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An investor’s share of losses of an investee (including any impairments of its investment as discussed in EM 4.8) may exceed the carrying amount of its investment (including unsecured or subordinated intercompany advances made by the investor other than accounts receivable in the ordinary course of business). It is appropriate to consider deferred intercompany profits (as discussed in EM 4.2) as a reduction in the carrying amount of the investment. The investor should also consider any other comprehensive income (OCI) amounts recorded by the investor that relate to its equity method investment. We believe that the equity method investment carrying amount should include the effects of any OCI amounts, except for OCI related to foreign currency translation adjustments.
There is a general presumption that equity method should be suspended and losses should not be recognized in excess of the total investment (including any additional advances). It is important that investors continue to track unrecognized equity method losses to determine when to record subsequent period equity method earnings. See EM 4.5.3 for further discussion.
An investor may record losses in excess of the carrying amount of the investment if the investor has guaranteed the investee’s obligations or has committed to provide further financial support to the investee, as described in ASC 323-10-35-20.

ASC 323-10-35-20

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.

Judgment should be exercised when assessing if the investor is committed to provide further financial support for the investee and should be based on an analysis of the related facts and circumstances. The following are factors that should be considered in making this assessment:
  • Legal and quasi-legal obligations

    When the investor is legally obligated to assume, underwrite, or guarantee investee obligations, an investor would recognize losses in excess of the its investment.

    When an investor has guaranteed investee obligations, it may need to record losses allocable to the other investors instead of only its proportionate share of the investee’s losses. If the investor is legally obligated to fund more than its portion of the investee losses (i.e., other investors are not obligated to fund losses), the investor will generally be required to record investee losses otherwise allocable to other investors, since it is likely that such other investors will not bear their share.

    When the other investors are obligated to fund a proportionate share, the investor should assess the ability of the other investors to fund if necessary, not the probability that the investee will require funding. If it is probable that the other investors will not fund their portion of the investee losses, the investor is required to record the entire loss of the investee up to its legal obligation (i.e., beyond its proportionate share). This could occur when the other investors, while legally obligated to provide support, choose not to or lack the financial capability to fund.

    Investors should also consider joint and several liability arrangements under which the lender can demand payment of the total amount from any one of the obligors (investors) or combination of obligors. While the investor may be able to pursue payment from the other investors, it again would need to consider the likelihood that the other investors would be able to fund their respective obligations. The accounting for joint and several liability arrangements is contained in ASC 405-40. See FG 2 for further information on the accounting for joint and several liability arrangements.

    Losses in excess of the investment should ordinarily be recognized when the investor has a “quasi-legal” obligation to underwrite investee losses. A quasi-legal obligation is based on factors other than a strict obligation, such as the business relationship and credit standing of the other investors. When the investor has followed the practice of underwriting investee losses through advances, or there is a strong presumption that the investor would “make good” the obligations of an investee in order to preserve its credit rating, business reputation, or other important relationships, recognition of losses may be required even without a legally binding obligation. This determination requires judgment and may be based predominantly on the intent of the investor. When the investor has previously acted upon that intent by funding the investee, it would be difficult to support a change in intent not to fund the investee, absent the occurrence of a change in business strategy.

    The investor must consider whether the other investors also have a quasi-legal obligation and will bear their share of the losses. This is necessary to determine whether the investor should record losses otherwise allocable to other investors, in addition to its allocated losses. The requirements of ASC 460 should be considered as they relate to such guarantees.

    To the extent an investor is funding the losses of an investee, the investor should consider the provisions of the variable interest entity model to determine whether the investee may be a VIE and require consolidation by the investor. The funding of losses may also require reconsideration of previous consolidation conclusions under ASC 810-10.
  • Publicly stated investor intentions

    Public statements by the investor of its intention to abandon, or to continue to provide support to, an investee should be considered.
  • Operating considerations

    Operating matters should be considered to the extent practicable. The following circumstances may indicate the investor is unlikely to abandon the investee and, therefore, full recognition of losses in excess of the investor’s investment is appropriate:

    • Investee losses are attributable to start-up costs, or similar circumstances that are considered temporary or nonrecurring, and a turnaround to profitable operations is expected.
    • The investee may be in an industry in which accounting losses can be sustained more or less indefinitely without impairing the going concern assumption (e.g., real estate development companies).
    • The operation experiencing losses may integrate favorably with other consolidated operations.
    • The investor is a major supplier to or major purchaser from the investee.
    • The investor is dependent on the investee for strategic development processes (for example, research and development or new technologies).
    • Any other factors indicating that the investor has an incentive to protect and support the investee.

The key consideration from an operating perspective is whether the investor would abandon the investee. This assessment is based on the investor’s relationship with the investee and the other investors and should consider all relevant facts and circumstances.
Losses are also required to be recognized by an investor in excess of its investment when the imminent return to profitability by the investee is assured. This determination requires the exercise of judgment. This differs from consolidation guidance in ASC 810-10, which requires losses to continue to be attributed to the noncontrolling interest even if that results in a debit balance.

ASC 323-10-35-21

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.

4.5.1 Change of interest after suspension of equity method losses

An investor should consider whether a subsequent investment in an investee after the investor has suspended recognizing equity method losses provides the investor with a controlling financial interest in the investee. If the investor gains a controlling financial interest in the investee, the investor would follow the acquisition guidance in ASC 805. See EM 5 for further discussion on the accounting for changes in interest.
When an additional investment does not provide an investor with a controlling financial interest, the investor should consider whether the additional investments, in substance, represent the funding of prior losses versus an additional investment. The investor should recognize previously suspended losses only up to the amount of the additional investment determined to represent the funding of prior losses. The investor should also consider whether it has otherwise become committed to provide financial support to the investee when making an additional investment.
Whether an investment represents the funding of prior losses depends on the facts and circumstances. Judgment is required to determine whether prior losses are being funded. All available information should be considered in performing the related analysis. ASC 323 provides additional factors for consideration.

ASC 323-10-35-29

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:

  1. Whether the additional investment is acquired from a third party or directly from the investee. If the additional investment is purchased from a third party and the investee does not obtain additional funds either from the investor or the third party, it is unlikely that, in the absence of other factors, prior losses are being funded.
  2. The fair value of the consideration received in relation to the value of the consideration paid for the additional investment. For example, if the fair value of the consideration received is less than the fair value of the consideration paid, it may indicate that prior losses are being funded to the extent that there is disparity in the value of the exchange.
  3. Whether the additional investment results in an increase in ownership percentage of the investee. If the investment is made directly with the investee, the investor shall consider the form of the investment and whether other investors are making simultaneous investments proportionate to their interests. Investments made without a corresponding increase in ownership or other interests, or a pro rata equity investment made by all existing investors, may indicate that prior losses are being funded.
  4. The seniority of the additional investment relative to existing equity of the investee. An investment in an instrument that is subordinate to other equity of the investee may indicate that prior losses are being funded.

4.5.2 Investor holds other investments in the investee

When an investor has investments outside its equity method investment, such as preferred stock and loans, the investor would continue to recognize investee losses up to the investor’s aggregate carrying value in those other investments. The recognition of losses would include any additional financial support made or committed to by the investor. An investment considered to be in-substance common stock may generally be grouped with, and considered, common stock for the purposes of performing the investee loss allocations required.

ASC 323-10-35-25

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).

Equity method losses should be applied to other investments based on seniority, beginning with the most subordinated investments. For each period, the basis of the other investments should first be adjusted for equity method losses and may need to be further adjusted after applying the relevant impairment guidance for those investments. For example, assume an investor invests in both common stock and preferred stock of an investee and made advances to the investee in the form of debt. Subsequently, if the investor’s share of equity method losses reduces the basis of its common stock investment to zero, the investor should continue to recognize equity method losses to the extent of, and as an adjustment to, the basis of the preferred stock (the next most senior security). The advance to the investee in the form of debt would continue to be accounted for in accordance with the provisions of an impairment of a loan by a creditor. However, once the cost basis of the investment in the preferred stock also reaches zero, investee losses would be recognized to the extent that the net carrying amount of the debt (net of any valuation account or amortization) exceeded zero. At all times, the preferred stock would require a write-up (or write-down) to fair value through income if it is an equity security as defined in ASC 321 (absent applying the measurement alternative) or through OCI if it is a debt security as defined in ASC 320 (and reported as available for sale).

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.

When an investor’s investment in common stock has been reduced to zero and it has other investments in the investee, the investor generally should not recognize incremental equity method losses against its other investments based only on percentage of investee common stock held in accordance with ASC 323-10-35-28. There are two acceptable methods that could be applied. An investor would either recognize investee losses based on (1) the ownership level of the particular investee security or loan/advance held by the investor to which the equity method losses are being applied, or (2) the change in the investor’s claim on the investee book value. Once elected, one method should be applied consistently for all equity method investments.
Example EM 4-8 illustrates the approach to attribute investee losses based on ownership level of the particular investee security or loan/advance held by the investor. EM 4.1.3 includes an example of a change in the investor’s claim on the investee book value from ASC 323-10-55-49.
EXAMPLE EM 4-8
Attribution of investee losses when investor has other investment
On January 1, 20X1, Company XYZ began its operations with three investors, Company A, Company B, and Company C.
  • Company A acquired 1,000,000 shares of Company XYZ’s common stock for $1 per share and loaned Company XYZ $1,000,000 in cash.
  • Company B acquired 750,000 shares of Company XYZ’s common stock for $1 per share and 1,000,000 shares of Series A voting preferred stock in Company XYZ for $2 per share. The preferred stock is not considered in-substance common stock.
  • Company C acquired 750,000 shares of Company XYZ’s common stock for $1 per share.

Company A, Company B, and Company C account for their respective investments in common stock under the equity method of accounting.
For simplicity, this example assumes the preferred stock is measured using the measurement alternative with no observable changes in fair value or impairment under ASC 321, Investments – Equity Securities, and the loan was not impaired under ASC 310, Receivables.
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 XYZ incurred losses of $2,500,000 and $2,750,000 in 20X1 and 20X2, respectively. None of Company XYZ’s investors is required to provide additional financial support. Assume that Company XYZ is not a VIE.
What are Company A, Company B, and Company C’s respective shares of Company XYZ’s losses for 20X1 and 20X2?
Analysis
The following table illustrates how Company A, B, and C should account for the losses in Company XYZ for 20X1 and 20X2, given their investments in Company XYZ.
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.

4.5.3 Investee return to profitability

When the investor does not recognize investee losses in excess of its investment and the investee returns to profitability and subsequently reports net income or OCI, the investor generally should resume applying the equity method, absent any investee capital transactions, only after the investee’s shareholders’ deficit is eliminated (i.e., once the investor has equity in the net assets of the investee). This requires the investor to continue to track its unrecorded share of investee losses during the period the equity method has been suspended.
The “share of net losses not recognized” should be the aggregate of the investor’s share of investee losses and any adjustments related to subsequent accounting for basis differences (see EM 4.3.1) that would have been charged to income during the period when losses were not recognized.

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.

When an investee returns to profitability, an investor generally restores its investment balance only to the extent of the investor’s equity in net assets of the investee. Therefore, an investor would generally not restore the remaining balance of any unamortized basis differences that were not recognized after losses reduced the investor’s investment balance to zero.
Example EM 4-9 illustrates the methodology that is generally employed when an investor restores its investment balance after (1) an investor does not recognize investee losses in excess of its investment balance and (2) an investee returns to profitability.
EXAMPLE EM 4-9
Prior losses in excess of investment not recognized
Investor pays $100 for a common stock investment in Investee and determines that it is able to exercise significant influence over Investee. At the date of acquisition, Investor’s share of Investee net assets is $70. Investor determines that the $30 excess cost over net assets of Investee (initial basis difference) relates entirely to a manufacturing plant. The basis difference assigned to the plant is being depreciated on a straight-line basis over 10 years.
Investee has incurred losses for the first three years. Investor’s share of those losses amounted to $40 per year. Investee is profitable in year four and five and Investor’s share is $70 in each of those years.
Composition of ending investment
Date
Investor share of Investee income (loss)
Depreciation of basis difference
Equity in net income of Investee (loss) reported by Investor
Period-end investment balance
Equity element
Basis difference
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)
0
12/31/20X4
70
20
20
20
0
12/31/20X5
70
70
90
90
0
In year 3, Investor recorded losses that reduced the carrying amount of its investment to zero, resulting in the elimination of the remaining unamortized basis difference.
In year four, Investor restored its investment only to the extent of Investor’s equity in net assets of Investee. Investor did not restore the unamortized basis difference related to the plant. Therefore, for the year ending 12/31/20X4, Investor’s proportionate share of Investee’s net income is limited to $20 ($20 = ($50) + $70).

If an investor had other investments (e.g., preferred stock) in the investee entity when equity method losses had also been recorded as an adjustment to these investments, the investor’s share of investee’s earnings in a subsequent return to profitability should first be applied to those other investments in reverse order (i.e., starting with the most senior investment).
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