On January 16, 2020, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2020-01, Clarifying the Interactions Between Topic 321, Topic 323, and Topic 815. The amendments are intended to reduce diversity in practice and increase comparability of the accounting for equity securities, equity method investments, and certain derivatives.
Following are the key provisions and effective dates entities should know.
Key Provisions
The amended guidance was issued to clarify the interaction of the accounting for equity securities under Topic 321, Investments—Equity Securities; investments accounted for under the equity method of accounting in Topic 323, Investments—Equity Method and Joint Ventures; and the accounting for certain forward contracts and purchased options accounted for under Topic 815, Derivatives and Hedging.
Accounting for Equity Securities
In 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which added Topic 321.
Among other changes, ASU 2016-01 requires equity securities not accounted for under the equity method to be measured at fair value through earnings. It also provides a measurement alternative that allows certain equity securities without a readily determinable fair value to be measured at cost, less any impairment.
Background
Under Topic 321, if the measurement alternative is elected and an entity identifies an observable transaction for a similar investment of the same issuer, the entity should remeasure the equity security at fair value as of the date that the observable transaction occurred.
After the issuance of ASU 2016-01, there was diversity in practice as to whether an entity should consider observable transactions that would require it to either apply or discontinue the equity method of accounting for the purpose of applying the measurement alternative. That is, determining if an investor should remeasure its investment in accordance with the measurement alternative when an observable transaction results in applying or discontinuing the equity method.
Clarifications
The amendments in ASU 2020-01 clarify that an entity should consider observable transactions that result in either applying or discontinuing the equity method of accounting for the purpose of applying the measurement alternative in Topic 321.
When an entity accounts for an investment in equity securities under the measurement alternative and is required to transition to the equity method of accounting because of an observable transaction, it should remeasure the investment at fair value immediately before applying the equity method of accounting.
Likewise, when an entity accounts for an investment in equity securities under the equity method of accounting and is required to transition to Topic 321 because of an observable transaction, it should remeasure the investment at fair value immediately after discontinuing the equity method of accounting.
These amendments align the accounting for equity securities under the measurement alternative with that of other equity securities accounted for under Topic 321, reducing diversity in accounting outcomes.
Forward Contracts and Purchased Options
The issuance of ASU 2016-01 also created uncertainty as to whether certain forward contracts and purchased options to acquire investments should be accounted for in accordance with Topic 321, Topic 323, or Topic 815.
Specifically, it wasn’t clear to stakeholders if the scope criteria of ASC 815-10-15-141(a) included forward contracts and purchased options to acquire securities that would be accounted for under the equity method of accounting upon settlement. That guidance requires the underlying securities to be accounted for under Topic 320 or 321 when the contract is settled.
Clarifications
The amendments in ASU 2020-01 clarify that when determining the accounting for nonderivative forward contracts and purchased options, an entity should not consider whether the underlying securities would be accounted for under the equity method or fair value option upon settlement or exercise, for the purposes of evaluating characteristic (a) in ASC 815-10-15-141.
These instruments won’t fail to meet the scope of Subtopic 815-10 solely because the securities would be accounted for under the equity method upon settlement of the contract or exercise of the option.
Effective Dates
For public business entities, the amendments are effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years.
For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. Early adoption is permitted.
The amendments should be applied prospectively when adopted.
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For more information on how these changes to the accounting for equity securities and certain derivatives may affect your business, contact your Moss Adams professional.