FASB Clarifies Accounting Interactions Between Investment Topics

In 2019, non-public entities were required to account for equity securities using a new reporting model. The model also established an alternate reporting model for equity securities without a readily determinable fair value. An entity electing the alternative model would record an equity security without readily determinable fair value at cost, less impairments, plus (minus) observable inputs. 

This new alternative model raised questions on its application when interacting within the equity method of accounting guidance. Divergence on how forward contracts and purchased options were accounted for also emerged.  To clarify the application, the FASB issued ASU 2020-01, Investments – Equity Securities, Investments – Equity Method and Joint Ventures, and Derivatives and Hedging – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815 which covers the following two issues: 

Issue 1: Applying or discontinuing the equity method of accounting

If an entity holds an equity investment that now qualifies for the equity method of accounting based on an observable price change, the company must remeasure the investment in accordance with the measurement alternative immediately prior to applying the equity method. Similarly, if the equity investment no longer qualifies for the equity method of accounting based on an observable price change, the entity must remeasure the equity investment in accordance with the measurement alternative immediately after the transition. 

Issue 2: Certain forward contracts and purchased options on certain securities

Forward contracts and purchased options are securities that give the purchaser the right to acquire an ownership interest in an entity at a fixed or determinable price. Reporting entities should not consider whether the underlying securities will be accounted for under the fair value method in Topic 815, Derivatives and Hedging or the equity method in Topic 323 upon settlement or exercise.  These investments are generally measured at fair value prior to settlement or exercise. 

Effective Dates

For public business entities, ASU 2020-01 is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. Changes are to be applied prospectively. Early adoption is permitted.