The Financial Accounting Standards Board on Friday issued the first accounting standard update of the new year—ASU 2020-1, which clarifies the interaction between accounting standards related to equity securities (ASC 321), equity method investments (ASC 323), and certain derivatives (ASC 815).
The ASU is based on a consensus of the Emerging Issues Task Force. FASB expects it will reduce diversity in practice and increase comparability in accounting for these transactions.
In 2016, “Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,” added Topic 321, “Investments—Equity Securities,” and made targeted improvements to accounting for financial instruments.
One of these improvements was a measurement alternative that permitted certain equity securities without a readily determinable fair value to be measured at cost, minus any impairment, unless an observable transaction for an identical or similar security occurred. In that case, the equity security would be measured at fair value at the date of that transaction. Stakeholders raised questions and asked FASB to clarify how this guidance should interact with accounting for equity method investments under Topic 323, “Investments—Equity Method and Joint Ventures,” specifically whether to consider observable transactions that require applying or discontinuing the equity method for the purpose of applying the measurement alternative.
ASU 2020-1 clarifies that a company should consider observable transactions that require it to apply or discontinue the equity method of accounting under Topic 323 when applying the measurement alternative in Topic 321. For example, if an observable transaction occurs that results in an ownership change that would result in a company’s applying or discontinuing the equity method, the carrying amount of the investment would be adjusted to its fair value immediately before applying or discontinuing the equity method.
ASU 2016-01 also raised questions about whether certain forward contracts and purchased options to buy securities that are accounted for under the equity method upon settlement of the forward contract or exercise of the option would be accounted for in accordance with Topic 321, Topic 323, or Topic 815, “Derivatives and Hedging.”
The new ASU clarifies that entities should not consider whether, upon settlement or exercise, the underlying securities would be accounted for under the equity method under Topic 323. ASC 815 should be the basis for determining the accounting for the forward contracts and purchased options to purchase securities in the scope of Topic 321.
The amendments are effective for public business entities for fiscal years beginning after Dec. 15, 2020, and interim periods within those fiscal years, and for all other entities, for fiscal years beginning after Dec. 15, 2021, and interim periods within those fiscal years. Early adoption is permitted. The amendments should be applied prospectively.