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New FASB rules issued to clarify interaction of equity investment accounting rules

The Financial Accounting Standards Board (FASB) on Jan. 16, 2020, issued narrow provisions to help accountants understand the interaction of rules for equity securities, the equity method, and forward contracts and purchased options on certain types of securities—areas where accounting differences among companies have bubbled up.

The guidance aims to resolve confusion about measurement of investment changes that result in an investor either applying or discontinuing the equity method of accounting.

The changes will, as a result, provide investors with more reliable, comparable financial reporting information from companies in this area, the “basis for conclusions” section of the standard states.

For public companies, the rules are effective for fiscal years beginning after Dec. 15, 2020, and interim periods within those fiscal years. For all other companies, it is effective for fiscal years beginning after Dec. 15, 2021, and interim periods within those fiscal years. Early adoption is permitted including in an interim period.

The rules should be applied prospectively, the document states. Under prospective transition, a company needs to apply the amendments at the beginning of the interim period that includes the adoption date.

The FASB issued the changes as Accounting Standards Update (ASU) No. 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 (A Consensus of the Emerging Issues Task Force).

The changes address the accounting for equity securities upon the application and discontinuance of the equity method accounting. Companies questioned whether to consider observable transactions that require them to either apply or discontinue the equity method of accounting for purposes of applying the measurement alternative under Topic 321, Investments–Equity Securities. The new standard affirms that they should do so, “immediately before applying or upon discontinuing the equity method.”

The standard also addresses scope considerations for forward contracts and purchase option on certain securities. The amendments clarify that when applying paragraph 815-10-15-141(a) an entity should not consider whether, upon the settlement of a forward contract or exercise of the purchased option, either individually or with existing investments, the underlying securities would be accounted for under the equity method or the fair value option in accordance with Topic 825, Financial Instruments.

The new rules had to be developed as a result of the FASB’s issuance in 2016 of ASU No. 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. That standard added Topic 321 and made targeted improvements to address certain aspects of accounting for financial instruments.

Among other changes, ASU No. 2016-01 provided a company with the ability to measure certain equity securities without a readily determinable fair value at cost, minus impairment, if any, unless an observable transaction for an identical or similar security occurs (the measurement alternative).

Accountants asked the FASB to clarify how this guidance should interact with equity method investments. They also asked the board to clarify whether certain forward contracts and purchased options should be accounted for in accordance with Topic 321, Topic 323, Investments—Equity Method and Joint Ventures, or Topic 815, Derivatives and Hedging.

For more information on this topic, or to learn how Baker Tilly accounting and assurance specialists can help, contact our team.

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