FASB Continues to Move Forward on Classification and Measurement
Yesterday, the FASB made a number of tentative decisions in two key areas related to the classification and measurement portion of the accounting for financial instruments project: (1) the practicability exception for nonmarketable equity securities held by nonpublic entities and (2) the accounting for equity investments under the equity method.
Practicability Exception for Nonmarketable Equity Securities Held by Nonpublic Entities
At its meeting on March 2, 2011, the FASB tentatively decided to permit nonpublic entities holding nonmarketable equity securities to measure such securities at cost less any other-than-temporary impairment (OTTI) plus upward adjustments in fair value based on observable changes in price. This represents an exception to the public-entity requirement to measure nonmarketable equity securities at fair value with all changes in fair value recognized in net income. That requirement is based on a tentative decision made during the same March 2, 2011, meeting (see Deloitte’s March 3, 2011, journal entry). Yesterday, the Board tentatively decided that:
- Nonpublic entities should adjust the carrying value of equity securities measured under the practicability exception upward and downward for observable price changes in an orderly transaction.
- Orderly transactions for the identical or similar equity securities of the same issuer should be used as input for adjusting the carrying value of a nonmarketable equity security.
- A single-step approach would be used to evaluate the impairment of nonmarketable equity securities measured under the practicability exception.
The single-step approach would require a nonpublic entity to recognize an impairment loss equal to the difference between the fair value of a nonmarketable equity security and its carrying value only after assessing certain qualitative factors to determine whether an investment is more likely than not to be impaired. Accordingly, a nonpublic entity would not be required to determine whether a security being accounted for under the practicability exception is subject to an OTTI, which is a change from the Board’s tentative decision made March 2. During discussions with the Board, staff members noted that the qualitative factors an entity would use to determine whether a nonmarketable equity security is impaired would be based on the factors in paragraphs 10(b)(1)–(5) of FSP FAS 115-1 and FAS 124-11 (codified in ASC 320-10-35-272). However, the Board also requested that the staff further develop these qualitative factors (or impairment indicators).
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Editor’s Note: At its meeting on March 2, 2011, the Board also requested the staff to further analyze whether the scope of the practicability exception should be restricted to nonpublic entities other than financial institutions. In addition, the staff was asked to analyze whether the scope should be expanded to include public entities. However, possible revisions to the scope of the practicability exception were not discussed at yesterday’s meeting. |
Equity Method Investments
The FASB noted in its May 26, 2010, exposure draft (ED)3 that an “investor shall apply the equity method of accounting only if the investor has significant influence over the investee as described in Topic 323 and if the operations of the investee are considered related to the investor’s consolidated operations.” However, in its summary of feedback received on the classification and measurement model in the ED, the FASB indicated that most users did not provide feedback on the additional qualification criterion — that the operations of an investee should relate to the operations of the investor — and that many nonusers did not support the change. According to the summary, many nonusers expressed the view that (1) “equity method investments are generally strategic [and therefore] fair value would not be a relevant or reliable measurement” and (2) the change would create operational issues. The Board voted yesterday to eliminate the additional criterion by a slim margin of 4 to 3 and requested the staff to review related disclosure requirements under Opinion 184 (codified in ASC 323-10-50) to determine whether additional disclosures would be appropriate.
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Editor’s Note: Under ASC 323, an investor should use the equity method of accounting when its investment in voting stock gives it the ability to exercise significant influence over operating and financial policies of a corporate investee. An investment of 20 percent should lead to a presumption that, in the absence of evidence to the contrary, an investor has the ability to exercise significant influence over a corporate investee. Yesterday’s decision retains this guidance. |
The Board also made the following tentative decisions concerning the measurement of equity method investments:
- To retain the ED’s elimination of the fair value option for equity method investments.
- That a single-step approach would be used to evaluate the impairment of such investments.
- To explicitly state in the final guidance that an entity may not reverse impairment losses previously recognized as reductions to the carrying value of equity method investments.
Although the ED’s elimination of the fair value option for equity method investments was retained, the Board also directed the staff to explore alternative criteria under which equity method investments would be required to be measured at fair value with changes in fair value recognized through net income. Its findings and recommendations will be reviewed by the Board at a later date.
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Editor’s Note: At its June 8 meeting, the Board plans to explore whether to provide a fair value option for the measurement of financial instruments other than those accounted for under the equity method. The ED did not provide an explicit option. However, IFRS 95 does provide a fair value option, which can be applied to both financial assets and financial liabilities under certain circumstances. |
The single-step approach to measuring the impairment of equity method investments is similar to the approach prescribed for nonmarketable equity securities measured under the practicability exception available to nonpublic entities (see the Board’s tentative decision above). One important difference should be noted; the Board requested the staff to draft language that would result in a single impairment model that could be applied to marketable and nonmarketable equity method investments. This model would also be presented to the Board at a future meeting.
For information about the Board’s previous tentative decisions on the classification and measurement of financial instruments, see Deloitte’s January 25, March 3, April 21, and May 5, 2011, journal entries and February 8 and May 10, 2011, Heads Up newsletters.
[1] FASB Staff Position Nos. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.”
[2] For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s "Titles of Topics and Subtopics in the FASB Accounting Standards Codification."
[3] FASB Proposed Accounting Standards Update, Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities — Financial Instruments (Topic 825) and Derivatives Hedging (Topic 815).
[4] Accounting Principles Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock.
[5] IFRS 9, Financial Instruments.
