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The investor ordinarily shall discontinue applying the equity method if the investment (and net advances) is reduced to zero and shall not provide for additional losses unless the investor has guaranteed obligations of the investee or is otherwise committed to provide further financial support for the investee.
An investor shall, however, provide for additional losses if the imminent return to profitable operations by an investee appears to be assured. For example, a material, nonrecurring loss of an isolated nature may reduce an investment below zero even though the underlying profitable operating pattern of an investee is unimpaired.
If a subsequent investment in an investee does not result in the ownership interest increasing from one of significant influence to one of control and, in whole or in part, represents, in substance, the funding of prior losses, the investor should recognize previously suspended losses only up to the amount of the additional investment determined to represent the funding of prior losses (see (b)). Whether the investment represents the funding of prior losses, however, depends on the facts and circumstances. Judgment is required in determining whether prior losses are being funded and all available information should be considered in performing the related analysis. All of the following factors shall be considered; however, no one factor shall be considered presumptive or determinative:
The cost basis of the other investments is the original cost of those investments adjusted for the effects of write-downs, unrealized holding gains and losses on debt securities classified as trading in accordance with Subtopic 320-10 or equity securities accounted for in accordance with Subtopic 321-10 and amortization of any discount or premium on debt securities or financing receivables. The adjusted basis is the cost basis adjusted for the allowance for credit losses account recorded in accordance with Topic 326 on measurement of credit losses for an investee financing receivable and debt security and the cumulative equity method losses applied to the other investments. Equity method income subsequently recorded shall be applied to the adjusted basis of the other investments in reverse order of the application of the equity method losses (that is, equity method income is applied to the more senior investments first).
Excerpt from ASC 323-10-35-24
[T]he investor shall continue to report its share of equity method losses in its statement of operations to the extent of and as an adjustment to the adjusted basis of the other investments in the investee. The order in which those equity method losses should be applied to the other investments shall follow the seniority of the other investments (that is, priority in liquidation). For each period, the adjusted basis of the other investments shall be adjusted for the equity method losses, then the investor shall apply Subtopic 310-10, 320-10, 321-10, 326-20, or 326-30 to the other investments, as applicable.
Company A
|
Company B
|
Company C
|
Total
|
|
Common stock (shares)
|
1,000,000 |
750,000 |
750,000 |
2,500,000 |
Percent of common stock ownership
|
40% |
30% |
30% |
100% |
Preferred stock (shares)
|
— |
1,000,000 |
— |
1,000,000 |
Total shares
|
1,000,000 |
1,750,000 |
750,000 |
3,500,000 |
Percent of total voting shares outstanding
|
28.6% |
50.0% |
21.4% |
100% |
Total value of shares outstanding
|
$1,000,000 |
$2,750,000 |
$750,000 |
$4,500,000 |
Loan
|
1,000,000 |
— |
— |
1,000,000 |
Total investment in company XYZ
|
$2,000,000
|
$2,750,000
|
$750,000
|
$5,500,000
|
Company A |
||
Common stock |
Loan |
|
Equity investment in Company XYZ - 1/1/20X1 |
$1,000,000 |
$1,000,000 |
Company A’s share of 20X1 net losses (($2,500,000) × 40%) |
(1,000,000) |
— |
Equity investment in Company XYZ - 12/31/20X1 (a) |
— |
1,000,000 |
Company A’s share of 20X2 net losses ($750,000) [that is, $2,750,000 less $2,000,000 that is first applied to preferred stock] |
— |
(750,000) |
Equity investment in Company XYZ - 12/31/20X2 (b) |
— |
250,000 |
Company B |
||
Common stock |
Preferred stock |
|
Equity investment in Company XYZ - 1/1/20X1 |
$750,000 |
$2,000,000 |
Company B’s share of 20X1 net losses (($2,500,000) × 30%) |
(750,000) |
— |
Equity investment in Company XYZ - 12/31/20X1 (a) |
— |
2,000,000 |
Company B’s share of 20X2 net losses [that is, $2,750,000, of which $2,000,000 is first applied to preferred stock] |
— |
(2,000,000) |
Equity investment in Company XYZ - 12/31/20X2 (b) |
— |
— |
Company C |
||
Common stock |
||
Equity investment in Company XYZ - 1/1/20X1 |
$750,000 |
|
Company C’s share of 20X1 of net losses (($2,500,000) × 30%) |
(750,000) |
|
Equity investment in Company XYZ - 12/31/20X1 (a) |
— |
|
Company C’s share of 20X2 net losses |
— |
|
Equity investment in Company XYZ - 12/31/20X2 (b) |
— |
|
a – In 20X1, Company XYZ’s losses ($2,500,000) should be allocated proportionately to the common stock held by Companies A, B, and C. As a result, at December 31, 20X1, the investment balance of Companies A, B, and C in the common stock of Company XYZ have all been reduced to zero due to the allocation of their proportionate share of Company XYZ’s net loss. This allocation was based on the percentage of common stock owned by each investor, not on the percentage ownership of total voting stock. As noted above, the preferred stock is not in-substance common stock for purposes of this example.
b – Because each company’s equity investment in Company XYZ is zero, in 20X2, the $2,750,000 net loss must be allocated to the next most senior level of capital (the $2,000,000 of preferred stock held by Company B), and then the remaining amount ($750,000) is allocated to Company A’s loan. Accordingly, at December 31, 20X2, Company B’s preferred stock investment in Company XYZ has been reduced to zero since the $2,750,000 net loss is first applied against the preferred stock investment, as it is the next most senior investment. Similarly, at December 31, 20X2, Company A’s loan investment in Company XYZ has been reduced to $250,000 since the remaining portion of Company XYZ’s net loss ($750,000) is applied against the loan investment balance.
|
Excerpt from ASC 323-10-35-26(b)(2)
If the adjusted basis reaches zero, equity method losses shall cease being reported; however, the investor shall continue to track the amount of unreported equity method losses for purposes of applying paragraph 323-10-35-20. If one of the other investments is sold at a time when its carrying value exceeds its adjusted basis, the difference between the cost basis of that other investment and its adjusted basis at the time of sale represents equity method losses that were originally applied to that other investment but effectively reversed upon its sale. Accordingly, that excess represents unreported equity method losses that shall continue to be tracked before future equity method income can be reported.
Date
|
Investor share of Investee income (loss)
|
Depreciation of basis difference
|
Equity income (loss) reported by Investor
|
Investor investment balance (A) |
Investor portion of Investee's equity (B) |
Memo Account (C)= A-B |
1/1/20X1 |
$ - |
$ - |
$ - |
$100 |
$70 |
$30 |
12/31/20X1 |
(40) |
(3) |
(43) |
57 |
30 |
27 |
12/31/20X2 |
(40) |
(3) |
(43) |
14 |
(10) |
24 |
12/31/20X3 |
(40) |
(3) |
(14
) |
— |
(50) |
50 |
12/31/20X4 |
70 |
20
|
20 |
20 |
0 |
|
12/31/20X5 |
70 |
70 |
90 |
90 |
0 |
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