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Figure LI 2-1 provides a framework for determining whether an investment in a financial instrument held by a for-profit reporting entity (other than those noted in LI 2.1) is within the scope of ASC 321.
Generally, a reporting entity considers whether consolidation, equity method, or derivative accounting applies before applying the recognition and measurement guidance in ASC 321.
Figure LI 2-1
Analysis of an equity interest held by for-profit reporting entities
*See LI 2.2.3 for information on specialized industries outside the scope of ASC 321.

2.2.1 Determining if an equity interest is a security

To determine the appropriate accounting treatment for an equity interest, a reporting entity should first determine whether the interest meets the definition of a security.
A security is defined in ASC 321 as follows.

Definition from ASC 321-10-20

Security: A share, participation, or other interest in property or in an entity of the issuer or an obligation of the issuer that has all of the following characteristics:
a. It is either represented by an instrument issued in bearer or registered form or, if not represented by an instrument, is registered in books maintained to record transfers by or on behalf of the issuer.
b. It is of a type commonly dealt in on securities exchanges or markets or, when represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment.
c. It either is one of a class or series or by its terms is divisible into a class or series of shares, participations, interests, or obligations.

The form of the instrument and the relevant jurisdiction should be considered when evaluating whether it meets the definition of a security under ASC 321. The definition in ASC 321 was based on the Uniform Commercial Code at the time the guidance was developed more than 20 years ago, but may not be consistent with the legal definition of a security today. As a result, the legal classification may not be conclusive for determining whether an instrument is a security as defined in ASC 321.
For information on equity interests that meet the definition of a security, see LI 2.2.2; for information on equity interests that do not meet the definition of a security, see LI 2.2.4.

2.2.2 Determining whether a security is a debt or equity security

After a reporting entity determines that an equity interest meets the definition of a security, it should then determine whether the security meets the definition of an equity or debt security. The accounting for debt securities is discussed in ASC 320, Investments — Debt Securities and LI 3.

Definition from ASC 321-10-20

Equity Security: Any security representing an ownership interest in an entity (for example, common, preferred, or other capital stock) or the right to acquire (for example, warrants, rights, forward purchase contracts and call options) or dispose of (for example, put options and forward sale contracts) an ownership interest in an entity at fixed or determinable prices. The term equity security does not include any of the following:
a. Written equity options (because they represent obligations of the writer, not investments)
b. Cash-settled options on equity securities or options on equity-based indexes (because those instruments do not represent ownership interests in an entity)
c. Convertible debt or preferred stock that by its terms either must be redeemed by the issuing entity or is redeemable at the option of the investor.

Securities that are legally equity interests may meet the definition of a debt security. For example, preferred stock that is mandatorily redeemable by the issuer or that can be redeemed at the option of the holder may be accounted for as a debt security. See LI 3 for information on the accounting for investments in debt securities. The definition of an equity security also includes the right to acquire an ownership interest in an entity (e.g., warrants and forward purchase contracts) or dispose of an ownership interest in an entity (e.g., put options and forward sale contracts) at fixed or determinable prices. See LI 2.2.4.1 for additional guidance.
Question LI 2-1 discusses whether an equity security issued by a mutual fund holding only US government debt should be accounted for as an equity security or a debt security.
Question LI 2-1
Should an equity security issued by a mutual fund holding only US government debt securities be accounted for as an equity security or a debt security?
PwC response
It is an equity security and is subject to the guidance in ASC 321. As discussed in ASC 320-10-55-8 and ASC 321-10-55-6, an investor should not look through the form of its investment to the nature of the interests held by the investee to determine whether ASC 320 or ASC 321 applies.

If an equity interest meets the definition of a security, but not the definition of an equity security, it should assess whether the security meets the definition of a debt security. See LI 3 for information on debt securities. Generally, we believe that the determination of whether a security meets the definition of a debt security or an equity security should be reassessed each reporting period.
Example LI 2-1, Example LI 2-2, and Example LI 2-3 discuss whether a contingently redeemable preferred stock investment should be classified as an equity security or a debt security.
EXAMPLE LI 2-1
Assessment of classification of a contingently redeemable preferred stock investment before continency has been resolved
On January 1, 20X1, a reporting entity purchases a preferred stock instrument with no maturity date. The preferred stock instrument has a contingent redemption feature such that if the issuer completes an initial public offering (“IPO”), the preferred stock instrument becomes redeemable at the investor’s option. If exercised, the redemption feature requires the issuer of the instrument to redeem the preferred stock for cash in an amount equal to its liquidation preference plus any unpaid dividends. Until such time that an IPO has been completed, the preferred stock instrument is not redeemable.
Should the reporting entity classify the preferred stock instrument as a debt or equity security at purchase?
Analysis
Upon purchase of the instrument, assuming an IPO has not yet been completed, the instrument should be considered an equity security and would be subject to the guidance in ASC 321. The definition of an equity security under ASC 321-10-20 states that preferred stock instruments that must be redeemed by the issuer or are redeemable at the investor’s option do not meet the definition of an equity security. While the preferred stock is contingently redeemable by the issuer, the redemption is only exercisable upon the successful completion of an IPO by the issuer, which is an event outside of the investor’s control. Upon purchase of the preferred stock, the instrument is neither mandatorily redeemable nor is it redeemable at the investor’s option. Therefore, the instrument would meet the definition of an equity security under ASC 321-10-20, and the reporting entity should classify it as such.
EXAMPLE LI 2-2
Assessment of classification of a contingently redeemable preferred stock investment after contingency has been resolved
On January 1, 20X1, a reporting entity purchases a preferred stock instrument with no maturity date. The preferred stock instrument has a contingent redemption feature such that if the issuer completes an initial public offering, the preferred stock instrument becomes redeemable at the investor’s option. If exercised, the redemption feature requires the issuer of the instrument to redeem the preferred stock for cash in an amount equal to its liquidation preference plus any unpaid dividends. On December 1, 20X5, the issuer completes an IPO.
On December 31, 20X5, should the reporting entity classify the preferred stock instrument as a debt or equity security?
Analysis
Following the completion of the IPO by the issuer, the reporting entity should reclassify the instrument to account for it as a debt security under ASC 320. Once the successful completion of the IPO has occurred, the redemption option is no longer contingently exercisable. The preferred stock instrument is now redeemable at any time at the reporting entity’s option. ASC 320-10-20 states that the definition of a debt security includes preferred stock that is redeemable at the option of the investor. The preferred stock instrument in this example has become redeemable at the option of the investor and therefore meets the definition of a debt security. The reporting entity should account for the preferred stock under ASC 320 as long as it has the right to redeem the security.
EXAMPLE LI 2-3
Assessment of classification of a redeemable preferred stock investment where the redemption option expires
On January 1, 20X1, a reporting entity purchases a newly issued preferred stock instrument with no maturity date. The preferred stock instrument becomes redeemable at the investor’s option five years after the issuance of the instrument (on January 1, 20X6). If exercised, the redemption feature requires the issuer of the instrument to redeem the preferred stock for cash in an amount equal to its liquidation preference plus any unpaid dividends. Once the preferred stock becomes redeemable, the investor has one year to exercise the redemption feature. After that one year, the preferred stock instrument is no longer redeemable (i.e., it is no longer redeemable as of January 2, 20X7).
On January 1, 20X1, should the reporting entity classify the preferred stock instrument as a debt or equity security? If the reporting entity still holds the instrument on January 2, 20X7 once the redemption option expires, should the reporting entity reassess the classification?
Analysis
The reporting entity should classify the preferred stock instrument as a debt security under ASC 320 when purchased on January 1, 20X1. While the preferred stock is not yet redeemable, there is no contingent event outside of the investor’s control that would prevent the instrument from becoming redeemable. Since the preferred stock instrument becomes redeemable simply by the passage of time, the preferred stock would meet the definition of a debt security under ASC 321-10-20.
If the reporting entity chooses not to exercise the redemption option when it becomes exercisable and the one-year exercise period passes, beginning on January 2, 20X7, the reporting entity should then reclassify the security to an equity security and account for it under ASC 321. Once the exercise period has passed, the preferred stock instrument is no longer redeemable. Therefore, it no longer meets the definition of a debt security under ASC 320-10-20 and now meets the definition of an equity security under ASC 321-10-20.

2.2.3 Entities within the scope of ASC 321

The ASC 321 accounting model for equity interests applies to all entities other than those that apply industry-specific guidance requiring substantially all investments to be measured at fair value with subsequent changes in fair value recognized in net income or in the change in net assets. Examples of these specialized industries include:
  • Brokers and dealers in securities
  • Defined benefit pension plans and other postretirement plans
  • Health and welfare plans accounted for under ASC 965
  • Investment companies
Some entities that are similar to the entities exempted from the scope of ASC 321 do not qualify for the scope exception and must apply the provisions of ASC 321. Examples of these industries include:
  • Cooperatives and mutual entities (such as credit unions and mutual insurance entities)
  • Trusts that do not report substantially all of their securities at fair value
Further, the specialized industry guidance that formerly applied to an insurance company’s investments in equity securities without readily determinable fair values has been superseded and no longer applies. As a result, these types of investments held by insurance companies are subject to ASC 321.
ASC 321 also applies to not-for-profit reporting entities. ASC 958-321 provides guidance on the accounting for investments in equity interests held by not-for-profit entities.
Question LI 2-2 discusses whether an investment company or broker-dealer can apply the measurement alternative for equity interests without readily determinable fair values.
Question LI 2-2
Can an investment company or broker-dealer apply the measurement alternative for equity interests without readily determinable fair values?
PwC response
No. Only entities in the scope of ASC 321 are able to apply the measurement alternative. Investment companies and broker-dealers are outside the scope of ASC 321.

2.2.4 Non-security equity interests within the scope of ASC 321

As noted in ASC 321-10-15-4, the scope of ASC 321 includes equity interests that meet the definition of an equity security, as well as certain other ownership interests in an entity.

ASC 321-10-15-4

The guidance in the Investments—Equity Securities Topic establishes standards of financial accounting and reporting for investments in equity securities and other ownership interests in an entity, including investments in partnerships, unincorporated joint ventures, and limited liability companies as if those other ownership interests are equity securities.

An investor that holds an ownership interest should account for the interest using the guidance in ASC 321 provided the investor is not required to consolidate the issuer in accordance with the guidance in ASC 810 or account for the ownership interest using the equity method of accounting.
ASC 323-30-S99-1 provides guidance on the applicability of the equity method of accounting to limited partnership (LP) interests. ASC 323-30-35-3 provides guidance to help determine whether an equity investment in a limited liability corporation (LLC) should be considered similar to a partnership for purposes of applying this guidance.

ASC 323-30-S99-1

The SEC staff’s position on the application of the equity method to investments in limited partnerships is that investments in all limited partnerships should be accounted for pursuant to paragraph 970-323-25-6. That guidance requires the use of the equity method unless the investor’s interest “is so minor that the limited partner may have virtually no influence over partnership operating and financial policies.” The SEC staff understands that practice generally has viewed investments of more than 3 to 5 percent to be more than minor.

ASC 323-30-35-3

An investment in a limited liability company that maintains a specific ownership account for each investor—similar to a partnership capital account structure—shall be viewed as similar to an investment in a limited partnership for purposes of determining whether a noncontrolling investment in a limited liability company shall be accounted for in accordance with the guidance in Topic 321 or the equity method.

For additional information on the use of the equity method of accounting, see EM.
Equity interests in LPs (and LLCs similar to a partnership) that do not result in consolidation and are not accounted for under the equity method may be eligible for a measurement alternative for equity interests without readily determinable fair values. See LI 2.3.2 for additional information on applying the measurement alternative.

2.2.4.1 Purchased options and forward contracts

The definition of an equity security subject to the guidance in ASC 321 includes certain gross physically-settled purchased options and forward contracts to acquire or dispose of an ownership interest. Gross physical settlement (or “physical settlement”) occurs when an entity settles a contract through the delivery of the underlying asset. Many physically-settled purchased options and forward contracts meet the definition of a derivative and should therefore be accounted for in accordance with ASC 815. However, entities with contracts that do not meet the net settlement criterion, or do not otherwise meet the definition of a derivative in ASC 815 but meet the definition of an equity security, need to apply the guidance in ASC 321. See DH 2.3.5 for information on the net settlement criterion.
In addition, ASC 815-10-15-141 describes certain option and forward contracts that are subject to ASC 321.

ASC 815-10-15-141

The guidance in the Certain Contracts on Debt and Equity Securities Subsections applies only to those forward contracts and purchased options having all of the following characteristics:
  1. The contract is entered into to purchase securities that will be accounted for under either Topic 320 or Topic 321.
  2. The contract’s terms require physical settlement of the contract by delivery of the securities.
  3. The contract is not a derivative instrument otherwise subject to this Subtopic.
  4. The contract, if a purchased option, has no intrinsic value at acquisition.

Recently issued guidance
In January 2020, the FASB issued ASU 2020-01, Investments—Equity Securities (Topic 321), Investments—Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815)—Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. When determining whether a forward contract or purchased option should be accounted for under ASC 321, the update clarifies that a reporting entity should not consider whether it will apply the equity method (or whether it will apply the fair value option to an investment that would otherwise apply the equity method) to the equity securities investment after the settlement of the forward contract or exercise of the purchased option. This guidance became effective for calendar year public business entities on January 1, 2021.
Subsequent to the adoption of ASU 2020-01 (see LI 13 for additional guidance on effective date and transition), ASC 815-10-15-141A provides guidance on applying ASC 815-10-15-141 to forward contracts and purchased options of equity securities that will be within the scope of ASC 323 upon purchase.

ASC 815-10-15-141A

For the purposes of applying paragraph 815-10-15-141(a) for forward contracts and purchased options, an entity shall not consider whether, upon the settlement of the forward contract or the exercise of the purchased option, individually or with existing investments, the underlying securities would be accounted for under either of the following:
  1. The equity method in accordance with Topic 323
  2. The fair value option in accordance with Topic 825 if those securities otherwise would have been accounted for under Topic 323

Question LI 2-3 discusses whether a gross physically-settled forward contract to purchase common stock issued by a public company at a fixed or determinable price is within the scope of ASC 321.
Question LI 2-3
Is a gross physically-settled forward contract to purchase common stock issued by a public company at a fixed or determinable price within the scope of ASC 321?
PwC response
Typically, no. A physically-settled forward contract to purchase common stock issued by a public company at a fixed or determinable price usually meets the definition of a derivative unless the number of shares to be delivered under the forward contract cannot be readily converted to cash (i.e., the number of shares to be delivered cannot be rapidly absorbed by the market). See DH 2.3 for information on the definition of a derivative. Forward contracts that do not meet the ASC 815 definition of a derivative are subject to the guidance in ASC 321.

Question LI 2-4 discusses whether a gross physically-settled forward contract to purchase a limited partnership interest subject to ASC 321 at a fixed or determinable price is within the scope of ASC 321.
Question LI 2-4
Is a gross physically-settled forward contract to purchase a limited partnership interest subject to ASC 321 at a fixed or determinable price within the scope of ASC 321?
PwC response
Typically, yes. A physically-settled forward contract to purchase a limited partnership interest at a fixed or determinable price would not typically meet the definition of a derivative (unless it provides for net share settlement) because many limited partnership interests cannot be readily converted to cash. In this case, it is not accounted for as a derivative, the forward contract should be accounted for as an equity security within the scope of ASC 321. ASU 2020-01 clarifies that a reporting entity should not consider whether it will apply the equity method (or whether it will apply the fair value option that would otherwise apply the equity method) to the equity securities investment after the settlement of the forward contract. This guidance became effective for calendar year public business entities on January 1, 2021. See LI 13 for additional information on the effective date and transition for ASU 2020-01. If the contract does not have a readily determinable fair value, it may be eligible for the measurement alternative discussed in LI 2.3.2.

Question LI 2-5 discusses whether a gross physically-settled option to purchase common stock issued by a private company at a fixed or determinable price is within the scope of ASC 321.
Question LI 2-5
Is a gross physically-settled option contract to purchase common stock issued by a private company at a fixed or determinable price within the scope of ASC 321?
PwC response
Typically, yes. A physically-settled option contract to purchase common stock issued by a private company at a fixed or determinable price does not usually meet the definition of a derivative (unless it provides for net share settlement) because the private company shares cannot be readily converted to cash. In that case, the option contract is considered an equity security within the scope of ASC 321. ASU 2020-01 clarifies that a reporting entity should not consider whether it will apply the equity method (or whether it will apply the fair value option that would otherwise apply the equity method) to the equity securities investment after the settlement of the forward contract. This guidance became effective for calendar year public business entities on January 1, 2021. See LI 13 for additional information on the effective date and transition for ASU 2020-01. If the contract does not have a readily determinable fair value, it may be eligible for the measurement alternative discussed in LI 2.3.2.
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