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5.2 Determining applicable change in interest guidance
Publication date: 30 Nov 2020
us PwC Equity method of accounting guide 5.2
A change in the investor’s ownership interest can arise from transactions entered into by the investor, the investee, or some combination thereof. Additionally, even where the investor does not obtain or dispose of an interest in the investee, a change in the level of influence or control can cause an investor to revisit how it accounts for its investment.
How an investor should account for a change in an ownership interest is dependent upon how the investment was accounted for prior to the change in interest, and what the appropriate accounting will be after the change.
5.2.1 Increase in ownership or influence in an investee
The ownership interest of an investor may increase when it purchases additional shares from a third party, or as a result of capital transactions undertaken by an investee. Additionally, an investor may gain significant influence or control of an investee, such as when there is an amendment to the agreements governing the arrangement. Figure EM 5-1 outlines the possible scenarios that can occur when the proportional ownership interest of an investor increases, or the investor gains significant influence or control.
Figure EM 5-1
Accounting for an increase in ownership or influence in an investee
Accounting for an increase in ownership or influence in an investee
Change in interest
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Impact to investor
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Discussed in
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Assuming fair value option not elected:
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Recognize cost for incremental investment (cost accumulation), determine basis differences arising on acquisition of new “step” interest using fair values of underlying investee assets and liabilities on the acquisition date.
Prospectively recognize investor’s share of equity investee’s earnings based on new ownership interest, adjusted for the effects of new and previous basis differences, and other items.
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Remeasure the previously-held equity method investment (and any other previously-held interests) at fair value and recognize any difference to the carrying amount in net income.
Recognize 100% of identifiable assets and liabilities, including the:
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5.2.2 Decrease in ownership or influence in an investee
The ownership interest of an investor may decrease when it sells shares to a third party, or as a result of capital transactions undertaken by an investee. Additionally, an investor may lose significant influence or control of an investee as a result of changes to the arrangement. Figure EM 5-2 outlines each of the possible scenarios that can occur when the ownership interest of an investor decreases, or the investor loses significant influence or control.
Figure EM 5-2
Accounting for a decrease in ownership or influence in an investee
Accounting for a decrease in ownership or influence in an investee
Change in interest
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Impact to investor
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Discussed in
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Deconsolidate investment and remeasure retained investment (noncontrolling interest) at fair value. Gain or loss recognized in net income.
Assuming fair value option not elected:
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Recognize gain or loss for the difference between the proceeds from the sale and the investor’s carrying amount of the equity method investment.
OCI balances associated with the portion of the equity method investment that was disposed of must be recycled from OCI through net income.
Prospectively recognize investor’s share of equity investee’s earnings based on new interest, adjusted for the effects of basis differences, and other items.
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Recognize gain or loss for the difference between the proceeds from the sale and the investor’s carrying amount of the equity method investment.
OCI balances associated with the equity method investment must be recycled from OCI through net income.
The investor’s initial carrying amount of any retained common stock or in-substance common stock investment would include its proportionate share of previously recognized earnings or losses of the investee.
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Prior accounting:
Equity method (ASC 323) New accounting:
N/A. Investor disposes of entire interest |
Recognize gain or loss for the difference between the proceeds from the sale and the investor’s carrying amount of the equity method investment.
AOCI balances associated with the equity method investment must be recycled from OCI through net income.
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5.2.3 Investee treasury transactions
A change in interest can arise from an investee capital transaction, such as an issuance or purchase of shares by the investee. The issuance of additional shares by an investee results in a decrease in ownership by the investor and has the same accounting effect as a direct sale of investee shares by the investor. Conversely, a repurchase of shares by an investee results in an increase in ownership by the investor and has the same accounting effect as a direct purchase of investee shares by the investor.
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.
Accordingly, an investor should consider capital transactions of an investee that result in a change in interest in a manner similar to how the investor evaluates its own purchases and sales of the investee stock. See EM 5.2.1 and EM 5.2.2 for an outline of possible scenarios.
Stock-based compensation awarded by an investee to its own employees is addressed in EM 4.3.6. The investor recognizes its portion of the investee’s compensation expense through the investor’s recognition of its portion of the investee’s earnings. A basis difference would be created, as the investee’s net equity would not be affected as a result of the stock award (i.e., dr. compensation expense, cr. APIC). Additionally, when an employee exercises its option, the employee consideration to the investee in return for the shares would include the total compensation expense previously recognized, along with the employee exercise price, and should be accounted for following the appropriate dilution scenario as described in EM 5.2.2.
Unique investee transactions, including those with noncontrolling shareholders, those with entities under common control, and those that do not result in a change in interest are addressed in EM 5.6.
5.2.4 Noncash transactions
An investor may increase its ownership interest through the contribution of noncash assets to the investee. See EM 3.2.4 for a discussion of when noncash assets are used to acquire an investment.
Similarly, when an investor transfers all or a portion of its equity method investment, the criteria in ASC 860-10-40-5 must be met in order to qualify for derecognition of the equity method investment and recognition of the associated gain or loss. This is because equity method investments are financial assets and therefore transfers of equity method investments are within the scope of ASC 860. The criteria in ASC 860 are further explained in TS 3. If the exchange is economically a dilution event, the issuer (investee) is deemed to have effectively issued additional shares to other investors. Such an exchange is not in the scope of ASC 860 and the change in interest guidance outlined in EM 5.2.1 and EM 5.2.2 would be applicable.
5.2.5 Fair value option
ASC 825-10, Financial Instruments, allows entities to elect to account for certain financial instruments using the fair value option, as discussed in FV 5.
An entity electing to adopt the fair value option for any of its equity method investments is required to present those equity method investments at fair value at each reporting period, with changes in fair value reported in the income statement. In addition, certain disclosures are required in the investor’s financial statements when it has elected the fair value option for an investment that otherwise would be accounted for under the equity method of accounting. See FSP 20.6.3.2 for these disclosure requirements.
The election of the fair value option is irrevocable unless an event creating a new election date occurs. Therefore, absent a qualifying event, a reporting entity that elects to adopt the fair value option to account for an equity method investment is precluded from subsequently applying the equity method of accounting to that investment.
5.2.5.1 Eligibility to elect the fair value option
As described in ASC 825-10-25-4, an investor may elect to apply the fair value option when an investment becomes subject to the equity method of accounting for the first time. For example, an investment would become subject to the equity method of accounting for the first time when an investor obtains significant influence by acquiring an additional investment in an investee, or when an investor loses control of an investee but retains an interest that provides it with the ability to exercise significant influence.
Excerpt from ASC 825-10-25-4
An entity may choose to elect the fair value option for an eligible item only on the date that one of the following occurs...
d. The accounting treatment for an investment in another entity changes because the investment becomes subject to the equity method of accounting.
An investor may elect to apply the fair value option to an equity method investment irrespective of the types of assets held by the equity method investee.
An investor that elects the fair value option and subsequently loses the ability to exercise significant influence would be required to continue to account for its retained interest on a fair value basis. That is, if it were subject to ASC 321, the entity could not elect to apply the measurement alternative but must continue to account for the instrument using the fair value option. An investor is precluded from applying the fair value option for a consolidated entity.
A reporting entity can generally elect the fair value option for a single eligible investment without needing to elect the fair value option for identical types of investments in other investees. That is, an instrument-by-instrument election is allowed. However, when an investor elects to apply the fair value option for an equity method investment, it must apply the fair value option to all of its eligible interests in the same investee (e.g., all tranches of equity, debt investments, guarantees), including any previously held interest.
Although equity method investments are generally eligible to be accounted for under the fair value option, doing so would not always be appropriate. Specifically, when an equity method interest includes a significant compensatory element and the investor is not required to separately account for the compensatory element, the investor should not elect the fair value option for its equity investment. For example, an equity method investment may include terms that provide one investor with a disproportionate allocation of returns in return for providing management services to the investee. In such cases, election of the fair value option would not be appropriate, as it could accelerate revenue that should be earned when future services are provided to the investee.
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