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Guidance Streamlines Equity Method Accounting

March 22, 2016

Investors will no longer be required to retroactively apply the equity method of accounting when their existing unconsolidated equity investment first qualifies for its use. The new guidance comes in Financial Accounting Standards Board (FASB)'s Accounting Standards Update (ASU) 2016-07, Investments- Equity Method and Joint Ventures (Topic 323), Simplifying the Transition to the Equity Method of Accounting.

An entity may increase its investment in equity securities of an entity or another change may occur that causes it to obtain significant influence over another entity that triggers an existing equity investment to qualify for the use of equity method in accounting. U.S. Generally Accepted Accounting Principles (GAAP) asks that when the investor transitions to the equity method because it gains significant influence over an investee, the investor must adjust the investment, results of the operations and retained earnings as if the equity method had been used since the investor's original investment. The retroactive application of the equity method was often costly and difficult to apply.

The Simplification Initiative earmarked equity method accounting transitions for change, citing the complexity in current practice. ASU 2016-07 addresses the issue by allowing the investor to add the cost of acquiring the additional interest in the investment on the basis of its previously held interest and then adopting the equity method of accounting as of the date the investment became eligible for the method.

Should the original equity investment be classified as available-for-sale, the investor recognizes the unrealized holding gain or loss in the investor's accumulated other comprehensive income on the date that the investment became eligible for the equity method.

Changes from the Proposed Standard

Not included in the final accounting standard is guidance regarding the basis difference, which the FASB marked for change in the same proposed ASU that it suggested eliminating the retroactive equity method of accounting.

In U.S. GAAP, when an investment becomes eligible for equity accounting, the investor must allocate the difference between the cost of the equity method investment and the book value of the ownership interest in the equity of the equity method investee based on the fair value of the investee's assets and liabilities using the guidance related to business combinations. The investor's proportionate share of the difference between the fair value of the investee's assets and liabilities and the assets and liabilities' book value is tracked and accounted for in all future periods.

The June 2015 proposed ASU suggested that allocating and tracking of the basis difference be eliminated from U.S. GAAP. After hearing feedback, the FASB separated the two proposals and asked its staff to conduct more research to identify ways to simplify the equity method of accounting.

Effective Date

All entity types will be able to eliminate their equity method of accounting retroactive application requirement for fiscal years beginning after December 15, 2016. Earlier adoption is also permitted.

When adopting, the amendment is to be applied on a prospective basis from the date the investment became eligible for the equity method of accounting.

For More Information

If you have any specific comments, questions or concerns about the changes to the equity method of accounting, please contact Mark Winiarski of the MHM Professional Standards Group. Mark can be reached at mwiniarski@cbiz.com or 816.945.5614.

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