The accounting treatment of investments is a complex area to understand, but the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update (“ASU”) in January 2016 in order to reduce the complexity of the original standard for financial instruments. This update was issued in order to enhance the reporting model for financial instruments and provide users of the financial statements with more useful information, as well as converge the US standard with the international accounting standards. Within the context of the update, it will address both recognition and measurement, as well as presentation and disclosure of financial instruments. This ASU has also created the accounting standard codification section 321 Investments – Equity Securities.
Effective Date & Transition Information
The amendment is effective for public business entities for fiscal years beginning after December 15, 2017 and for all other entities (including not-for-profit entities, private entities, and certain employee benefit plans) for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Early adoption was permitted for all entities that are not public for fiscal years beginning after December 15, 2017. The amendment is to be applied using the cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. For entities that have equity securities without a readily determinable fair value, the amendment is to be applied prospectively to the equity investments that exist as of the date of adoption of the Update.
Overview of Main Provision Changes
For investments that were previously carried at Cost Basis (typically those investments under 20% ownership), the main provision changes are as follows:
- Investments will now be measured at fair value with any changes in fair value recognized through net income. If the investment does not have a readily determinable fair value, it may be measured at cost minus impairment, if any, plus or minus changes resulting from observable price changes that occur in orderly transactions for identical or similar investments of the same issuer.
- For those investments to be measured at cost minus impairment, the assessment for impairment has been simplified. The requirements are a qualitative assessment to identify any impairment and if there is evidence that impairment exists, the investment will be required to be measured at fair value.
For investments that were previously classified differently, the main provision changes are as follows (equity investments that are accounted for under the equity method of accounting or result in consolidation of an investee are not included within the scope of this Amendment.):
- The Amendment eliminates the classification categories of equity investments (such as trading, available-for-sale, or held to maturity) and their different treatments.
- Investment in equity securities are to be carried at fair value through net income (FVTNI). Previously, the changes in fair value were to be recorded into other comprehensive income until the gain or loss are realized.
Impairment Considerations
In an effort to simplify the impairment model for equity securities, the FASB eliminated the requirement in U.S. generally accepted accounting principles (U.S. GAAP) to assess whether an impairment of such an investment is other than temporary. At each reporting period, entities should consider the following indicators to determine whether the investment may be impaired:
- A significant deterioration in the earnings performance, credit rating, asset quality, or business prospects of the investee.
- A significant adverse change in the regulatory, economic, or technological environment of the investee.
- A significant adverse change in the general market condition of either the geographical area or the industry in which the investee operates.
- 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 the investment.
- 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.
If, based on any of the indicators listed above, an investment is determined to be impaired, the entity shall recognize an impairment loss equal to the amount by which the security’s carrying amount exceeds its fair value.
Financial Statement and Disclosure Considerations
Going forward, changes in the values of equity securities will flow through net income and be included in earnings each year. If there is a subsequent sale of a security, since the changes each year will have already gone through income, there will likely not be any gain or loss recorded.
For those equity securities that do not have a readily determinable fair value, the disclosures will include the following:
- The carrying amount of investments without readily determinable fair values.
- The amount of impairments and downward adjustments, if any, both annual and cumulative.
- The amount of upward adjustments, if any, both annual and cumulative.
- As of the date of the most recent financial statement of financial position, additional information (in narrative form) that is sufficient to permit financial statement users to understand the quantitative disclosures and information that the entity considered in reaching the carrying amounts and upward or downward adjustments resulting from observable price changes.
- For each period for which the results of operations are presented, an entity shall disclose the portion of unrealized gains and losses for the period that relates to equity securities still held at the reporting date.
Summary
- Cost method investments are now recorded at cost less impairment and shown as equity securities for those that do not have a readily determinable fair value.
- Impairment considerations for equity securities have been simplified.
- Changes in the fair value of equity securities will flow through net income each reporting year.
Emily Bartlett is a Senior Assurance Manager at CDH, P.C. She began her career in accounting in September 2008 after receiving her Bachelor of Science from Augustana College and her Masters of Professional Accountancy from Elmhurst College.