Equity interests are investments that represent ownership interests in another entity, such as common stock, partnership interests, and interests in limited liability companies (LLCs).

Equity interests acquired by purchase are initially measured at their acquisition cost, and interests acquired by contribution are initially measured at fair value. Under ASU 2016-01, acquisition cost excludes brokerage and other transaction fees; prior to adoption of the ASU, brokerage and other transaction fees were included in initial measurement.

Subsequent to acquisition, equity interests are accounted for by either (a) consolidating the investee, (b) applying the equity method, or (c) periodically remeasuring the investment to fair value. Prior to an entity’s adoption of ASU 2016-01, a fourth approach – the cost method – must also be considered.

Within the NFP financial reporting model, these approaches view the economic relationship between the investor and investee along a spectrum of rights granted to the investor through ownership. Figure NP 9-3 illustrates this spectrum.

Figure NP 9-3
Spectrum of economic relationships underlying the investment accounting approaches

View image

A hierarchy exists regarding the order in which these approaches must be considered. An investor begins by considering the most substantial potential economic relationship—that is, whether the investor controls the investee, meaning that the investor can control the direction of the investee’s management and policies to such an extent that the entities should be presented as a single economic entity (consolidation). If that is the case, the investor includes the investee’s assets, liabilities, revenues, and expenses in its own financial statements. The next type of relationship considered is whether the investor can significantly influence the operating and financial policies of the investee. If so, a portion of the investee’s income or loss earned should be included in the investor’s activities for the period (equity method). If neither of those relationships exists, the investor recognizes income as the value of the investment changes (fair value), or, prior to the adoption of ASU 2016-01, only when it receives distributions from the investee (the cost method).

In some cases, application of the hierarchy‘s requirements can be overcome by adopting one or more fair value measurement options, discussed in NP 9.3. For example, an NFP that adopts the PWFVO or the general fair value option in ASC 825-10 is permitted to apply fair value measurement to an investment that would otherwise require application of the equity method. NP 9.6 provides further information on the interaction of the PWFVO with the hierarchy of approaches. NP 9.7, NP 9.8, and NP 9.9 discuss application of the hierarchy to investments in common stock, interests in limited partnerships, and LLC interests, respectively.