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9.7 Common stock and interests in certain LLCs
Publication date: 27 May 2020
us NFP guide
This section discusses application of the general accounting requirements described in NP 9.5 to investments in common stock of corporations. Except for considerations related to application of the equity method, it also applies to interests in limited liability companies (LLCs) that are the functional equivalent of corporations (see NP 9.9.1).
Figure NP 9-6 illustrates the decision tree used in accounting for common stock and LLC investments when the PWFVO has not been elected.
Figure NP 9-6
Decision tree—investments in common stock when the PWFVO is not elected
Decision tree—investments in common stock when the PWFVO is not elected
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If a common stock investment or LLC interest is held within a portfolio for which the PWFVO has been elected, the decision tree in Figure NP 9-4 would instead be applied.
9.7.1 Consolidation
An NFP that owns a controlling financial interest in a corporation or functionally-equivalent LLC should consolidate that entity. According to ASC 958-810-15-4(a) (ASC 954-810-15-3(b) for NFP HCOs), an NFP applies the guidance in ASC 810-10, Consolidation, to determine whether it has a controlling financial interest. ASC 810-10 describes two models used to evaluate relationships for consolidation: the voting interest entity (VOE) model and the variable interest entity (VIE) model. NFPs are required to use the voting interest model, which is detailed in the “General” subsections of ASC 810-10. When applying that guidance, NFPs should disregard all references to VIEs, including the need to consider whether a potential investee is subject to the VIE guidance prior to applying the VOE model (as would be required for a business entity).
An NFP with a controlling financial interest through direct or indirect ownership of a majority voting interest in a for-profit entity that is other than a limited partnership or similar legal entity shall apply the guidance in the General Subsections of Subtopic 810-10. However, in accordance with paragraph 810-10-15-17, NFPs are not subject to the Variable Interest Entities Subsections of that Subtopic.
According to ASC 810-10-25-1 and ASC 810-10-15-8, a controlling financial interest usually exists when an investor owns over 50% of a corporation’s outstanding voting shares (or for a functionally-equivalent LLC, over 50% of the member interests). This gives the investor a majority voting interest over matters on which shareholders or members are entitled to vote. Typically, the holder of a controlling financial interest will be able to control significant financial and operating decisions made for an investee. CG 7.2 discusses situations when control might exist with less than a majority voting interest.
For legal entities other than limited partnerships, consolidation is appropriate if a reporting entity has a controlling financial interest in another entity and a specific scope exception does not apply (see Section 810-10-15). The usual condition for a controlling financial interest is ownership of a majority voting interest, but in some circumstances control does not rest with the majority owner.
For legal entities other than limited partnerships, the usual condition for a controlling financial interest is ownership of a majority voting interest and, therefore, as a general rule, ownership by one reporting entity, directly or indirectly, of more than 50 percent of the outstanding voting shares of another entity is a condition pointing toward consolidation. The power to control may also exist with a lesser percentage of ownership, for example, by contract, lease, agreement with other stockholders, or by court decree.
If circumstances indicate that control does not rest with the owner of the majority of the voting interests, however, the majority owner would not have a controlling financial interest, and consolidation would not be appropriate. Control might not rest with a majority owner if, for example, the investee is in legal reorganization or bankruptcy, or if other owners can participate in certain financial and operating decisions made in the ordinary course of business (referred to as “substantive participating rights”). See NP 9.8.4.2 for information on substantive participating rights; in this context, the rights of noncontrolling shareholders would be analogous to the rights of limited partners. CG 7.2.2 provides additional information regarding situations when control would not rest with a majority owner.
9.7.2 Equity method investments
If consolidation of the corporation or functionally-equivalent LLC is not required, the NFP must assess whether it should apply the equity method. The rules for applying the equity method to LLC interests differ from those for common stock; for information on applying the equity method to LLC interests, see NP 9.9.2.
The equity method applies when a noncontrolling investor can nonetheless exercise significant influence over the investee’s operating and financial policies. According to ASC 958-810-15-4(c), an NFP applies the guidance in ASC 323-10, Investments—equity method and joint ventures—overall, to evaluate whether significant influence exists based on ownership of voting stock.
An NFP that owns 50 percent or less of the voting stock in a for-profit entity shall apply the guidance in Subtopic 323-10 unless the investment is measured at fair value in accordance with applicable GAAP, including the guidance described in (e).
According to ASC 323-10, an investor that holds between 20% and 50% of a company’s voting stock is presumed to have the ability to exercise significant influence over the operating and financial policies of an investee, unless evidence exists to the contrary. However, use of the equity method may also be appropriate when the holding falls outside this range and may be inappropriate for some entities within this range, depending on the nature of the actual relationship between the investor and investee. Exercise of judgment may be required in light of the facts and circumstances associated with a particular investment.
ASC 958-810-15-4(e) discusses use of fair value measurement as an alternative to applying the equity method. Those situations relate to interests held within portfolios that are subject to a “portfolio-wide” fair value accounting policy election (see NP 9.6) and interests for which an irrevocable election to report at fair value pursuant to the fair value option subsections of ASC 825-10 has been made (see NP 9.3).
9.7.3 Investments that are not consolidated or reported using the equity method
Investments in stock (or member interests in an LLC that is functionally-equivalent to a corporation) that require neither consolidation nor application of the equity method are accounted for at fair value in accordance with ASC 321, Investments—equity securities.
The scope of ASC 321 applies to both equity securities with readily-determinable fair values and equity interests that do not have readily-determinable fair values. Under ASC 321, equity interests that are not equity securities—such as member interests in partnerships, unincorporated joint ventures, and limited liability companies—are accounted for as if they were equity securities. LI 3 provides a comprehensive discussion of ASC 321.
The default measurement principle under ASC 321 is that investments within its scope are measured at fair value on a recurring basis in accordance ASC 820. If the investment does not have a readily-determinable fair value, two optional measurement accommodations may be available:
- Net asset value practical expedient. The net asset value (NAV) practical expedient is described in ASC 820-10-35-59. If elected, the fair value of investments in funds that have the characteristics of an investment company specified in ASC 946 (such as hedge funds, private equity funds, and the like), can be measured using the per-share NAV reported by the investee without any adjustment, as long as the investor provides certain disclosures regarding the investment’s nature and risk. FV 6.2.6 discusses the NAV practical expedient and the circumstances in which it can be elected.
- Measurement alternative. ASC 321 provides a “measurement alternative” that can be elected for an investment that does not have a readily-determinable fair value and which is ineligible for the NAV practical expedient. This measurement alternative is defined as cost, less impairment, adjusted (increased or decreased) for information about fair value of the investment from observable price changes, whenever those occur, rather than an obligation to remeasure the investment at fair value at each reporting date. Under this measurement alternative, observable price changes are from orderly transactions for an identical or similar investment of the same issuer. An entity must elect to apply the measurement alternative upon acquisition of an eligible equity interest and is made on an instrument-by-instrument basis. The measurement alternative is not available for equity instruments for which the fair value option in ASC 825-10 has been elected. Its use may also be limited for investments in portfolios for which the portfolio-wide fair value option has been elected as discussed in NP 9.6. For more information about the measurement alternative and the circumstances in which it can be elected, see LI 2.3.2.
Investments that are structured similar to mutual funds (for example, hedge funds, private equity funds, and common collective or commingled trusts) must be evaluated against the ASC Master Glossary definitions of equity security and readily determinable fair value when evaluating their ability to use the NAV practical expedient or the measurement alternative. If such an investment is a security that has a fair value per share (unit) that is published and is the basis for current transactions, then its fair value is readily determinable, and it is not eligible for either of the measurement accommodations. FV 6.2.6.2 discusses considerations for making these evaluations.
9.7.3A Investments that are not consolidated or reported using the equity method (prior to adoption of ASU 2016-01)
Prior to an entity’s adoption of ASU 2016-01, investments in common stock (or member interests in an LLC that is the functional equivalent of a corporation) that neither require consolidation nor application of the equity method are measured at either fair value or cost less impairment (cost method).
If the interest is an equity security with a readily-determinable fair value, it must be accounted for at fair value in accordance with ASC 958-320. See LI 2.2 and LI 2.3 for discussion of the ASC Master Glossary definitions of “equity security” and “readily determinable fair value,” as well as circumstances in which investments with structures similar to mutual funds are considered to have readily determinable fair values. FV 6 discusses the requirements in ASC 820 for the measurement of financial assets.
As discussed in NP 9.11.1, changes in fair value of investments are reported within the respective category of net assets—with donor restrictions or without donor restrictions—as required by ASC 958-321-15-3 and ASC 958-220-45-8. For NFP HCOs, such changes in fair value are included in or excluded from the performance indicator as prescribed by ASC 954-220-45-9 through ASC 954-220-45-11. As discussed at NP 9.2.2A, NFP HCOs must classify equity securities within the scope of ASC 958-320 into “trading” and “other than trading” categories. Changes in fair value of equity securities classified as “other than trading” are reported below the performance indicator, while changes in the fair value of equity securities classified as “trading” are included within the performance indicator. Other NFPs are not required to make this distinction but may apply the NFP HCO reporting conventions voluntarily. Once ASU 2016-01 is adopted, the classification requirement for equity securities with readily-determinable fair values will be eliminated but will continue to apply to debt securities, as discussed in NP 9.4.
9.7.3.1A Reporting investments using the cost method
Prior to adoption of ASU 2016-01, the cost method is used to account for investments in stock of a corporation (or member interests in an LLC that is the functional equivalent of a corporation) that do not require consolidation, require application of the equity method, and do not have readily-determinable fair values. Application of the cost method varies slightly by types of NFPs; for additional information on those variations, see NP 9.2.3A.
Guidance for applying the cost method is contained in ASC 325-20. Under the cost method, an investment is reported at its historical cost, which is not subsequently adjusted unless an impairment occurs. “Historical cost” refers to the purchase price or, if contributed, the fair value of the investment on the date of acquisition. The methodology for determining impairment and evaluating whether the impairment is other than temporary is described in ASC 320-10-35-25 and ASC 958-325-35-8 through ASC 958-325-35-13.
ASU 2016-01 eliminates the cost method. Subsequent to its adoption, equity interests previously subject to the cost method will instead be reported at fair value, or the measurement alternative (see NP 9.7.3) in accordance with ASC 321.
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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