Simplification Initiative: Equity Method of Accounting

By Baker Newman Noyes June 8, 2016

In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-07, Investments—Equity Method and Joint Ventures, Simplifying the Transition to the Equity Method of Accounting, which seeks to ease the application of the equity method of accounting. The ASU is one of many that the FASB has issued and will issue in conjunction with its Simplification Initiative. As noted in the ASU, “The objective of the Simplification Initiative is to identify, evaluate, and improve areas of generally accepted accounting principles (GAAP) for which cost and complexity can be reduced while maintaining or improving the usefulness of the information provided to users of the financial statements.”

The equity method of accounting is required for investments when the entity can influence the operating or financial decisions of the investee. This influence may be evidenced by several factors such as board representation, participation in policy making, or percentage of ownership. Generally, an ownership percentage of 20% or more indicates influence unless there is evidence to the contrary. The cost method of accounting is applied for investments exerting no significant influence.

This ASU results from stakeholders’ concerns of both cost and resource constraints endured for an accounting policy application that has not proven useful in financial reporting to investors.

This ASU impacts investments prospectively from the effective date of either the increase in the level of ownership interest or degree of influence requiring the application of the equity method of accounting. The cost of acquiring the additional interest in the investee (if any) is added to the current basis of the investor’s previous investment. The prospective application will provide consistency with the International Financial Reporting Standards (IFRS) which does not require retroactive adjustment.

If an investment was previously classified as available-for-sale, the entity will recognize in earnings the unrealized holding gain or loss from accumulated other comprehensive income commensurate with the date the investment requires the application of the equity method of accounting. No additional disclosures are required upon adoption of this ASU.

In summary, the significant changes to the equity method of accounting are as follows:

• Prospective application from the effective date of the increase in level of either the ownership interest or degree of influence;
• Simplicity going forward for investments requiring equity method of accounting based on level of ownership or influence;
• Alignment of GAAP with IFRS; and
• No additional disclosure requirements.

This ASU is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016.

For more information pertaining to ASU No. 2016-07, please visit the FASB website.

If you have any questions, please call your BNN service provider at 1.800.244.7444.