The accounting for investments in equity securities changed as a result of ASU 2016-01 Recognition and Measurement of Financial Assets and Financial Liabilities. In a previous post we outlined the scope of ASC Topic 321 Investments – Equity Securities (ASC 321) and provided an overview of the accounting for investments in equity securities. In this post, we’ll explore the measurement alternative prescribed by ASC 321-10-35-2.
What is the measurement alternative?
The measurement alternative is an accounting policy election available to entities to account for investments in equity securities that:
- Do not have a readily determinable fair value; and
- Do not qualify for use of net asset value (NAV) as a practical expedient.
Check out this post for more information on these conditions. In addition, the measurement alternative is not permitted for investments in equity securities for which the entity has elected the fair value option under ASC 825.
The measurement alternative is not required; entities are always permitted to account for such investments at fair value with changes in fair value reported in earnings. However, if elected, an entity shall continue to apply the measurement alternative until the investment no longer qualifies for its use. Each reporting period, an entity is required to reassess whether the investment’s fair value becomes readily determinable or whether it now qualifies for use of NAV as a practical expedient.
How does the measurement alternative work?
Under the measurement alternative, the investment is measured at cost minus impairment, if any, plus or minus changes results from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Let’s take a look at each of these components that comprise the carrying value of such investments:
All investments in equity securities within the scope of ASC 321, including those for which the measurement alternative is being used, are initially measured at cost. ASC 321 does not provide guidance on whether transaction costs, incremental costs associated with the acquisition of the investment, should be included in the cost. We understand that some entities defer such costs and include them as part of the initial cost of the investment, while others immediately expense transaction costs when incurred. Whichever accounting policy is chosen, it should be applied consistently each period.
Impairment is a condition that exists when the fair value of an investment is less than its carrying amount. Each reporting period, an entity must make a qualitative assessment considering impairment indicators to evaluate whether an investment accounted for under the measurement alternative is impaired. ASC 321-10-35-3 outlines impairment indicators that entities should consider.
If such qualitative assessment indicates that an investment is impaired, the investment’s fair value must be estimated in accordance with ASC 820. This isn’t going to be easy. Remember, under the measurement alternative the investment did not have a readily determinable fair value! However, this exercise must be done because the impairment loss reported in net income is the difference between the fair value of the investment and its carrying amount.
Observable price changes
Identifying observable price changes is going to be a challenge. Specifically:
- Identifying relevant transactions,
- Assessing if such transactions were orderly, and
- Determining whether a security issued by the same issuer is similar to the equity security held by the entity.
Luckily, the FASB provided the implementation guidance found within ASC 321-10-55-8 through 55-9. Entities should make a reasonable effort, without expending undue cost or effort, to identify any observable transactions that it may not be readily aware of. However, the FASB clarified that an entity need not conduct an exhaustive search for all observable price changes.
What disclosures are required?
If the measurement alternative is elected, entities are required to disclose the following quantitative information:
- The carrying amount of investments without readily determinable fair values;
- The amount of impairments and downward adjustments, if any, both annual and cumulative; and
- The amount of upward adjustments, if any, both annual and cumulative.
An entity is also required to disclose, as of the most recent balance sheet date, additional information in narrative form to help users understand the quantitative disclosures and the information the entity considered to determine carrying amounts, including any upward or downward adjustments from observable price changes. In addition, for each period for which the results of operations are presented, an entity must disclose the portion of unrealized gains and losses for the period that relates to equity securities still held at the reporting date.
Are you experiencing challenges implementing ASC 321?
We’d love to hear from you if you have any questions about applying the new guidance related to accounting for investment in equity securities under ASC 321 or if you’ve experienced any challenges regarding implementation. Leave a comment in the section below or contact us. Your questions become future blog posts which, hopefully, will help others in similar situations!
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