United States

Simplification of transition to the equity method of accounting

FINANCIAL REPORTING INSIGHTS  | 

Under existing equity method accounting guidance, when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. Stakeholders have told the Financial Accounting Standards Board (FASB) that this requirement to retroactively adopt the equity method of accounting is costly and time consuming when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence. Also, this requirement does not provide a clear benefit to users of financial statements.

The FASB recently published Accounting Standards Update (ASU) 2016-07, Investments – Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting, to eliminate the requirement to retroactively adopt the equity method of accounting. Per the ASU, the equity method investor should add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. The ASU requires that an entity that has an available-for-sale equity security that becomes qualified for the equity method of accounting recognize through earnings the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method.

The ASU is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. The amendments should be applied prospectively upon their effective date to increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. Earlier application is permitted. No additional disclosures are required at transition.