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2.3 Accounting for equity interests
Publication date: 31 May 2022
us Loans & investments guide
Figure LI 2-2 provides a framework for determining the accounting treatment for an equity interest within the scope of ASC 321.
Figure LI 2-2
Accounting for equity interests
Accounting for equity interests
2.3.1 Equity interests with readily determinable fair values
Equity interests with readily determinable fair values are carried at fair value with changes in value recorded in earnings. ASC 321 provides a definition of readily determinable fair value.
Definition from ASC 321-10-20
Readily Determinable Fair Value: An equity security has a readily determinable fair value if it meets any of the following conditions:
- The fair value of an equity security is readily determinable if sales prices or bid-and-asked quotations are currently available on a securities exchange registered with the U.S. Securities and Exchange Commission (SEC) or in the over-the-counter market, provided that those prices or quotations for the over-the-counter market are publicly reported by the National Association of Securities Dealers Automated Quotations systems or by OTC Markets Group Inc. Restricted stock meets that definition if the restriction terminates within one year.
- The fair value of an equity security traded only in a foreign market is readily determinable if that foreign market is of a breadth and scope comparable to one of the U.S. markets referred to above.
- The fair value of an equity security that is an investment in a mutual fund or in a structure similar to a mutual fund (that is, a limited partnership or a venture capital entity) is readily determinable if the fair value per share (unit) is determined and published and is the basis for current transactions.
We believe there is a rebuttable presumption that the primary exchange in a foreign country has a similar breadth and scope to the US markets. Trading volumes that provide liquidity and quoted market prices (even if such volumes do not compare to the volumes on US stock exchanges) are indicators that a primary exchange in a foreign country has a similar breadth and scope to the US markets.
2.3.1.1 Readily determinable fair value of restricted stock
Stock with a substantive restriction generally does not have a readily determinable fair value even when similar unrestricted shares are publicly traded. To be considered restricted stock, the restriction must be an attribute of the instrument itself and not a restriction on the current owner of the instrument. For example, securities pledged as collateral do not meet the definition of restricted stock regardless of whether the loan agreement prohibits sale or substitution of the securities. Voluntary restrictions on sales of stock also do not meet the definition of restricted stock.
Restricted stock with a restriction that terminates within one year of the reporting date has a readily determinable fair value based on the definition in ASC 321-10-20 (provided the unrestricted stock has a readily determinable fair value). See FV 4.8 for information on the measurement of restricted securities.
If an investor owns equity securities that are not subject to registration with the SEC, and the investor cannot require a registration statement to be filed, the securities should be considered unrestricted if and to the extent that the securities can be qualified for sale within one year under Rule 144 of Section 4 of the Securities Act of 1933, or similar rules of the SEC. Rule 144 specifies that, if certain conditions are met, a security may be sold to the public without an effective registration statement on file with the SEC, subject to a limitation on the number of shares that may be sold during a given time period.
If an investor can require that a registration statement covering the securities be filed, the securities should be considered unrestricted if it can reasonably be expected that a registration statement could become effective within one year from the date of the balance sheet, regardless of the investor’s intent with respect to requiring the filing of a registration statement. Any portion of the security holding that can be reasonably expected to qualify for sale within one year is not considered restricted and would be measured at fair value with subsequent changes in fair value recorded in net income.
Question LI 2-6 discusses whether an equity interest covered by a written call option is considered restricted stock.
Question LI 2-6
Is an equity interest covered by a written call option considered restricted stock?
Is an equity interest covered by a written call option considered restricted stock?
PwC response
An equity interest covered by a written call option is not considered restricted stock as the written call option is not an attribute of the equity interest. For example, assume a reporting entity buys common stock for $3 per share and sells a covered call option that is exercisable at $7 per share. Until the covered call option expires, the reporting entity’s policy is not to sell the security. The definition of restricted stock indicates that, if unrestricted stock is pledged as collateral, it does not become restricted stock. The same logic applies to voluntary limitations imposed when the covered call option is sold. An equity interest does not become restricted simply because a call option is voluntarily written against it.
2.3.2 Equity interests without a readily determinable fair value
ASC 321-10-35-2 provides a measurement alternative to the requirement to carry equity interests at fair value in accordance with ASC 820, Fair value measurement. The measurement alternative applies to certain equity interests without readily determinable fair values that are within the scope of ASC 321 and are otherwise required to be measured at fair value under ASC 321. It is not available for equity investments that qualify for the practical expedient within ASC 820-10-35-59, which allows the use of net asset value per share when certain conditions are met. See FV 6.2.6 for additional information on the practical expedient in ASC 820-10-35-59. The measurement alternative is also not available for equity interests for which the fair value option in ASC 825, Financial Instruments, has been elected or for reporting entities that do not apply ASC 321 because they apply certain specialized industry accounting practices (see LI 2.2.3). Application of the measurement alternative is optional and if elected, should be applied upon acquisition of an equity interest on an instrument-by-instrument basis.
ASC 321-10-35-2 provides guidance on the measurement alternative election.
An entity may elect to measure an equity security without a readily determinable fair value that does not qualify for the practical expedient to estimate fair value in accordance with paragraph 820-10-35-59 at its cost minus impairment, if any. If an entity identifies observable price changes in orderly transactions for the identical or a similar investment of the same issuer, it shall measure the equity security at fair value as of the date that the observable transaction occurred. An election to measure an equity security in accordance with this paragraph shall be made for each investment separately. Once an entity elects to measure an equity security in accordance with this paragraph, the entity shall continue to apply the measurement guidance in this paragraph until the investment does not qualify to be measured in accordance with this paragraph (for example, if the investment has a readily determinable fair value or becomes eligible for the practical expedient to estimate fair value in accordance with paragraph 820-10-35-59). The entity shall reassess at each reporting period whether the equity investment without a readily determinable fair value qualifies to be measured in accordance with this paragraph. If an entity measures an equity security in accordance with this paragraph (and the security continues to qualify for measurement in accordance with this paragraph), the entity may subsequently elect to measure the equity security at fair value. If an entity subsequently elects to measure an equity security at fair value, the entity shall measure all identical or similar investments of the same issuer, including future purchases of identical or similar investments of the same issuer, at fair value. The election to measure those securities at fair value shall be irrevocable. Any resulting gains or losses on the securities for which that election is made shall be recorded in earnings at the time of the election.
ASC 825-10-50-8 clarifies that equity interests measured in accordance with the measurement alternative in ASC 321 are not required to be included within the fair value hierarchy.
Question LI 2-7 discusses whether a reporting entity can apply the measurement alternative to an equity interest without a readily determinable fair value if it has elected the fair value option under ASC 825 for that interest.
Question LI 2-7
Can a reporting entity apply the measurement alternative to an equity interest without a readily determinable fair value if it has elected the fair value option under ASC 825 for that interest?
Can a reporting entity apply the measurement alternative to an equity interest without a readily determinable fair value if it has elected the fair value option under ASC 825 for that interest?
PwC response
No. If the fair value option is elected for an equity interest, its fair value must be measured in accordance with the provisions of ASC 820.
2.3.2.1 Election of the measurement alternative
The election to apply the measurement alternative is made upon the purchase or acquisition of the investment. Subsequent information cannot be used in hindsight to determine if a reporting entity should elect the measurement alternative. A reporting entity should document their election.
If elected for an equity interest, the measurement alternative should continue to be applied thereafter, unless the equity interest no longer meets the measurement alternative’s requirements or unless an entity chooses to discontinue use of the measurement alternative (as discussed in LI 2.3.2.6). If the measurement alternative is not elected, equity interests without readily determinable fair values should be reported at fair value in accordance with the provisions of ASC 820, with all subsequent changes in fair value recorded in net income.
2.3.2.2 Recognition and measurement - measurement alternative
When a reporting entity elects the measurement alternative in ASC 321, the equity interest is recorded at cost, less impairment. The carrying amount should be subsequently remeasured to its fair value in accordance with the provisions of ASC 820 when observable price changes (i.e., observable prices in orderly transactions for an identical or similar investment of the same issuer) occur as of the date the transaction occurred or it is impaired. Any adjustments to the carrying amount are recorded in net income.
Question LI 2-8 discusses whether the costs to acquire an equity investment, that will be accounted for under the measurement alternative, can be capitalized as part of the carrying amount.
Question LI 2-8
Can the costs to acquire an equity investment that will be accounted for under the measurement alternative be capitalized as part of the carrying amount?
Can the costs to acquire an equity investment that will be accounted for under the measurement alternative be capitalized as part of the carrying amount?
PwC response
ASC 321 does not address the initial measurement of equity investments accounted for under the measurement alternative. As a result, other applicable GAAP should be applied in determining the initial cost basis of the investment. However, it is explicit in ASC 820 that transaction costs are not a characteristic of an asset or a liability; rather, they are specific to a transaction. Therefore, once an equity investment accounted for under the measurement alternative is remeasured to fair value based on an orderly transaction of the same or similar investment from the same issuer or due to an impairment, any transaction costs capitalized upon initial measurement would effectively be written off.
Orderly transactions
ASC 321-10-20 defines an orderly transaction.
Orderly Transaction: A transaction that assumes exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction (for example, a forced liquidation or distress sale).
Observable transactions
ASC 321-10-55-8 provides guidance on determining observable prices.
To identify observable price changes, an entity should consider relevant transactions that occurred on or before the balance sheet date that are known or can be reasonably known. To identify price changes that can be reasonably known, the entity should make a reasonable effort (that is without expending undue cost and effort) to identify any observable transactions that it may not be readily aware of. The entity need not conduct an exhaustive search for all observable price changes.
Although companies are not expected to perform an exhaustive search to identify observable prices under this exception, companies should have the necessary processes and controls in place to identify observable price changes in accordance with the guidance.
Figure LI 2-3 shows examples of transactions and whether or not they would qualify as observable transactions/prices consistent with ASC 321.
Figure LI 2-3
Examples of observable transactions/prices consistent with ASC 321
Examples of observable transactions/prices consistent with ASC 321
Transaction
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Orderly and observable?
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An investee entity issues the same or similar equity instrument to new or previously-existing equity owners in exchange for cash consideration.
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Absent evidence that this is not an orderly transaction, the equity investment should be remeasured. A reporting entity should ensure that the remeasurement results in the investment being reported at fair value as defined by ASC 820.
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An existing investor sells the same or similar equity instrument from the same issuer to a new or existing investor for cash consideration.
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Absent evidence that this is not an orderly transaction, the equity investment should be remeasured. A reporting entity should ensure that the remeasurement results in the investment being reported at fair value as defined by ASC 820.
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The equity investment of an investee is sold as part of a transaction between an existing investor and a new investor for cash. The transaction involves the sale of the same investment held by the reporting entity along with several other investments in other companies. The other investments have readily determinable fair values.
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Absent evidence that this is not an orderly transaction, this transaction should be considered and the equity investment should be remeasured.
The observable price in this transaction would be calculated by subtracting the fair value of the other investments (which have readily determinable fair values) from the cash paid for the group of investments.
A reporting entity should ensure that the remeasurement results in the investment being reported at fair value as defined by ASC 820.
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The equity investments of an investee are sold as part of a transaction between an existing investor and a new investor for cash. The transaction involves the sale of the same investment held by the reporting entity along with several other investments. The other investments do not have readily determinable fair values.
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This transaction, in isolation, would not be considered a remeasurement event unless it provided evidence of impairment.
Unlike the example above, the transaction involves other investments that do not have readily determinable fair values. The transaction price of the investment held by the reporting entity would not be observable without separate observable transactions/prices for the other investments.
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Equity interests issued to employees as a form of compensation in exchange for services rendered as part of an approved long-term incentive compensation plan would not be considered an orderly transaction as it does not involve marketing activities that are usual and customary for sales of investments. In addition, it would likely not be considered an observable transaction/price because the value the reporting entity received in exchange for the equity instrument (the performance of services) is generally not observable. However, it may provide evidence of impairment.
Equity interests issued to non-employees may result in an observable transaction/price that would result in a remeasurement of the equity investment, or may provide evidence of impairment. The involvement of a third party could support a conclusion that the transaction is orderly but other factors may be considered, such as whether the price is considered observable. If the fair value of the services or goods exchanged are not readily determinable then it would be appropriate to conclude that this is not an observable transaction/price. However, it may provide evidence of impairment.
If the equity interest is remeasured or an impairment is recorded, the reporting entity should ensure that the remeasurement results in the investment being reported at fair value as defined by ASC 820.
Question LI 2-9 discusses whether identifying an orderly transaction in the same investment or similar investment of the same issuer that occurred during a prior reporting period, but the transaction was not identified until after the issuance of the financial statements for that period, would be considered an error.
Question LI 2-9
Assume a reporting entity identifies an orderly transaction in the same investment or similar investment of the same issuer that occurred during a prior reporting period but the transaction was not identified until after the issuance of the financial statements for that reporting period. Would this be considered an error?
Assume a reporting entity identifies an orderly transaction in the same investment or similar investment of the same issuer that occurred during a prior reporting period but the transaction was not identified until after the issuance of the financial statements for that reporting period. Would this be considered an error?
PwC response
A reporting entity should have processes and internal controls over identifying transactions. These processes and controls should continually be re-evaluated based on changes in market conditions and practices. If the reporting entity made a reasonable effort to search for observable transactions but did not identify the transaction, then the subsequent discovery of a pre-balance sheet date transaction would not constitute an error. The reporting entity should record an adjustment to the carrying value in the period in which the transaction is identified. If a reporting entity concludes that the transaction should have been identified in a previous reporting period because processes and controls were insufficient, this should be evaluated as an error under ASC 250.
Question LI 2-10 and Question LI 2-11 discuss the accounting implications of identifying an orderly transaction in the same investment or similar investment of the same issuer after the balance sheet date but prior to the issuance of financial statements for that period.
Question LI 2-10
Assume a reporting entity identifies an orderly and observable transaction in the same investment or similar investment of the same issuer that occurred during the current reporting period, but the transaction is not identified until after the balance sheet date, yet prior to the financial statements being issued. Should the reporting entity adjust the carrying value of the equity interest to its fair value as of the date of the observable transaction in the financial statements that have not yet been issued?
Assume a reporting entity identifies an orderly and observable transaction in the same investment or similar investment of the same issuer that occurred during the current reporting period, but the transaction is not identified until after the balance sheet date, yet prior to the financial statements being issued. Should the reporting entity adjust the carrying value of the equity interest to its fair value as of the date of the observable transaction in the financial statements that have not yet been issued?
PwC response
Yes, we believe a reporting entity should adjust the carrying value of that equity interest to its fair value because an orderly and observable transaction in the same or similar investment occurred prior to the balance sheet date and was identified before the financial statements were issued. ASC 321-10-35-2 states that a reporting entity should measure an equity interest at fair value as of the date the orderly transaction occurred. Since the orderly transaction occurred prior to the balance sheet date, the carrying value of that equity interest must be adjusted to reflect the remeasurement to fair value triggered by the observable transaction.
Question LI 2-11
Assume a reporting entity identifies an orderly and observable transaction in the same investment or similar investment of the same issuer that occurred after the balance sheet date but is identified prior to the financial statements being issued. Should the reporting entity adjust the carrying value of the equity interest to its fair value in the financial statements that have not yet been issued?
Assume a reporting entity identifies an orderly and observable transaction in the same investment or similar investment of the same issuer that occurred after the balance sheet date but is identified prior to the financial statements being issued. Should the reporting entity adjust the carrying value of the equity interest to its fair value in the financial statements that have not yet been issued?
PwC response
ASC 321-10-35-2 states that the equity interest should be measured at fair value as of the date the orderly transaction occurs. As a result, the observable transaction would be a trigger to remeasure the equity investment to fair value in the subsequent reporting period.
However, an orderly transaction that occurs after the balance sheet date that indicates that the fair value of the equity interest is below the current carrying value could be an indication that an impairment existed as of the balance sheet date. If an impairment existed as of the balance sheet date, the reporting entity should measure the equity interest at its fair value as of the balance sheet date. Refer to LI 2.3.2.5 for further discussion on the impairment of equity interests using the measurement alternative.
The reporting entity should consider disclosing the impact from remeasuring the instrument to fair value under the subsequent events guidance.
Similar investments
ASC 321-10-55-9 provides guidance on identifying similar investments of the same issuer.
To identify whether a security issued by the same issuer is similar to the equity security held by the entity, the entity should consider the different rights and obligations of the securities. Differences in rights and obligations could include characteristics such as voting rights, distributions rights and preferences, and conversion features. The entity should adjust the observable price of a similar security for the different rights and obligations to determine the amount that should be recorded as an upward or downward adjustment in the carrying value of the security measured in accordance with paragraph 321-10-35-2 to reflect the fair value of the security as of the date that the observable transaction for the similar security took place.
Application of the above guidance could be operationally challenging for reporting entities. In order to determine whether an equity interest issued by the same issuer is similar to an equity interest held by the reporting entity, a detailed understanding of the contractual terms of both equity interests must be obtained. Even in circumstances when differences in rights and obligations are readily apparent, determining whether two equity interests are similar is highly judgmental.
ASC 321 provides limited guidance on how to determine if an instrument is similar. To identify whether an instrument issued by the same issuer is similar to the equity instrument held by the reporting entity, the entity should consider if there are different rights and obligations of the investments, which may include differences in liquidation preferences, distribution/dividend rights, conversion features, or voting rights.
The reporting entity should consider, among other things, the following questions in evaluating whether the instruments are similar:
- Would differences in rights and obligations have a significant impact on the valuation of an instrument?
- Would the adjustment from the observable transaction price to reflect the differences in rights and obligations require significant use of unobservable data?
The determination of whether an instrument is similar should be based on a holistic analysis. Individual factors may not be determinative. For example, the adjustment to compensate for the differences between two instruments may involve significant use of unobservable data, but if the adjustment would have an insignificant impact on the fair value of the instrument, this may indicate that the instruments are similar. In other situations, the impact on fair value of an identified difference may be significant, but if it is easy to calculate and does not require significant use of unobservable data, this may also indicate the instruments are similar.
Conclusions on whether or not instruments are similar may change over time based on changes to the investee’s business and capital structure (e.g., a start-up versus an established company). Reporting entities should document the support of their conclusions.
Even if a reporting entity concludes that the observable transaction does not involve similar equity instruments, the transaction may be an indicator of impairment.
If a reporting entity concludes that the investments are similar, it should adjust the price of the similar investment as appropriate in order to arrive at a value that represents the fair value of the instrument held.
2.3.2.3 Remeasurement of purchased options and forward contracts
As discussed in LI 2.2.4.1, physically-settled purchased options and forward contracts to acquire or dispose of an ownership interest that do not meet the net settlement criterion, or do not otherwise meet the definition of a derivative under ASC 815 but meet the definition of an equity security, should apply ASC 321. See DH 2.3.5 for information on the net settlement criterion.
Under the measurement alternative, a change in the observable price or impairment of the forward contract or purchased option’s underlying equity investment results in the remeasurement of the entire fair value of the forward contract or purchased option in accordance with ASC 815-10-35-6. As such, when remeasuring the forward contract or option, a reporting entity is required to update all inputs to the valuation and not just the input related to the change in the value of the underlying security.
ASC 815-10-35-6 requires that equity instruments that are subject to ASC 321 acquired under forward contracts should be recorded at their fair values at the settlement date. It also requires the same treatment for option contracts with no intrinsic value at acquisition. We generally believe this guidance should also be applied to option contracts that have intrinsic value at acquisition. As a result, a reporting entity applying the measurement alternative would measure the entire fair value of the equity security as of the settlement date of the forward contract or purchased option.
Changes in the fair value of forward contracts and purchased options on equity securities within the scope of this Subsection shall be recognized in earnings as they occur. Changes in observable price or impairment of forward contracts and purchased options on equity securities without readily determinable fair value within the scope of this Subsection measured in accordance with paragraph 321-10-35-2 shall be recognized in earnings as they occur. A change in observable price or impairment of the underlying securities of forward contracts and purchased options on equity securities shall result in a remeasurement of the entire fair value of the forward contracts and purchased options as of the date that the observable transaction took place. Equity securities within the scope of this Subsection purchased under a forward contract or by exercising an option shall be recorded at their fair values at the settlement date.
2.3.2.4 Remeasurement - foreign denominated equities
Foreign denominated equity investments that do not result in consolidation or the application of the equity method are considered non-monetary assets under ASC 830. If the equity investment is measured at fair value, the period end exchange rates should be utilized, as changes in exchange rates are considered part of changes in fair value. If the measurement alternative is applied to the equity investment, then the guidance in ASC 830-10-45-18 should be applied. Under that guidance, the historical rate at acquisition should be utilized until a remeasurement event occurs. In the period the carrying value is adjusted because of either an impairment or an observable price change, consistent with ASC 820, the fair value of the instrument should be reflected in the reported entity’s functional currency based upon the spot rates in effect at the time of the remeasurement event. The resulting change in the carrying value, inclusive of the changes in value attributed to changes in exchange rates, would be recorded in earnings. The spot rate used at that point would become the “new” historical exchange rate until the carrying value is adjusted again as a result of an observable transaction or impairment.
2.3.2.5 Impairment of equity interests—measurement alternative
An ongoing assessment will need to be performed to determine whether an equity interest for which the measurement alternative has been elected has become impaired. The interest is impaired if based on a qualitative assessment of impairment indicators, the fair value of the equity interest is less than its carrying amount. If considered impaired, the difference between the carrying amount and fair value should be recorded in net income.
The impairment charge is a basis adjustment that reduces the carrying amount of the equity interest to its fair value. It is not a valuation allowance. The carrying amount of an equity interest should be remeasured to fair value even if the equity interest has previously been impaired if there is an observable price from an orderly transaction for identical or similar security from the same issuer or an additional impairment.
ASC 321 discusses impairment indicators that a reporting entity should consider. Other impairment indicators outside of those listed in ASC 321-10-35-3 should be considered if relevant.
Excerpt from ASC 321-10-35-3
a. A significant deterioration in the earnings performance, credit rating, asset quality, or business prospects of the investee
b. A significant adverse change in the regulatory, economic, or technological environment of the investee
c. A significant adverse change in the general market condition of either the geographic area or the industry in which the investee operates
d. A bona fide offer to purchase, an offer by the investee to sell, or a completed auction process for the same or similar investment for an amount less than the carrying amount of that investment
e. Factors that raise significant concerns about the investee’s ability to continue as a going concern, such as negative cash flows from operations, working capital deficiencies, or noncompliance with statutory capital requirements or debt covenants.
In assessing an equity investment for impairment, the measurement alternative model does not include a significance threshold or the ability to avoid an impairment if a reporting entity believes the decline in fair value is temporary. ASC 321 does not recognize the concept of “other than temporary” as it relates to an impairment assessment.
The impairment model under ASC 321 is a one-step impairment model under which a reporting entity should compute the fair value of an equity investment in accordance with ASC 820 if it has reason to believe the investment’s fair value is below the carrying value. If the equity investment’s fair value is below the carrying value, the reporting entity must record an impairment for the difference.
Question LI 2-12 discusses whether changes in foreign currency exchange rates can result in an impairment of a foreign-denominated equity investment accounted for under the measurement alternative.
Question LI 2-12
Can changes in foreign currency exchange rates result in an impairment of a foreign-denominated equity investment accounted for under the measurement alternative?
Can changes in foreign currency exchange rates result in an impairment of a foreign-denominated equity investment accounted for under the measurement alternative?
PwC response
Yes. If a reporting entity has reason to believe the fair value of an equity investment accounted for under the measurement alternative is below the carrying value of the instrument, the entity must compute the fair value of the instrument. The entity would record an impairment if the fair value is below carrying value. Changes in spot rates affect the fair value of a foreign-denominated equity investment since, consistent with ASC 820, the fair value of an instrument is recorded in the reporting entity’s functional currency. Accordingly, fluctuations in foreign currency exchange rates are an indicator that should be considered in conjunction with other indicators in the assessment of impairment.
Example LI 2-4 demonstrates the application of the impairment model for an equity security without a readily determinable fair value when a reporting entity has elected to apply the measurement alternative.
EXAMPLE LI 2-4
The measurement alternative impairment model
The measurement alternative impairment model
Investor Corp purchases preferred stock issued by Private Co, a private manufacturer of digital technology equipment, for $100. Investor Corp has concluded that its investment meets the definition of an equity security and is therefore within the scope of ASC 321. The preferred stock does not have a readily determinable fair value and does not qualify for the practical expedient in ASC 820-10-35-59. Investor Corp elects to account for its investment in Private Co in accordance with the measurement alternative in ASC 321-10-35-2.
As a result of a significant technological advance by a competitor, Private Co’s digital technology becomes obsolete; as a result, its ability to attract new business has been adversely impacted and its cash flow projections have been revised significantly downward.
How should Investor Corp assess the need for an impairment charge?
Analysis
To determine whether its equity interest in Private Co has been impaired, Investor Corp should first determine whether the deterioration in Private Co’s business will have an adverse effect on the fair value of its investment in Private Co. Investor Corp would likely conclude that an impairment has occurred given the presence of the following impairment indicators:
- The significant deterioration in the ability to attract new business
- The obsolescence of Private Co’s technology relative to the environment it operates in
- The downward revision to cash flow projections
Investor Corp would therefore need to estimate the fair value of the investment. If the estimated fair value is below its carrying amount, the investment is impaired and its carrying amount should be written down to the estimated fair value (determined in accordance with ASC 820) with the offset recorded in net income.
Example LI 2-5 demonstrates how to subsequently account for an equity interest without a readily determinable fair value that had an impairment in a prior period.
EXAMPLE LI 2-5
Adjustment arising from an observable price for a similar security of the same issuer
Adjustment arising from an observable price for a similar security of the same issuer
Investor Corp purchases preferred stock issued by Private Co, a private manufacturer of digital technology equipment, for $100. Investor Corp has concluded that its investment meets the definition of an equity security and is therefore within the scope of ASC 321. The preferred stock does not have a readily determinable fair value and does not qualify for the practical expedient in ASC 820-10-35-59. Investor Corp elects to account for its investment in Private Co in accordance with the measurement alternative in ASC 321-10-35-2.
As a result of a significant technological advance by a competitor, Private Co’s digital technology becomes obsolete; as a result, its ability to attract new business has been adversely impacted and its cash flow projections have been revised downward. Investor Corp’s assessment resulted in an impairment of $20, resulting in a carrying value of $80.
The following reporting period, Private Co issues additional shares of preferred stock to new investors. The preferred stock has the same terms as the preferred stock acquired by Investor Corp. Third-party investors that participated in the new round of financing acquired the preferred shares for $85 per share.
How should Investor Corp account for its investment in Private Co?
Analysis
Since the additional round of financing is an observable price of an identical security, and assuming Investor Corp has concluded that the fair value of the security in accordance with ASC 820 is $85, Investor Corp should remeasure its equity investment in Private Co to $85 by recording the following journal entry.
Dr. Investment in Private Co equity interest |
$5 |
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Cr. Gain on equity interest |
$5 |
2.3.2.6 Discontinuance of the measurement alternative
Under ASC 321-10-35-2, a reporting entity can choose to discontinue the use of the measurement alternative and move to the fair value through current earnings model. While the initial election of the measurement alternative can be made on an investment-by-investment basis, the guidance stipulates that once the voluntary election is made, stopping use of the measurement alternative on one investment means that the measurement alternative can no longer be applied to any identical or similar investments from the same issuer. In addition, the measurement alternative cannot be applied to future purchases of the same or similar investments from the same issuer, even if the current position is liquidated between purchases. The election to stop applying the measurement alternative and apply fair value through current earnings is irrevocable.
Use of the measurement alternative should be discontinued if changes in facts and circumstances result in the equity interest no longer being eligible for the measurement alternative. For example, if an equity interest issued by a private company becomes exchange traded as a result of the issuer undergoing an IPO, the equity interest would no longer qualify for the measurement alternative and the equity instrument should be measured at fair value prospectively in accordance with ASC 820 beginning on the date of the remeasurement event (i.e., the IPO).
When a reporting entity moves from the measurement alternative to the fair value through earnings model (either voluntarily or because the investment now has a readily determinable fair value), the entire difference between the investment’s fair value and carrying value is recorded through current earnings.
2.3.2.7 Sale of equity instruments
When an equity instrument is transferred to another entity, it should first be determined whether or not the transfer qualifies as a sale under ASC 860 (see PwC’s guide to Transfers and servicing of financial instruments for additional information on assessing whether a transfer should be recorded as a sale). If the transfer is a sale, it is generally recorded as a debit to cash (or trade date receivable) and a credit to equity instrument to remove the instrument at its fair value (or sales price). The sale of an equity security does not necessarily give rise to a gain or loss if all changes in the security’s fair value are reported in earnings as they occur.
A sale of an equity instrument may constitute an observable transaction or an indicator of impairment that could require remeasurement of equity investments that continue to be held.
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