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5.4 Decrease in ownership, influence, or control
Publication date: 30 Nov 2020
us PwC Equity method of accounting guide 5.4
There are a number of potential scenarios in which the ownership interest of an investor decreases or the investor loses significant influence or control. These may include:
- an investment that was previously consolidated but will now qualify for the equity method (see EM 5.4.1),
- an existing equity method investment in which the investor’s ownership interest decreased, however, it will continue to be accounted for under the equity method (see EM 5.4.2),
- an investment that was previously accounted for under the equity method, but it will now be accounted for under ASC 321 (see EM 5.4.3), or
- an investment that was previously accounted for under the equity method, but it has been fully disposed of (see EM 5.4.4).
5.4.1 Previously consolidated but now applying equity method
An investor should reassess, on an ongoing basis, whether it has lost control of an investee.
An investor may lose a controlling financial interest over the investee but retain a noncontrolling investment in common stock or in-substance common stock that gives it significant influence over that investee entity. In such situations the investor should apply the equity method to its retained interest.
Change of interest transactions that result in the investor losing control generally result in the recognition of a gain or loss in net income for the sale of the controlling interest and the remeasurement of any retained noncontrolling investment at fair value. See BCG 5.5 for a discussion of change in interest transactions that result in a loss of control. If the controlling interest is a nonfinancial asset or in substance a nonfinancial asset as described in PPE 6.2.2.5, then the criteria described in PPE 6.2.4 must also be met before the investee may be deconsolidated.
When an investor applies the equity method to a retained interest in a previously consolidated investee, the fair value of the retained interest forms the basis for the initial measurement. Basis differences arise if the fair value of the investment differs from the investor’s proportionate share in the carrying amount of the investee’s net assets.
When changing from consolidation to the equity method, the investee is consolidated until the point when control is lost, and the equity method is applied from that point forward.
5.4.2 Interest reduced but will continue to apply equity method
An investor that applies the equity method of accounting may reduce its ownership interest in the investee by selling a portion of its shares or through an investee transaction (see EM 5.2.3).
When an investor disposes of a portion of an equity method investment, the investor will need to determine the applicable gain or loss on disposition. A gain or loss on disposal is recorded when the selling price per share is more or less than the investor’s carrying amount per share.
In determining the gain or loss, the carrying amount of shares sold should generally be calculated based on the average carrying amount of all shares held by the investor. Other methods have been applied in practice, such as the “identified certificate” or FIFO basis; however, the average carrying amount will often best reflect the economic substance of the disposition. For example, under the "identified certificate" method, the gain or loss on disposition will be impacted by the specific certificates that are selected for sale; therefore, this method is not often considered an appropriate method. It should also be noted that a temporary difference arises when the “identified certificate” or FIFO basis is used to compute taxable income and the average basis is used to determine the gain or loss for financial reporting.
No new basis differences would arise as a result of a disposal; basis differences only arise on the acquisition of an interest in an investee. Notwithstanding, an investor would eliminate the portion of a preexisting basis difference associated with the portion of the investment sold. The investor would prospectively adjust its share of earnings and losses of the investee only for the remaining basis difference.
An investor’s equity method ownership interest in the investee that will continue to be accounted for using the equity method, will decrease when:
- the investor sells a portion of its shares to a third party (see EM 5.4.2.1),
- the investee issues new shares and the investor buys less than its proportionate ownership interest, making it a “net seller” (see EM 5.4.2.2), or
- the investee buys shares as treasury stock and the investor sells more than its proportionate ownership interest in the investee making it a “net seller” (see EM 5.4.2.3).
5.4.2.1 Investor sells a portion of its shares to a third party
An investor that applies the equity method may sell a portion of its interest in the investee to a third party. For such transactions, the investor should recognize a gain or loss equal to the difference between the selling price and the carrying value of the interest sold at the time of sale.
In determining the gain or loss in a partial disposition of an equity method investment, the carrying amount of shares sold should generally be calculated based on the average carrying amount of all shares held by the investor, as noted in EM 5.4.2.
5.4.2.2 Investee sells unissued shares and investor is a net seller
When an investee sells additional shares and an investor purchases no shares, or purchases less than its proportionate interest, the investor’s ownership interest in the investee decreases. Such a transaction is effectively an indirect disposal of part of the investor’s ownership interest. Accordingly, the investor should recognize a gain or loss equal to the difference between the selling price per share and the investor’s carrying amount per share.
Example EM 5-3 illustrates a transaction when the investee issues previously unissued shares at a price greater than the investor’s carrying amount in the investment and the investor does not buy any additional shares.
EXAMPLE EM 5-3
Investor is a net seller in investee transaction
Investor is a net seller in investee transaction
Investor owns 40 common shares in Investee representing a 40% ownership interest (a total of 100 shares are outstanding). The carrying value of the investment on Investor’s books is $10 per share, which is also Investee’s book value per share (i.e., no basis differences exist). Investee subsequently issues 25 shares at $20 to third parties. This price exceeds Investee’s book value per share of $10.
As a result of this transaction, Investor’s ownership interest in Investee has declined from 40% to 32% (Investor’s 40 shares/125 shares total shares outstanding).
How should Investor account for the issuance of shares by Investee?
Analysis
The ownership interest of Investor was reduced from 40% to 32% and Investor therefore has in substance sold a part of its interest in Investee.
Investor’s gain can be calculated as the difference between (a) Investor’s proportionate share of Investee’s new carrying value (32% x $1,500 = $480) and (2) the carrying value of Investor’s ownership interest in the Investee prior to the transaction ($400). This would result in a gain of $80, which could be reflected as a debit to equity method investment and a credit to gain.
Alternatively, Investor’s gain can be thought of as the amount by which its investment increased as a result of Investee’s issuance of shares to third parties.
Issuance price per share
|
$20
|
Investor A’s carrying value per share
|
10
|
Excess paid over carrying value per share
|
10
|
Shares issued
|
x 25
|
Total excess paid over carrying value per share
|
250
|
Investor’s % ownership in Investee
|
x 32%
|
Investor’s change in interest gain
|
$80
|
In this example, there were no basis differences. However, if there were, Investor would have to adjust the memo accounts for the portion of the basis difference sold.
When the investee issues additional shares as a result of the exercise of employee stock options, the dilution gain/loss should be calculated similar to Example EM 5-3. However, the consideration received for the shares issued upon exercise includes any previously recognized compensation expense plus cash proceeds upon exercise (i.e., exercise price multiplied by the number of shares). See EM 4.3.6 for a discussion of stock compensation awarded by an investee to employees.
5.4.2.3 Investee purchases shares and investor is net seller
When the investee offers to purchase shares from all or some investors in a treasury stock transaction and the investor sells a proportion greater than its pre-transaction ownership interest, the investor is a “net seller” as its percentage ownership interest in the investee is decreased (i.e., investor effectively sells part of its ownership interest in the investee).
An investor may sell a portion of an equity method investment to the investee in an investee treasury stock transaction. The gain or loss recognized by the investor is equal to the difference between (1) the proceeds received by the investor in return for the stock sold and (2) the investor’s carrying amount for the stock sold. If there were basis differences, the investor would have to adjust the memo accounts for the portion of the basis difference sold.
Example EM 5-4 illustrates the determination of an investor’s gain or loss from an investee treasury stock transaction.
EXAMPLE EM 5-4
Gain or loss calculation in an investee treasury stock transaction
Gain or loss calculation in an investee treasury stock transaction
Investor A owns 200 common shares representing a 50% ownership interest in Investee and accounts for its investment under the equity method of accounting. The common shares have an aggregate carrying value on the books of Investor A of $600 and a fair value of $800. Investors B and C each own 25% of the outstanding common shares of Investee.
Investor A agrees to sell 100 of its shares in Investee (with a fair value of $400) to Investee, which will be accounted for as a treasury stock transaction in Investee’s financial statements. Investor A has no basis differences between the carrying amount of its investment and its proportional interest in the carrying amount of Investee’s net assets.
Immediately prior to the sale by Investor A, the shareholdings of Investee can be summarized as follows:
Shares
|
Fair value
|
Book value
|
|
Investor A
|
200 shares (50%)
|
$800
|
$600
|
Investor B
|
100 shares (25%)
|
400
|
300
|
Investor C
|
100 shares (25%)
|
400
|
300
|
Total
|
$1,600
|
$1,200
|
|
After the sale, Investors A, B, and C each own 100 shares in Investee, resulting in each having a 33% ownership interest. Investor A’s ownership interest effectively declined from 50% to 33%. Investors B and C have effectively increased their respective ownership interest from 25% to 33%.
Investee’s net assets have also declined from $1,200 to $800, as it paid Investor A $400 to complete the transaction.
What is Investor A’s gain on the sale of its shares?
Analysis
Investor A’s gain is $66 calculated as follows:
Proceeds received by Investor A
|
$400
|
Carrying amount of Investor A’s investment prior to the transaction
|
$600
|
Carrying amount of Investor A’s investment after the transaction ($800 Investee’s net assets post transaction/3)
|
266
|
Reduction in carrying amount
|
334
|
Investor’s change in interest gain
|
$66
|
An alternative way to consider the gain would be to consider a scenario in which rather than providing a $400 payment to Investor A, Investee made a pro-rata distribution providing $200 to Investor A, and $100 each to Investor B and C. After the return of the proportionate share of net assets, the carrying value of Investor A’s interest would have been reduced to $400 ($600-$200).
Investor B and C would then use the cash they received in this hypothetical scenario to purchase shares from Investor A so that each investor would have a one-third interest. For this to occur, Investor A would need to sell 67 shares (rounded) for $200, $100 each from Investors B and C. That would represent 33.5% (67/200 shares) or $134 of Investor A’s basis (33.5% x $400). The gain on sale recognized by Investor A as a result of the transaction would be $66 ($200 cash received from Investors B and C less the carrying amount of the shares surrendered which was $134).
Example EM 5-4 was simplified as it presumes no basis difference. Accordingly, the investor’s pre-transaction investment carrying amount is its proportionate share in the carrying amount of the investee’s net assets.
In contrast, when the investor’s carrying amount is more or less than its proportionate share in the carrying amount of the investee’s net assets, additional consideration must be given to the unamortized basis difference when computing the gain or loss to be recognized in income. Example EM 5-5 illustrates the determination of a gain or loss when an investor is a net seller in an investee transaction and there are unamortized basis differences.
EXAMPLE EM 5-5
Investor is a net seller in an investee transaction
Investor is a net seller in an investee transaction
Investee has 100 shares outstanding and equity of $1,000 or $10 per share.
Investor owns 40% (40 of 100 outstanding shares) of Investee and the carrying amount of its investment is $500. Accordingly, the carrying amount of Investor’s investment exceeds its 40% share in the carrying amount of Investee’s assets by $100 (Investor’s 40% of Investee’s net assets of $1,000 is a $400 share of Investee net assets). The excess of $100 has been assigned to fixed assets ($60) and goodwill ($40). See EM 3.3.1 for a discussion of basis differences.
Investee sells 25 newly-issued shares for $500($20 per share). Investor buys no shares and therefore its ownership interest declines from 40% to 32% (Investor’s 40 shares/125 shares total shares outstanding). This represents a 20% decline in interest (8%/40%). No portion of the basis difference was amortized prior to the Investee’s issuance of additional shares.
How should Investor account for the issuance of shares by Investee?
Analysis
Investor’s gain would be computed as follows:
Investor’s share of Investee’s net assets after the transaction (40 shares/125 shares × $1,500 = less)
|
$480
|
Investor’s share of Investee’s net assets prior to transaction (40/100 × $1,000)
|
(400)
|
Gain due to increase in Investee’s net assets
|
$80
|
Less pro rata write-off of unamortized difference between Investor’s carrying amount and its interest in the Investee’s carrying amount: $100 × 20%
|
(20)
|
Change of interest gain
|
$60
|
The adjustment of the unamortized excess cost should be applied (generally pro rata) to the unamortized components of the difference. Thus, the $20 would be applied as follows to Investor’s equity method memo accounts:
Excess assigned to:
|
Before
|
Pro rata adjustment
|
Pro rata percentage
|
After
|
Fixed assets
|
$60
|
$12
|
60%
|
$48
|
Goodwill
|
40
|
8
|
40%
|
32
|
$100
|
$20
|
$80
|
Investor would continue to amortize the adjusted amounts of fixed assets prospectively over appropriate remaining periods.
5.4.3 Previously applied equity method and will apply ASC 321
An investor may lose significant influence over the investee entity due to the sale of a portion of its investment, the issuance or purchase of shares by the investee (see EM 5.2.3), or a change to the investee’s governing documents. The reassessment of whether an investor has significant influence over the investee entity is an ongoing evaluation.
An investor may lose significant influence when an investee is in legal reorganization or in bankruptcy or operates under foreign exchange restrictions, controls, or other government-imposed restrictions so severe that they limit the investor’s ability to exert significant influence over the investee.
Equity method investments are financial assets; therefore, transfers of equity method investments are within the scope of ASC 860, as further discussed in EM 5.2.4.
If an investor loses significant influence, then the equity method of accounting should be discontinued. The investor would no longer accrue a share of earnings or losses of the investee from the point that significant influence is lost. As noted in ASC 323-10-35-36, previously accrued earnings or losses should not be retroactively adjusted.
An investment in voting stock of an investee may fall below the level of ownership described in paragraph 323-10-15-3 from sale of a portion of an investment by the investor, sale of additional stock by an investee, or other transactions and the investor may thereby lose the ability to influence policy, as described in that paragraph. An investor shall discontinue accruing its share of the earnings or losses of the investee for an investment that no longer qualifies for the equity method. The earnings or losses that relate to the stock retained by the investor and that were previously accrued shall remain as a part of the carrying amount of the investment. The investment account shall not be adjusted retroactively under the conditions described in this paragraph. Upon the discontinuance of the equity method, an investor shall remeasure the retained investment in accordance with paragraph 321-10-35-1 or 321-10-35-2, as applicable. For purposes of applying paragraph 321-10-35-2 to the investor’s retained investment, if the investor identifies observable price changes in orderly transactions for the identical or a similar investment of the same issuer that results in it discontinuing the equity method, the entity shall remeasure its retained investment at fair value immediately after discontinuing the equity method. Topic 321 also addresses the subsequent accounting for investments in equity securities that are not consolidated or accounted for under the equity method.
Any of the investee’s OCI recorded in the investor’s financial statements would be reclassified to the investor’s carrying value of its investment.
In the circumstances described in paragraph 323-10-35-37, an investor’s proportionate share of an investee’s equity adjustments for other comprehensive income shall be offset against the carrying value of the investment at the time significant influence is lost. To the extent that the offset results in a carrying value of the investment that is less than zero, an investor shall both:
- Reduce the carrying value of the investment to zero
- Record the remaining balance in income.
As discussed in ASC 323, the sale of investee shares by an investor generally results in gain or loss recognition.
Sales of stock of an investee by an investor shall be accounted for as gains or losses equal to the difference at the time of sale between the selling price and carrying amount of the stock sold.
For the purposes of calculating the gain or loss on the portion of the investment sold, the carrying amount of the stock sold would include a proportionate share of the investor’s basis differences.
Refer to the financial instruments guidance for any remaining common stock (i.e., ASC 321) or in-substance common stock investments (i.e., ASC 320 or ASC 321) in the investee. See LI 2 for a discussion of accounting for equity instruments.
As discussed in ASC 321-10-30-1, the carrying amount of any retained equity interest in the investee forms the initial basis for which subsequent changes in fair value are measured. If the retained equity interest has a readily determinable fair value, it should be carried at fair value with changes in value recorded in net income. Any adjustment to the carrying amount of the retained interest upon the application of ASC 321 (i.e., to adjust the investment’s carrying amount to fair value) should be recognized in net income. If the retained equity interest does not have a readily determinable fair value, it may be eligible for the measurement alternative, as discussed in LI 2.3.2. Entities applying the measurement alternative must consider all observable transactions, including those that required the investor to discontinue the equity method of accounting.
Example EM 5-6 illustrates the determination of a gain or loss recognized by an investor upon a sale of a portion of its interest that results in a loss of significant influence.
EXAMPLE EM 5-6
Loss of significant influence
Loss of significant influence
Investor owns 25 shares representing a 25% ownership interest in Investee, a public entity. Investor paid $250 for the investment ($10 per share) and accounts for it under the equity method. No basis differences arose at the time of the acquisition and Investee has had no net income since the acquisition.
In 20X0, Investee acquired a debt security that it accounted for as available for sale. Investee recognized a decrease in OCI of $100 for the year due to a decline in the fair value of the security. Investor recorded its proportionate share of that decrease of $25 (25% of the amount recorded within Investee’s OCI). As a result, the net carrying value of Investor’s investment in Investee at the end of the year, including the impact reflected in OCI, was $225 million or $9 per share.
In 20X1, Investor sold 10 shares in Investee to an unrelated third party for $120. At the time of sale, Investee’s publicly-traded share price was $12 per share. As a result of the sale, Investor’s ownership percentage decreased from 25% to 15% and it was determined to have lost significant influence. For illustrative purposes the tax impacts of the transaction have been ignored.
What is the gain or loss recognized by Investor?
Analysis
Investor would recognize a $20 gain on the sale reflecting the difference between the consideration received and the associated carrying amount for the portion sold.
Shares
|
Book value per share
|
Total value
|
|
Initial investment
|
25
|
$10
|
$250
|
Decrease in debt security value
|
(1)
|
(25)
|
|
Carrying value of investment prior to sale
|
25
|
$9
|
225
|
Gain or loss calculation:
|
|||
Sale of portion of investment
|
(10)
|
$120
|
|
Less: adjusted carrying amount ($9 × 10)
|
(90)
|
||
Realization of loss classified in OCI
|
(10)
|
||
Gain on sale of investment
|
$20
|
Since Investor has lost significant influence, it should discontinue accruing its share of earnings/losses in Investee. Its remaining proportionate share of Investee’s OCI of $15 (15 /25 shares × $25 recorded in OCI) should be reclassified to the carrying value of the investment.
The remaining carrying amount of the investment at the time of the disposition would be $135 ($225 net carrying amount - $90 carrying amount of interest sold). Investor would then need to mark its remaining investment to fair value in accordance with ASC 321, resulting in an additional gain of $45 ((15 shares * $12 fair value) - $135).
The journal entries to reflect Investor’s accounting for these events would be as follows:
Journal entries
|
|||
20X0
|
Dr. Investment
|
$250
|
|
Cr. Cash
|
$250
|
||
To record acquisition of investment
|
|||
Dr. OCI
|
$25
|
||
Cr. Investment
|
$25
|
||
To record share of decline in fair value of debt security recorded by Investee in OCI (25% × $100)
|
|||
20X1
|
Dr. Cash
|
$120
|
|
Cr. Investment
|
$90
|
||
Cr. Realized gain on sale
|
30
|
||
To record sale of portion of investment
|
|||
Dr. Realized loss on sale
|
$10
|
||
Cr. OCI
|
$10
|
||
To record recycling of portion of OCI Balance (10/25 * 25)
|
|||
Dr. Investment
|
$15
|
||
Cr. OCI
|
$15
|
||
To record reclassification of remaining OCI balance on loss of significant influence ((15/25) *$25)
|
|||
Dr. Investment
|
$45
|
||
Cr. Gain
|
$45
|
||
To mark the investment to its fair value
((15 shares x $12 fair value) - $135 carrying value at transition) |
|||
5.4.4 Investor fully disposes of equity method investment
An investor may dispose of an equity method investment. Equity method investments are financial assets; therefore, transfers of equity method investments are within the scope of ASC 860, as further discussed in EM 5.2.4.
For the purposes of calculating the gain or loss of the investment sold, the carrying amount of the stock sold would include a proportionate share of the investor’s basis differences.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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