force acknowledged that under the existing model in ASC 606, an entity could achieve different economic results simply by granting additional rights at a price lower than their SSP.

The Task Force also deliberated possible accounting alternatives for the revocation of licensing rights, including the conversion of term software licenses to SaaS arrangements. Views differed on the various methods discussed, under which an entity would recognize revenue in the following ways:

• In a manner consistent with that of the sale-with-a-right-of-return model in ASC 606 — Under this method, an entity would establish an estimated reserve for returns.
• Prospectively — Under this method, an entity would recognize revenue upon transfer of control of a license of intellectual property and would not reverse revenue upon the conversion to a SaaS arrangement. It would prospectively account for any incremental revenue from the SaaS arrangement.
• Over time — Under this method, an entity would recognize revenue for the term license at each point at which the customer has the option to convert to a SaaS arrangement (e.g., daily, monthly).

The Task Force did not make any decisions on Issue 19-B and asked the FASB staff to perform additional research on the Issue. The Task Force also asked the FASB staff to develop illustrative examples that demonstrate the financial statement impact of each alternative in situations in which (1) another right is added to existing rights (and the contract term is extended) and (2) licensing rights are revoked.

Effective Date and Transition: The effective date of the amendments resulting from this Issue and transition guidance will be discussed at a future meeting.

Next Steps: At its next meeting, the Task Force is expected to redeliberate this Issue on the basis of the FASB staff’s additional research.