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An investor may hold stock or other instruments that have risk and reward characteristics that are substantially similar to common stock. These instruments are commonly referred to as in-substance common stock investments.
To determine whether an investment is “substantially similar” to common stock, an investor should consider the following characteristics outlined in ASC 323-10-15-13:
If any of these characteristics of the investment are not substantially similar to common stock, the investment is not in-substance common stock and would not be within the scope of ASC 323. In that case, the investor should not apply the equity method of accounting, even if the investor has significant influence.
If an investor cannot make a determination based on a qualitative assessment of these characteristics, the investor should perform a quantitative assessment by analyzing 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 investee’s common stock. If not, the investment is not considered in-substance common stock.
Paragraph 5 of EITF 02-14 noted that investments in other non-corporate entities, such as partnerships or limited liability companies, are not subject to the in-substance common stock guidance. While not included in the FASB codification, we believe this guidance should still be followed when determining scope. Therefore, these investments should be accounted for under ASC 323-30-15-2. See EM 1.3 for further information.
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