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10.4 Equity method investments—income statement presentation
Publication date: 30 Sep 2023
us Financial statement presentation guide
ASC 323-10-45-1 requires an investor's share of earnings or losses from its investment in common stock accounted for under the equity method to be shown as a single amount on the income statement, except for its share of accounting changes reported in the financial statements of the investee, which should be classified separately in the investor's income statement. In addition, an investor may need to make other adjustments to its proportionate share of the earnings or losses of an investee (e.g., eliminating intercompany gains and losses, recognizing impairments at the investor level, converting the investee's financial statements to US GAAP), as further discussed in this section. Equity method investments can be aggregated for purposes of presenting the investor's share of earnings or losses in the income statement.
When practicable, the investee's financial information should be as of the same dates and for the same periods as presented in the reporting entity's financial statements. However, if the investee's financial information is reported on a lag, the reporting entity would ordinarily record its share of the earnings or losses of an investee using the most recently available financial statements, provided this approach is applied consistently. If an investor changes the period of the lag, that would generally be considered a change in accounting principle and require retrospective application and disclosures in accordance with ASC 250. See EM 4.4 for further information on lag reporting.
10.4.1 Equity method investments—presentation alternatives
The investor's share of the investee's earnings or losses is generally presented as a single amount in the income statement. Limited exceptions to this presentation are permissible, as discussed in this section.
Example FSP 10-1 illustrates the presentation of equity in net earnings of an investee as a single amount in the income statement.
EXAMPLE FSP 10-1
Presentation of equity in net earnings of investee as a single amount
Presentation of equity in net earnings of investee as a single amount
FSP Corp owns 40% of the common stock of Company A and has the ability to exercise significant influence over the operating and financial policies of this investee. FSP Corp accounts for Company A as an equity method investee. There are no intercompany transactions, consolidation-type adjustments required for investee capital changes (e.g., exercise of stock options issued by investee), or differences between investor cost and underlying equity in investee net assets. FSP Corp is taxed at 40%.
Additionally, note that any tax provision required by ASC 740, Income Taxes, relating to the temporary difference arising from the use of the equity method for book purposes and the cost method for tax purposes has been omitted to simplify the illustration.
During the year, FSP Corp has income before taxes of $160,000 and income taxes of $64,000. FSP Corp's portion of Company A's earnings is $39,000, net of tax.
How should FSP Corp present the equity in net earnings of Company A as a single amount in the financial statements?
Analysis
FSP Corp should present the equity in net earnings of Company A as a single amount as follows:
Income before income taxes and equity in net earnings of affiliate
|
$160,000
|
Income taxes
|
64,000
|
Income before equity in net earnings of affiliate
|
96,000
|
Equity in net earnings of affiliate
|
39,000
|
Net income
|
$135,000
|
The presentation in Example FSP 10-1 is consistent with the presentation requirements of S-X-5-03. S-X 5-03 generally requires equity method earnings to be presented below the income tax line unless a different presentation is justified by the circumstances. The SEC staff has indicated that, in certain limited circumstances, it may be appropriate to include income from equity investments in operations because some reporting entities operate their business largely through equity investees, or the equity investee may be integral to the investor's operations. However, classification within revenue from contracts with customers is not allowed.
The income statement caption for the equity method earnings should be appropriately titled depending on its nature (e.g., "Equity in net earnings of Company A," or "Share of net earnings of equity method investee"). Additionally, the subtotal for income prior to equity in net earnings of affiliate (required for SEC registrants) should be appropriately titled, as illustrated in Example FSP 10-1.
If the equity method earnings are of such a nature that it is acceptable for them to be presented within operations, the amount must be net of taxes as recorded by the investee in determining its net income. To do otherwise would be tantamount to proportionate consolidation.
When the investee is a partnership, the investor/partner's share of the income of the partnership is taxable at the investor level, not at the partnership level. In such cases, a question may arise as to whether the equity earnings should be reported before or after the investor's income tax provision on its income statement. We would encourage the investor to report equity earnings after the income tax provision line on its income statement because any taxes due on its equity method investment in the partnership would be reported in its income tax provision.
Figure FSP 10-1 illustrates common methods an investor may use for income statement presentation of equity method earnings, which depend on the nature of the equity method investee and whether the investee is a taxable or non-taxable entity.
In practice, the presentation of equity in earnings in the income statement varies. Careful consideration should be given to how investor and investee activity related to an equity method investment is presented. Depending on the facts and circumstances, an alternative presentation may be acceptable when accompanied by appropriate disclosures in order to allow users of the financial statements to understand the activity presented.
Figure FSP 10-1
Methods of presenting earnings of equity method investees in the income statement
Methods of presenting earnings of equity method investees in the income statement
Presentation |
Additional considerations |
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|---|---|---|---|
Earnings of non-taxable investees
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In operating profit
|
The SEC staff has indicated that presenting equity method earnings from an investee within the operating income section of the investor's income statement is acceptable in very limited circumstances.
|
|
Before tax provision line item
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For a non-taxable investee, there is no difference between gross or net of tax presentation as the investee is not taxed.
|
||
Below tax provision line item
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The investor's income tax provision line would include any income tax levied against the investor for its share of the investee's results.
|
||
Earnings of taxable investees ("net of tax" presentation)
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In operating profit
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The SEC staff has indicated that presenting equity method earnings from an investee within the operating income section of the investor's income statement is acceptable in very limited circumstances.
|
|
Below tax provision line item
|
The investor's income tax provision line would include any income tax levied against the investor for its share of the investee's results.
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10.4.1.1 Other relationships between the investor and investee
In certain situations, investments are made principally to secure channels of distribution or to finance licensees. In such cases, the return on the investment in common stock may be nominal and incidental to earning royalties, technical fees, and similar types of income. In other cases, in addition to an investment in common stock, the investor may have a substantial investment in the investee in the form of advances or senior securities.
In such circumstances, because of the interplay between royalties, technical fees, interest, or other items, and the return on investment in the investee entity, it may be more meaningful to combine these amounts in presenting equity in income of the investee. When such presentation is used, the following should be considered:
- The investment account on the balance sheet should include the investment in common stock, advances, and senior securities consistent with how it is presented in the income statement.
- The separate amounts and the fact that they were combined in the financial statements are required to be disclosed. Appropriately descriptive captions should be used (e.g., "equity in income of and technical fees and interest earned from investees").
10.4.1.2 Full or partial sale of equity method investment
The gain or loss from the sale of an equity method investment may be presented in either of the following ways in the income statement:
- In non-operating income, gross of tax, before the income tax provision
- In the same line item in which the investor reports the equity in earnings of the investee
These methods are also appropriate to record a gain or loss when the investor's ownership interest is diluted as a result of the investee issuing additional shares, and the investor does not maintain its proportionate ownership interest (i.e., an indirect sale). See EM 5.4 for further information on indirect sales. Appropriate disclosures about the sale should be made in the investor's financial statements as necessary, in accordance with the guidance in ASC 860.
In accordance with ASC 205-20-45, the sale of an equity method investment may qualify as discontinued operations. For more information on the criteria for reporting discontinued operations, refer to FSP 27.
10.4.1.3 Other-than-temporary impairment
When an investor records an other-than-temporary impairment charge for an equity method investment, the impairment charge should generally be included as a component of the investor's share of the earnings or losses of the investee.
In the absence of prescriptive disclosure requirements for an other-than-temporary impairment under ASC 323, a reporting entity may consider disclosing the following in the notes to the financial statements in the period in which it recognizes an other-than-temporary impairment:
- A description of the impaired equity method investment and the facts and circumstances leading to the impairment, and
- The amount of the impairment loss included in the investor’s share of earnings or losses of the investee
See FSP 20.3 for the required disclosures for assets measured at fair value on a non-recurring basis.
10.4.1.4 Investor cost vs. underlying equity in net assets of investee
When an investor purchases an investment that will be accounted for by the equity method, the amount paid for the investment may not equal the investor's proportionate share of the investee's net book value. Any difference between the two amounts is commonly referred to as a basis difference. The investor's share of the investee's earnings should be adjusted for the amortization or accretion of basis differences between the carrying amount and its interest in the underlying net assets of the investee, if applicable (see EM 3.3.1 and EM 4.3.1 for further information).
The guidance in ASC 323-10-35-13 requires that a difference between the cost of an investment and the amount of underlying equity in net assets of an investee be accounted for as if the investee were a consolidated subsidiary. The investor must identify which individual assets or liabilities have fair values different from the corresponding amounts recorded in the investee's financial statements. If the basis difference is assigned to depreciable or amortizable assets, such as property, plant, and equipment or intangibles assets, the difference should be depreciated, amortized, or accreted over the useful lives of the related assets and included as a component of the investor's share of the earnings or losses of the investee.
10.4.1.5 Intercompany profits on transactions between investor and investee
The presentation of the effects of intercompany profits on transactions between an investor and an investee in an investor's income statement and balance sheet will depend on what is most meaningful in the circumstances. A number of alternative methods of presentation may be acceptable, as discussed in EM 4.2. Refer to FSP 26.4 for further information on related party disclosure requirements.
10.4.1.6 Private company accounting alternatives adopted by investee
A public company investor may have an interest in a private company investee that has elected an accounting alternative approved by the Private Company Council (PCC) and endorsed by the FASB (PCC alternative). A public company investor should eliminate the effects of its private company investee's application of such PCC alternatives by adjusting its proportionate share of the earnings or losses of the investee to arrive at an equity in earnings amount as if the investee had never elected the PCC alternative. These adjustments are required because PCC alternatives are not available to public companies.
10.4.1.7 New accounting principle adopted by investee at a different time
An investor and its investees may adopt new accounting principles at different times because of early adoption of the standard by one of the entities or a later mandatory adoption date for companies that are not public business entities.
An investor is not required to adjust its financial statements for a difference in the investee’s adoption date.
10.4.1.8 Discontinued operations reported by an investee
If the investee reports a discontinued operation, the investor should consider whether this represents a strategic shift that has (or will have) a major effect on its own operations and financial results and, therefore, also requires discontinued operation presentation by the investor. It is rare for the criteria for discontinued operations to be met at the investor level and, therefore, an investor would generally not report discontinued operations in its income statement for its share of the discontinued operations of an equity method investee. See FSP 27 for further information on the presentation of discontinued operations. If the investor does not report discontinued operations, it would report its share of the investee’s discontinued operations as part of the single amount in the income statement representing the investor’s share of the investee’s earnings or losses.
10.4.1.9 Investments in tax credit entities (after adoption of ASU 2023-02)
New guidance
In March 2023, the FASB issued ASU 2023-02, Investments – Equity Method and Joint Ventures (Topic 323): Accounting for investments in tax credit structures using the proportional amortization method. The new guidance expands the use of the proportional amortization method of accounting for investments in tax credit vehicles, which historically was only allowed for qualifying investments in affordable housing tax credit structures. ASU 2023-02 is effective for public entities for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. For all other entities, the guidance is effective for fiscal years beginning after December 15, 2024. Early adoption is permitted.
Many companies, particularly financial institutions, invest in limited partnerships or limited liability companies that generate various tax credits, such as those for qualified affordable housing projects, new markets, or renewable energy such as solar or wind. These investors earn federal tax credits as the principal return for providing capital to facilitate the development, construction, and/or rehabilitation of qualified projects. See FSP 16 for additional disclosure considerations and TX 3.3.6 for additional discussion on investments in tax credit structures, including criteria for determining which programs may be eligible for the proportional amortization method.
For guidance related to accounting for investments in tax credit entities prior to the adoption of ASU 2023-02, refer to FSP 10.4.1.9A.
10.4.1.9A Low income housing tax credit partnerships (before adoption of ASU 2023-02)
Many companies, particularly financial institutions, invest in limited partnerships or similar limited liability companies that operate qualified affordable housing projects or invest in one or more other entities that operate qualified affordable housing projects. These investors earn federal tax credits as the principal return for providing capital to facilitate the development, construction, and rehabilitation of low income rental property. The income statement presentation of these types of equity investments is discussed in EM 1.3.6. ASC 323-740-50 discusses the disclosure requirements for these types of investments.
For guidance related to accounting for investments in tax credit entities after adoption of ASU 2023-02, refer to FSP 10.4.1.9.
10.4.1.10 Proportionate consolidation
The proportionate consolidation method reflects an investor’s proportionate share of each item of income and expense of the investee, as adjusted for any consolidation entries. As discussed in FSP 10.3, this presentation method is only permitted in limited circumstances.
Intercompany sales between the investor and investee should be eliminated; however, the amount eliminated under the proportionate consolidation method should not exceed the investor’s share of investee sales. If intercompany sales are equal to or less than the investor’s share of the investee sales, the intercompany sales should be fully eliminated.
10.4.2 Investee accounting changes
An investor's equity share of an investee's accounting change should be reported in the investor's financial statements as if the investor had made the change. This treatment is a logical extension of the consolidation guidance.
ASC 250-10-45-3 clarifies that the adoption of accounting changes should follow the transition requirements specified in the Accounting Standards Update. In the unusual instance when there are no transition requirements, the update should be adopted by adjusting assets, liabilities, and opening retained earnings in the first comparative period presented.
When an investee records the cumulative effect of adoption of an accounting change retrospectively through opening retained earnings, the investor would reflect the investee's adoption through a corresponding adjustment to its opening retained earnings. Example FSP 10-2 illustrates this concept. Conversely, adoption of an accounting change by an investee through net income, which is less common, would be recorded by the investor through its net income.
EXAMPLE FSP 10-2
Presentation of investor’s share of an investee’s accounting change
Presentation of investor’s share of an investee’s accounting change
FSP Corp owns 40% of the common stock of Company C and has the ability to exercise significant influence over the operating and financial policies of this investee. FSP Corp accounts for Company C as an equity method investee. As a result of adoption of a new accounting standard on January 1, 20X1, Company C recorded a cumulative effect charge through retained earnings.
FSP Corp's portion of Company C's net income is $104,000 and its portion of the cumulative effect charge is $20,000. FSP Corp's net income for the year, prior to its equity earnings in Company C, is $134,000.
How should FSP Corp present the effect of Company C's accounting change in its financial statements?
Analysis
FSP Corp should record its share of the cumulative effect charge as an adjustment to retained earnings since that is how Company C recorded adoption of the new accounting standard.
FSP Corp's statement of changes in stockholders' equity should be presented as follows:
FSP Corp Statement of Changes in Stockholders' Equity Year ended December 31, 20X1 |
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Common stock $0.01 par value |
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Shares |
Amount |
Additional paid-in capital |
Retained earnings |
Total stockholders' equity |
|
Balance at December 31, 20X0
|
1,000,000
|
$10,000
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$20,546,987
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$5,000,000
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$25,556,987
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Issuance of common stock
|
200,000
|
2,000
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1,999,800
|
—
|
2,001,800
|
Net income
|
238,000
|
238,000
|
|||
Cumulative effect charge resulting from an accounting change at equity method investee
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(20,000)
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(20,000)
|
|||
Balance at December 31, 20X1
|
1,200,000
|
$12,000
|
$22,546,787
|
$5,218,000
|
$27,776,787
|
10.4.3 Investment becomes qualified for the equity method
As discussed in ASC 323-10-35-33, a reporting entity with an investment that was previously accounted for on a basis other than the equity method (e.g., at fair value) may increase its level of ownership such that the investor has the ability to exercise significant influence. The equity method of accounting should be applied prospectively, including all required equity method disclosures, from the date significant influence is obtained. See EM 5.3 for further information on investments that qualify for the equity method of accounting.
For example, assume a reporting entity owns 15% of an investee that is measured at fair value through earnings. It subsequently increases its ownership interest to 40%, which results in the investor applying the equity method. The investor would prospectively reflect its 40% interest using the equity method.
10.4.4 Investment no longer qualifies for the equity method
As discussed in ASC 323-10-35-36, when an investment in common stock of an investee entity no longer qualifies for accounting under the equity method (e.g., the ability to exercise significant influence over operating and financial policies of an investee no longer exists), the investor should discontinue accruing its share of earnings or losses of the investee. This is a change of circumstances, not a change in accounting principle, and therefore is not reflected retrospectively. Additionally, as discussed in ASC 323-10-35-39, the investor's share of the investee's other comprehensive income should be reclassified to the carrying value of the investment at the time of discontinuance of the equity method of accounting. In executing the reclassification, the reporting entity should first reduce the carrying value of the investment to zero and then record any remaining balance in income. See EM 5.4.3 for further information on investments that no longer qualify for the equity method.
10.4.5 Controlling interest to noncontrolling investment—equity method
In accordance with ASC 250-10-20, a change in reporting entity includes "changing specific subsidiaries that make up the group of entities for which consolidated financial statements are presented." Circumstances may arise in which a parent's controlling financial interest (e.g., generally an ownership interest in excess of 50% of the outstanding voting stock) is reduced to a noncontrolling investment that still enables it to exercise significant influence over the operating and financial policies of the investee. A change that results from changed facts and circumstances (such as a partial sale of a subsidiary), where there was only one acceptable method of accounting prior to the change in circumstances (consolidation) and only one acceptable method of accounting after the change (equity method accounting), is not a change in reporting entity and should not be accounted for retrospectively. Accordingly, a change from a consolidated controlling interest to a noncontrolling investment accounted for under the equity method should be accounted for prospectively from the date of change in control.
If a reporting entity loses control of a subsidiary that is a business, it should follow the derecognition guidance in ASC 810-10-40 and the disclosure requirements in ASC 810-10-50 (see FSP 18.7.2). If a reporting entity loses control of a subsidiary that is not a business and all or substantially all of the assets of the subsidiary are non-financial assets, the reporting entity should follow the derecognition guidance in ASC 610-20. See PPE 6.2.4 for further guidance on the derecognition standard for non-financial assets.
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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