The equity method under ASC 323

When does the ASC 323 equity method apply?

When the investor can exercise significant influence over the investee's operating and financial policies, or is a venturer in a corporate joint venture. Holding 20% or more of the voting stock is presumed to give significant influence, and less than 20% presumes it does not, unless shown otherwise. Board representation, participation in policy-making, material intra-entity transactions, interchange of managers and technological dependency are evidence. Investments in partnerships and LLCs that keep separate capital accounts generally use the equity method from much lower stakes, often more than 3% to 5%. An investor can instead elect the fair value option under ASC 825. See ASC 810 consolidation for when an investee must be consolidated instead.

How is the purchase price split?

The investor compares what it paid with its share of the investee's net assets at book value. The difference is allocated, as in a business combination, to the investee's identifiable assets and liabilities whose fair values differ from book values, and anything left is equity method goodwill. These amounts are not recorded separately: they sit inside the single investment balance and are tracked in memo records. Amounts relating to depreciable or amortizable assets are amortized through equity in earnings; goodwill is not amortized, unless a private company has elected the goodwill amortization alternative, and is not tested separately for impairment.

ASC 323 in practice: the first year's journal entries

On January 1, an investor pays $3,000 thousand for 30% of a company whose net assets have a book value of $8,000 thousand. The investee's equipment is worth $1,000 thousand more than its book value and has 5 years of life left. Everything else is at fair value. During the year the investee earns $1,200 thousand and pays dividends of $400 thousand. All amounts are in $ thousand.

Equity in earnings is $300 thousand: the 30% share of net income, $360 thousand, less $60 thousand of extra depreciation on the equipment step-up. The dividends of $120 thousand are a return of investment, not income. The investment closes at $3,000 + 300 - 120 = $3,180 thousand. Had the investor sold inventory to the investee at a profit, its share of the profit on goods still unsold at year end would also be eliminated. See the IFRS equity method example and IAS 28 vs ASC 323.

What happens when the investee makes losses?

The investor keeps recognizing its share of losses until the investment, including loans and other advances to the investee, reaches zero. It then stops, unless it has guaranteed the investee's obligations or committed to provide further financial support, or the investee is expected to return to profit imminently. When the investee becomes profitable again, the investor resumes recognizing its share only after its share of profits has covered the losses not recognized.

How is an equity method investment tested for impairment?

The investment as a whole is written down to fair value when its value has declined and the decline is other than temporary. Indicators include a sustained fall in a quoted price, continued losses at the investee and its inability to sustain earnings. The write-down is not reversed. The investor also records its share of impairments the investee recognizes in its own statements. See ASC 820 fair value.

What happens when ownership changes?

• Becoming an equity method investor, for example by buying more shares: the equity method starts prospectively from that date, with the cost of the earlier stake added to the new cost. Since ASU 2016-07 there is no retroactive restatement.
• Losing significant influence: the investor stops the equity method and accounts for the remaining interest under ASC 321, starting from its carrying amount at that date.
• Gaining control: the investor applies ASC 805, remeasuring its previous interest to fair value with a gain or loss in earnings. See ASC 805 business combinations.

What changed for joint ventures?

ASU 2023-05 requires a joint venture formed on or after January 1, 2025 to measure the assets contributed and liabilities assumed at fair value on formation in its own financial statements, recognizing goodwill for the excess of the fair value of the venture as a whole over its identifiable net assets. It does not change how the venturers account for their investments under the equity method. Tax equity investors can also elect the proportional amortization method for qualifying investments, which ASU 2023-02 widened beyond low-income housing.

How does ASC 323 compare with IAS 28?

The equity method is very similar. Differences include the IFRS requirement for the investee's accounting policies to be conformed to the investor's, IFRS's use of an impairment test under IAS 36 with reversals allowed, US GAAP's lower thresholds for partnerships and LLCs, and a time lag of up to three months under both, with adjustments for significant events required under IFRS. IAS 28 is being revised, with a new standard expected in 2027. See IFRS 11 and IAS 28 and IFRS vs US GAAP key differences.

This guide is general information. It is not tax or legal advice for your situation.