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Although an equity method investment is presented on the balance sheet of the investor as a single amount, the underlying accounting for the investment is similar to how an entity would account for a consolidated subsidiary. That is, an investor must allocate the initial cost of its equity method investment to its proportionate share of the individual assets and liabilities of the investee.

ASC 323-10-35-13

A difference between the cost of an investment and the amount of underlying equity in net assets of an investee shall be accounted for as if the investee were a consolidated subsidiary…

ASC 323-10-35-34

The carrying amount of an investment in common stock of an investee that qualifies for the equity method of accounting as described in paragraph 323-10-15-12 may differ from the underlying equity in net assets of the investee. The difference shall affect the determination of the amount of the investor's share of earnings or losses of an investee as if the investee were a consolidated subsidiary. However, if the investor is unable to relate the difference to specific accounts of the investee, the difference shall be recognized as goodwill and not be amortized in accordance with Topic 350.

3.3.1 Determination of basis differences

While the investor’s initial carrying amount of an equity method investment will reflect its cost of the investment, the investee carries the underlying assets and liabilities utilizing its own historical cost basis. Therefore, a difference will usually exist between (a) the carrying value of the investment and (b) the investor’s proportionate share of the carrying amount of the investee’s net assets.
The investor should use its own cost basis in the investee, rather than the investee’s basis in its own assets and liabilities to record the equity method investment.
Application of the guidance in ASC 323-10-35‑13 requires that the investor account for the basis adjustments as if the subsidiary was a consolidated subsidiary in memo accounts. Accordingly, the investor must determine its cost basis in the individual assets and liabilities of the investee, including those assets and liabilities not recorded in the investee’s general ledger (e.g., unrecognized intangible assets), similar to how the acquisition method is applied in a business combination. The difference between the cost of an investment and the investor’s share of the net assets as recognized by the investee is generally attributable to multiple assets and liabilities of the investee.
While assets that have appreciated will have a positive basis difference (i.e., the investor’s basis will be greater than that of the investee), basis differences can be either positive or negative.
As illustrated in Example EM 3-3 and Example EM 3‑4, subsequent to acquisition, basis differences assigned to identified assets and liabilities will often impact earnings, with a corresponding increase or decrease to the equity investment balance.
See BCG 2 for general information on the application of the acquisition method. See EM 3.3.4 for a discussion of the deferred tax implications of these basis differences. See EM 4.3.1 for further information on the subsequent accounting for the basis differences identified.
An investor, through its ability to exercise significant influence over the investee, will generally be able to obtain sufficient financial data to determine the primary assets and liabilities giving rise to a basis difference. In the unusual circumstance when an investor is unable to do so, the inability to obtain such information from the investee must be reconciled with the conclusion that the investor has the ability to exercise significant influence over the operating and financial policies of the investee.
New guidance—added January 2022
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. The guidance requires all contract assets and contract liabilities from contracts with customers acquired in a business combination to be recognized and measured by the acquirer on the acquisition date in accordance with ASC 606, Revenue from Contracts with Customers. Equity method investments are not directly within the scope of the new guidance. However, as described in ASC 323-10-35-13, when an entity acquires an equity method investment, any difference between the investor’s cost basis and its share of the investee’s net assets should be accounted for as if the investee were a consolidated subsidiary. In practice, that means that the investor performs an acquisition accounting-like allocation to determine its share of the underlying net assets of the investee in order to calculate its “basis differences” for subsequent recognition. We believe an investor would apply the new guidance in ASU 2021-08 when performing such calculations.
Example EM 3‑5 illustrates the assignment of a positive basis difference on the date of acquisition when the positive basis difference is attributable to one asset. Example EM 3‑6 illustrates the assignment of a negative basis difference on the date of acquisition when the negative basis difference is attributable to one asset. For purposes of each example, transaction costs and tax implications are ignored.
EXAMPLE EM 3-5
Accounting for a positive basis difference on the date of acquisition
Investor purchased a 40% interest in the voting common stock of Investee for $56 million. Investor determined that it has the ability to exercise significant influence over the operating and financial policies of Investee. Therefore, Investor accounts for its interest in Investee under the equity method.
Investor engaged a third-party valuation firm to perform a fair value assessment of Investee’s fixed assets and determined that the fair value was $90 million. Investor also concluded that Investee’s carrying value of its current assets was representative of fair value.
At the date of acquisition, Investee’s assets and liabilities are as follows (in millions):
Line item
Carrying value
(CV) of
Investee
Fair value
(FV) of
Investee
Investor share
of Investee CV
Investor
share of
Investee FV
Current assets
$50
$50
$20
$20
Fixed assets
50
90
20
36
Net assets
$100
$140
$40
$56
How should Investor record its investment in Investee on the acquisition date?
Analysis
Investor should record its investment in Investee at its cost of $56 million. The difference between the Investor’s share of the net assets measured at (1) fair value (i.e., its outside basis) and the (2) investors share of the investee’s carrying value (i.e., the inside basis) is $16 million ($56 – $40) and is entirely attributable to the fixed assets. The positive basis difference would be recorded as fixed assets in the investor’s memo accounts and would be depreciated over the useful life of the fixed assets. The depreciation would be recorded by the Investor as a reduction of the Investor’s share of the Investee’s earnings and would reduce the Investor’s equity method investment balance.
EXAMPLE EM 3-6
Accounting for a negative basis difference on the date of acquisition
Investor purchased a 40% interest in the voting common stock of Investee for $32 million. Investor determined that it has the ability to exercise significant influence over the operating and financial policies of Investee. Therefore, Investor accounts for its interest in Investee under the equity method.
Investor performed extensive due diligence of Investee. During that process, Investor noted that Investee had recently performed a long‑lived asset impairment test for its fixed assets and determined that the carrying value of its fixed assets were recoverable under a held and used model. Therefore, no impairment charge was recorded by Investee (even though there had likely been a decline in the fair value of the fixed assets to below carrying value). As a result, the cost of the investment was less than the Investor’s proportionate share in the amount at which the Investee carries the underlying net assets.
At the date of acquisition, Investee’s assets and liabilities are as follows (in millions):
Line item
Carrying
value (CV) of
Investee
Fair value
(FV) of
Investee
Investor
share of
Investee CV
Investor share of
Investee FV
Current assets
$50
$50
$20
$20
Fixed assets
50
30
20
12
Net assets
$100
$80
$40
$32
How should Investor record its investment in Investee on the acquisition date?
Analysis
Investor should record its investment in Investee at its cost of $32 million. The difference between the Investor’s share of the net assets measured at (1) fair value (i.e., its outside basis) and (2) the investors share of the investee’s carrying value (i.e., the inside basis) is negative $8 million ($32‑$40) and is entirely attributable to the fixed assets. This negative basis difference would be accreted in the investor's equity method memo accounts reducing depreciation expense over the life of the fixed assets. This accretion would be recorded by the Investor as an increase in Investor’s share of the Investee’s earnings and would also increase the Investor’s equity method investment balance.

3.3.2 Basis differences when investee has a noncontrolling interest

An investee may consolidate a non wholly‑owned subsidiary, and therefore present a noncontrolling interest on its balance sheet. In such cases, the investor should be mindful of the value held by the noncontrolling interest when determining the fair value of the assets and liabilities underlying its investment, as illustrated in Example EM 3‑7.
EXAMPLE EM 3-7
Accounting for the investor’s interest in the net assets of an investee’s non wholly‑owned subsidiary
Investor purchased a 40% interest in the voting common stock of Investee and determined that it should account for its interest under the equity method.
Investee holds an 80% interest in Subco and consolidates Subco in its financial statements. Investee presents the 20% interest in Subco held by other investors as a noncontrolling interest.
Subco has fixed assets which Investee includes in its consolidated financial statements. The carrying amount of the fixed assets for Investee is $100, and it is determined that the fair value of the fixed assets is also $100.
When determining its proportionate share in the assets and liabilities of Investee, what would be the Investor’s interest in the fixed assets of Subco?
Analysis
Investee is required to consolidate 100% of the net assets of Subco and present separately the 20% noncontrolling interest, as described in FSP 2.5. Investor, however, should only recognize its proportionate share of the investee’s interest in those net assets. The Investor’s interest in the fixed assets of Subco would be $32 (Fair value of the fixed assets [$100] x percentage owned by Investee [80%] x Investor’s ownership percentage [40%]). Accordingly, Investor should allocate $32 to the fixed assets of Subco in its memo accounts.

3.3.3 Equity investment acquired as part of a business combination

A reporting entity may acquire a business that has an equity method investment. As part of its purchase price allocation, the reporting entity should determine the fair value of the equity method investment, as described in BCG 2.5. The reporting entity should also determine any basis differences, following the guidance described in EM 3.3.1.

3.3.4 Deferred taxes in investor’s equity method memo accounts

While an investee’s financial statements will already reflect deferred tax assets and liabilities for temporary differences between the carrying values of the investee’s assets and liabilities and their associated tax bases, incremental temporary differences may be created when the investor allocates its investment cost to individual assets and liabilities in memo accounts, as described in EM 3.3.1.
Accordingly, an investor must track the deferred tax consequences associated with these incremental basis differences and reflect those tax consequences in its equity method memo accounts. This is accomplished by tax affecting basis differences using the investee’s tax rate and including any resulting deferred tax asset or liability in the memo accounts.
As the investor amortizes its excess basis in the memo accounts, it would unwind the corresponding deferred tax liability, and recognize the associated impact of the tax effected amortization in its calculated share of the investee’s earnings.
At acquisition, an investor may also need to consider how its equity method accounting interplays with any previously established valuation allowances of the investee. See EM 3.3.4.1 for further discussion.
Subsequent to the acquisition, an investor may recognize income for book purposes but not receive distributions of those earnings. This will create a difference between the carrying amount of the equity method investment and its tax basis (i.e., outside basis difference), which is discussed in TX 11.6.
Example EM 3‑8 illustrates the establishment of a deferred tax liability related to basis differences.
EXAMPLE EM 3-8
Establishing a deferred tax liability related to basis differences
Investor obtains a 40% interest in Investee. Investee’s carrying amount of its fixed assets is $50, whereas the fair value is $90. Accordingly, a difference exists between Investor’s proportionate share of the fair value of Investee‑owned property, plant, and equipment, which is $36 ($90 x 40%), and the Investee’s carrying amount in those same assets, which is $20 ($50 x 40%). This basis difference of $16 ($36‑$20) would be reflected in the Investor’s memo account.
Investee’s tax rate is 25%.
Should Investor recognize a deferred tax liability in connection with allocating its cost basis to the acquired assets and liabilities?
Analysis
Yes. In the equity method memo accounts, a deferred tax liability should be recognized. That deferred tax liability reflects the taxable temporary difference created in the memo account of the Investor (i.e., the amount by which the investor’s carrying amount exceeds its proportionate interest in the investee’s carrying value of those assets). Accordingly, a deferred tax liability of $4 would be established, calculated as the $16 basis difference multiplied by the Investee’s 25% tax rate.

3.3.4.1 Considerations related to investee’s valuation allowance

An investee may have deferred tax assets for which a partial or full valuation allowance has been recorded. This would occur when the investee has concluded that the deferred tax assets are not “more‑likely‑than‑not” to be realized.
When an investor records its proportionate interest of the investee, the investor must consider whether there is any new information resulting from its acquisition of the investee which results in an impact on investee’s valuation allowance. ASC 740 provides four sources of future taxable income to consider when assessing the need for a valuation allowance (see TX 5.3). One of the sources is future taxable amounts resulting from the reversal of taxable temporary differences. When an investor recognizes a deferred tax liability in its memo accounts (as explained in EM 3.3.4), the investor should consider whether that deferred tax liability can serve as a source of future taxable income to support realization of the investor’s proportionate share of deferred tax assets acquired.
Example EM 3‑9 illustrates a scenario where a deferred tax liability recognized in the investor’s memo account serves as a source of realization for a deferred tax asset of an investee. This source of realization relates to the investor’s memo accounts and investor’s share of the earnings of investee.
EXAMPLE EM 3-9
Determining whether a deferred tax liability recognized in a memo account serves as a source of realization for a deferred tax asset of an equity method investee
Investee has a deferred tax asset of $400 associated with net operating losses. Investee recognized a valuation allowance of $400 against the deferred tax asset as it believes that it is “more‑likely‑than‑not” that the benefit associated with the deferred tax asset will not be realized. Investee’s balance sheet shows net assets of $750. Investee has a tax rate of 25%.
Investor acquires a 40% equity interest in Investee for $800, and accounts for its investment using the equity method of accounting. Investor’s proportionate share in the investee’s book basis is $300 ($750 x 40%), resulting in a basis difference of $500 ($800‑$300). Investor determined that the basis difference is entirely associated with intellectual property which will be amortized for book purposes over 10 years. Investor’s acquisition of Investee’s equity interest did not generate any tax basis in the intellectual property. Accordingly, Investor should record a deferred tax liability of $125 ($500 * 25%) related to the basis difference in its equity method memo accounts.
Investor determined that its proportionate share of Investee’s deferred tax asset is $160 ($400 x 40%).
Should Investor recognize any portion of the underlying deferred tax asset of Investee?
Analysis
Yes. The deferred tax liability recorded by Investor within the equity method memo accounts should be considered a potential source of taxable income to support realization of its proportionate share of Investee’s deferred tax assets, regardless of the assessment concluded and recorded by Investee. Therefore, Investor would recognize $125 of the deferred tax asset (i.e., no valuation allowance is needed for that portion) in its equity method memo accounts upon acquisition of Investee. This reflects the portion of the deferred tax asset for which Investor has a source of taxable income to support realization of its portion of Investee’s deferred tax assets (through future reversal of the deferred tax liability recognized in its equity method memo account).

In some cases, an investor may be willing to pay a premium to obtain an interest in such an investee if the investor believes that the associated deferred tax assets have value in excess of the amount recorded (net of the valuation allowance) in the investee’s financial statements. Simply paying a premium does not in and of itself provide evidence of future taxable income under ASC 740. In such cases, no portion of the premium would be allocated to the investee’s deferred tax assets.
Example EM 3‑10 illustrates an investor’s accounting for the excess of the cost of the investor’s share of investee net assets when a premium is attributable to tax benefits of the investee that carry a valuation allowance.
EXAMPLE EM 3‑10
Accounting for the excess of cost over the investor’s share of investee net assets when a premium is attributable to tax benefits of the investee that carry a valuation allowance
Investee is a public company that has a substantial deferred tax asset related to net operating loss (NOL) carryforwards. Investee has a full valuation allowance recorded against the deferred tax asset because of losses in recent years. Investee is currently traded at a premium compared to its net assets, which has been attributed to a belief by investors that Investee will eventually be able to employ a strategy to utilize its NOL carryforwards.
Investor acquired a 20% ownership interest in the voting common stock of Investee and determined that it should account for the investment under the equity method of accounting. At the date on which Investor acquires its 20% interest in Investee at market price, its cost exceeds its proportionate share of the carrying amount of the net assets of Investee by $500. For simplicity, assume there are no unrecognized intangible assets or liabilities and no other recognized assets or liabilities of Investee to which the premium paid by Investor should be attributed.
Should any portion of the $500 premium paid by Investor be assigned to the deferred taxes related to NOL carryforwards, or is the entire premium allocated to goodwill?
Analysis
The premium should be allocated to goodwill. There are no new sources of taxable income as a result of the initial equity method accounting that could provide for realization of Investee’s deferred tax assets. Additionally, since there has been no change in control, the Investor’s investment does not provide the Investee with any new ability to recover the deferred tax asset. Accordingly, Investor would not assign any carrying value to the deferred tax asset when assigning the premium paid to acquire the investment. Instead, the $500 premium of cost over fair value should be considered goodwill in Investor’s equity method memo accounts.
Prospectively, Investor will need to analyze its investment for impairment in accordance with the provisions of ASC 323‑10‑35‑32. See EM 4.8 for further information.

3.3.5 Accounting for excess assigned to purchased IPR&D (equity method)

A portion of the value paid by an investor to acquire an equity interest in an investee may be due to the value of in‑process research and development (IPR&D) of the investee. An investor should measure the underlying IPR&D at fair value at the acquisition date in its memo accounts.
If the investee is not a business (i.e., an asset acquisition), as defined in ASC 805, the investor should immediately recognize a charge to expense for acquired IPR&D if the IPR&D does not have an alternative future use (see ASC 805‑50‑35‑1).
If the investee qualifies as a business, the investor should record an intangible asset to capitalize the IPR&D in its equity method memo accounts, regardless of whether it has an alternative future use, as if the investee were a consolidated subsidiary pursuant to the guidance in ASC 323‑10‑35‑13.
See the guidance described in BCG 1.2 to determine if an acquisition meets the definition of a business. See BCG 4.3.4.1 for further information on the accounting for purchased IPR&D.

3.3.6 Equity method goodwill

The investor’s cost of an equity method investment may exceed its proportionate share of the fair value of the investee’s underlying assets and liabilities identified. This excess consideration paid over the investor’s share of the investee’s net assets, should be assigned by the investor to “equity method goodwill,” if the investee meets the definition of a business as described in BCG 1.2. If the investee does not meet the definition of a business, equity method goodwill should not be recognized. Rather, the excess, if any, should be allocated to the assets acquired, based on their relative fair values, in a manner similar to the acquisition of assets described in ASC 805‑50‑30‑3.
An investor should make all reasonable efforts to attribute the cost of the investment to identifiable assets and liabilities of the investee before determining that the excess paid reflects goodwill. This includes considering not only the fair value of assets and liabilities already recognized by the investee, but also assets and liabilities that may not have been previously recognized by the investee, such as intangibles. If the cost of the investment is incorrectly attributed to goodwill, ongoing earnings may be misstated as goodwill is generally not amortized.
The carrying amount of an equity method investment reflects the accumulated cost of the investment and includes items such as transaction costs (see EM 3.2.1), and subsequent changes in the value of contingent consideration (see EM 3.2.2), which would not be included in the carrying amount of business combination accounted for in accordance with ASC 805. Accordingly, goodwill for an equity method investment, which is calculated as the residual of the cost paid over the assets and liabilities identified, may be different than if the investment was a business combination accounted for under ASC 805.
This subsequent accounting for goodwill, including the private company goodwill accounting alternative, is discussed in EM 4.3.1.
Example EM 3‑11 illustrates the process for allocating the cost of an investment to the underlying net assets, deferred taxes, and equity method goodwill.
EXAMPLE EM 3-11
Assignment of basis differences with residual excess assigned to equity method goodwill
Investor purchased a 25% interest in the voting common stock of Investee for cash consideration of $1,000. On the acquisition date, the net assets of Investee, as reflected in its general ledger and determined in accordance with GAAP, were as follows:
Line Item
Balance
Cash
$175
Other net current assets
125
Fixed assets
1,200
Net assets
$1,500
Investor’s 25% share
$375
Investor determined the following:
  • Investee’s property and plants are modern with current technologies and have a fair value of $2,400.
  • Investee holds valuable patents on its technical processes that have a fair value of $400. Costs associated with developing the processes were fully expensed by Investee.
  • Investee has a strong earnings growth record, a relevant consideration for income tax accounting purposes (e.g., realizability of deferred tax assets). Investee’s applicable tax rate is 25%.
  • Other net current assets represent raw materials, receivables, and payables. The carrying values of these items approximate their fair value.
How should Investor account for the basis difference between the cost of its investment and its share of the net assets of the Investee?
Analysis
The following table illustrates how Investor would assign the $625 basis difference that reflects the difference between its proportionate interest in (a) the carrying value of the investee’s assets and liabilities and (b) the fair value of those assets and liabilities.
Line item
Carrying
value (CV)
Fair value (FV)
Excess of
FV over CV
Investor’s
interest in
CV
Investor’s
basis
difference
Cash
$175
$175
$0
$44
$0
Other net current assets
125
125
0
31
0
Fixed assets
1,200
2,400
1,200
300
300
Patents
0
400
400
0
100
Deferred tax liability
0
(400) A
(400)
0
(100)
Goodwill
0
1,300
1,300
0
325 C
Total
1,500
4,000  B
2,500
375
625
A – The deferred tax liabilities relate to the difference between the underlying fair values and the carrying values of the investee’s assets and liabilities. The deferred tax liability of $400 is calculated as the product of total taxable temporary differences, excluding goodwill ($1,200 basis difference of fixed assets + $400 basis difference of patents), and the Investee’s applicable tax rate (25%). It is assumed for simplicity that at the date of investment there is no difference between the investor’s book and tax bases in the investment. If there were such a difference, the deferred tax effects might have to be considered in allocating the investor’s excess cost of its investment. See TX 11 for further information.
B – Investor purchased a 25% interest in the voting common stock for $1,000. Therefore, for illustrative purposes, the fair value of 100% of the Investee is assumed to be $4,000.
C – Equity method goodwill is calculated as the excess of Investor’s purchase price paid to acquire the investment over the fair value amounts assigned to the identified tangible and intangible assets and liabilities (fair value of Investor’s share of Investee’s net assets).
Investor would record its 25% interest in the voting common stock of Investee based on the $1,000 cost of its investment. The underlying acquired assets include the investors proportionate interest in: (1) the net assets of the investee based on the investee’s carrying amount ($1,500 x 25% = 375), (2) the net excess of fair value over the investee’s carrying value of the identified tangible and intangible assets and liabilities as well as goodwill ($625).

3.3.7 Bargain purchase

In limited cases it is possible that the fair value of the investment acquired (i.e., the fair value of the investor’s share of the investee’s net assets) exceeds the cost of the investment. In such situations, the investor should not recognize a bargain purchase gain, even though such gains would be recognized in the context of a business combination in accordance with ASC 805.
A bargain purchase gain should not be recognized when an investor acquires an equity method investment because, unlike in a business combination, an investor in an equity method investment does not control the underlying assets of the investee. Therefore, the investor would not be able to realize the gain by selling the underlying assets of the investee. Additionally, the carrying amount of an equity method investment is based on the accumulated cost of acquiring the investment, not on a fair value basis.
Therefore, if the fair value of the investment acquired exceeds the cost of the investment, the investor should allocate the difference as a pro‑rata reduction (on a fair value basis) to the amounts that would otherwise have been assigned to the acquired noncurrent assets. This treatment of the residual excess is consistent with the asset acquisition guidance in ASC 805‑50.
Example EM 3‑12 illustrates the allocation of a bargain purchase as a pro rata reduction to the acquired noncurrent assets.
EXAMPLE EM 3-12
Assignment of a bargain purchase to reduce acquired noncurrent assets
Investor purchased a 25% interest in the voting common stock of Investee for cash consideration of $1,000. Investee’s tax rate is 25%. On the acquisition date, Investor’s share of the net assets of Investee on a book and fair value basis are as follows:
Line item
Carrying
value
Fair
value
Investors
share
carrying value
Investor’s share
preliminary fair
value
Cash
$800
$800
$200
$200
A
Accounts receivable
1,000
1,000
$250
$250
A
Fixed assets
2,000
3,700
$500
925
B
Patent (noncurrent)
0
220
0
55
C
Deferred tax liability
0
(480)
0
(120)
D
Accounts payable
(800)
(800)
(200)
(200)
A
Total
$3,000
$4,440
$750
$1,110
E
A – Investor concluded that Investee’s carrying value was representative of fair value.
B – Investor determined that its share of the fair value of Investee’s fixed assets was $925.
C – Investor determined that its share of the fair value of Investee’s patent was $55.
D – The preliminary deferred tax liability ($120) is calculated as the product of total taxable temporary differences, excluding goodwill. That includes the sum of the basis difference for fixed assets ($925‑$500 = $425) and the basis difference of the patent ($55) multiplied by the Investee’s applicable tax rate (25%). It is assumed for simplicity that there is not any difference at the date of investment between the investor’s book and tax bases in the investment. If there were such a difference, the deferred tax effects might have to be considered in allocating the investor’s excess cost of its investment. See TX 11 for further information.
E – Investor’s proportionate share of the fair value of Investee’s net assets of $1,110 exceeds the cost of its investment of $1,000, resulting in residual excess of $110.
How should Investor account for the basis difference between the cost of the investment ($1,000) and its share of the Investee’s net assets ($1,110)?
Analysis
Investor should not recognize a bargain purchase gain of $110 for the amount by which the fair value of its investment exceeds its cost. Rather, Investor should allocate the excess $110 as a pro‑rata reduction of the preliminary fair value amounts assigned to the fixed assets and patent and related deferred tax effects utilizing an iterative calculation. After performing such an iterative calculation, which can be accomplished through use of basic software, the final fair value of Investor’s proportionate share of the Investee’s net assets, including the deferred tax liability, should equal Investor’s cost of the investment.
Line item
Carrying
value
Preliminary
fair value
Final fair
value
Basis
difference
Cash
$200
$200
$200
$0
Accounts receivable
250
250
250
0
Fixed assets
500
925
786
286
Patent (noncurrent)
0
55
47
47
Deferred tax liability
0
(120)
(83)
(83)
Accounts payable
(200)
(200)
(200)
0
Share of net assets
$750
$1,110
$1,000
$250
Investor should assign the adjusted basis differences of $286 and $47 to the acquired fixed assets and patent, respectively, within the equity method memo accounts.

3.3.8 Accumulated other comprehensive income – basis differences

An investee may hold assets or liabilities whose changes in value are reported in accumulated other comprehensive income (AOCI) pursuant to other GAAP. For example, an investee may have investments in available‑for‑sale securities accounted for pursuant to ASC 320, Investments–Debt and Equity Securities, derivative financial instruments accounted for pursuant to ASC 815, Derivatives and Hedging (e.g., derivative financial instrument designated as a cash flow hedge), and/or pension or post‑employment benefits accounted for pursuant to ASC 715, Compensation—Retirement Benefits.
At the date on which it obtains an investment that is to be accounted for under the equity method of accounting, an investor must identify and measure all of the investee’s identifiable assets and liabilities at their acquisition date fair values. For those assets and liabilities whose changes in value are reported in AOCI, the investor will not recognize its proportionate share of the amounts previously reported in the investee’s AOCI balance. This is because the investor would record the associated assets and liabilities at fair value and, therefore, there are no unrealized amounts to report in AOCI from the investor’s perspective.
Accordingly, the amounts reported in the investee’s AOCI balance create additional basis differences that must be tracked by the investor within the equity method memo accounts in order to ensure that the investor does not recognize such amounts when they are reclassified to earnings in the investee’s financial statements.
Example EM 3‑13 illustrates an investor’s accounting for the investee’s AOCI at date of acquisition and upon sale.
EXAMPLE EM 3-13
Investor’s accounting for investee’s AOCI at date of acquisition and upon sale
Investor acquired a 20% interest in the voting common stock of Investee that will be accounted for under the equity method of accounting. Investee holds an available‑for‑sale debt security that it purchased for $100. The fair value of the available‑for‑sale debt security at the investment date is $150; therefore, investee reports $50 in unrealized gains in AOCI. One year later, Investee sells the available‑for‑sale security for $150.
How should Investor account for its proportionate share of Investee’s available‑for‑sale debt security at the investment date and upon Investee’s sale of the available‑for‑sale security?
Analysis
At the acquisition date, Investor would recognize in its memo accounts its proportionate share of the fair value of the available‑for‑sale debt security of $30 ($150 * 20%) and AOCI of $0, creating a basis difference of $10 in the investor’s AOCI memo accounts.
Upon sale for $150, Investee would recognize a realized gain of $50; however, Investor would not record its proportionate share of Investee’s realized gain because its basis in the Investee’s available‑for‑sale debt security would already reflect the security’s appreciation. Therefore, Investor would reduce its equity in earnings of Investee by $10 ($50 * 20%), reflecting the reversal of the AOCI basis difference.

3.3.9 Investee financial statements are not US GAAP

When an investee’s financial statements are prepared on a basis other than US GAAP, an investor that follows US GAAP should convert the investee’s financial statements to US GAAP to eliminate variances, prior to determining the difference between the cost of its investment and its share of the underlying equity in the investee’s net assets. Variances from US GAAP must be accounted for on a continuing basis, similar to the required accounting for basis differences discussed in EM 3.3.1. See EM 4.3.4 for further discussion of adjustments for the application of different accounting principles by the investee.

3.3.10 Investee reporting on a lag

If an investor determines that the financial statements of an investee will not be ready at the time the investor files its financial statements, the investor can elect to adopt an accounting policy to use financial statements of the investee as of an earlier reporting period. A lag in reporting should be consistent from period to period as noted in ASC 323‑10‑35‑6.
While ASC 323 does not specifically state the maximum permissible lag for equity method investees, ASC 810-10-45-12, which addresses consolidated subsidiaries, states it should not be more than “about three months.” We believe the same guidance can be applied by analogy to equity method investees.
When lag reporting will be applied, the investor should determine the equity method basis differences at the date of acquisition using (a) the cost of the investment and (b) its proportionate interest in the carrying amount of the investee’s assets and liabilities as of the acquisition date.
See EM 4.4 for subsequent accounting for investments with lag reporting.
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