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2.3 Predominant evidence to the contrary
Publication date: 29 Feb 2024
us Equity method of accounting guide
As discussed in EM 2.1, there’s a presumption that an investor has the ability to exercise significant influence when it owns (directly or indirectly) 20% or more of the outstanding voting common stock or in-substance common stock of an investee. However, ASC 323-10-15-10 provides a list of indicators (not all-inclusive) that an investor may be unable to exercise significant influence, despite an ownership interest of greater than 20% of the outstanding voting common stock.
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.
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.
There are other indicators that may provide predominant evidence to overcome the presumption of significant influence. For example, if an investor owns a 20% interest in a foreign investee that operates in a country that has imposed exchange restrictions or in a market that creates other significant uncertainties, the investor may not be able to exercise significant influence.
Additionally, no individual circumstance is necessarily conclusive that an investor is unable to exercise significant influence over an investee’s operating and financial policies. As stated in ASC 323-10-15, predominant evidence is necessary to overcome the presumption of significant influence. An evaluation of all related facts and circumstances is required.
Example EM 2-10 and Example EM 2-11 illustrate the evaluation of whether contrary evidence exists to overcome the presumption of an investor’s ability to exercise significant influence over the operating and financial policies of an investee.
EXAMPLE EM 2-10
Contrary evidence not sufficient to overcome presumption
Contrary evidence not sufficient to overcome presumption
Investor owns a 25% voting interest in Investee. Investor is a passive investor and has not exercised its ability to influence the operating and financial policies of Investee in the past. Further, Investor does not intend to influence the operating and financial policies of Investee in the future. No other contrary evidence exists to overcome the presumption of significant influence.
Is there predominant evidence to the contrary to overcome the presumption that Investor has the ability to exercise significant influence over the operating and financial policies of Investee?
Analysis
The fact that Investor (1) has not exercised its ability to influence Investee in the past and (2) does not intend to influence Investee in the future is not considered contrary evidence to overcome the presumption that Investor has the ability to exercise significant influence.
EXAMPLE EM 2-11
Contrary evidence exists to overcome presumption
Contrary evidence exists to overcome presumption
Investor owns a 20% voting interest in Investee. The majority ownership of Investee is concentrated among a small group of shareholders who operate Investee without regard to the views of Investor. Investor has tried unsuccessfully to obtain representation on Investee’s board of directors. Investee has actively and publicly resisted the exercise of influence by Investor.
Is there sufficient evidence to the contrary to overcome the presumption that Investor has the ability to exercise significant influence over the operating and financial policies of Investee?
Analysis
Investor may be able to conclude that there is predominant evidence to overcome the presumption that it has the ability to exercise significant influence as a result of (1) the small group of shareholders that own a majority ownership interest in Investee and operate Investee without regard to the views of Investor, (2) Investor’s failed attempts to obtain representation on Investee’s board of directors, and (3) Investee’s active and public resistance to the exercise of influence by Investor. Investor should evaluate all other facts and circumstances relating to the investment.
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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