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By Denise Lugo
May 11 — The Financial Accounting Standards Board has abandoned its project to simplify the equity method of accounting.
The equity method is a technique companies use to assess profits—worth billions of dollars in some cases—from their investments in other companies. Real estate investment trusts (REITs) that own, operate and finance commercial real estate, or any company that invests in joint ventures or limited partnerships would likely be impacted by such accounting because those types of investments could qualify to apply it.
FASB members, by a 4-3 vote on May 11, said that because of the myriad of investments and assets involved, there is no “one size fits all” accounting solution that would make simplification of the equity method a feasible path forward.
Some board members cautioned that companies currently may not be properly applying ASC 323, Investments—Equity Method and Joint Ventures (APB Opinion No. 18), or correctly considering key aspects of it. Therefore, amending the equity method wouldn't necessarily solve complexity, board discussions indicated.
Companies should consider that “the 20 percent is just a presumption and that presumption can be overcome and perhaps should be overcome in many instances in applying the equity method,” FASB member Lawrence Smith said.
“It's not that ‘if you own 20 percent you automatically should apply the equity method'—that's not true at all and people should probably read paragraph 17 of APB 18 because there are considerations that one should make,” he said.
“At the end of the day, the standard's been applied for 45 years—quite frankly, because one size does not fit all, I personally don't think we're going to come up with anything appropriate and I would vote to just drop,” Smith said.
Amending ASC 323 would have likely had an impact because a number of companies have reported that they use the rule to account for equity ownership interests.
Texas-based exploration and projection company ConocoPhillips Co., for example, reported that its equity ownership interests subject to the equity method of accounting totaled about $23 billion as of the end of 2014. The company, which was among a number of respondents to FASB's proposal, said it recognized about $3 billion of earnings from those interests.
Similarly, insurance company Prudential Financial Inc. reported it had $4.6 billion of investments in joint ventures, limited partnerships and limited liability companies accounted for under the equity method at the end of December 2014.
FASB added the project to its agenda in March 2015 as part of its simplification initiative, which is its ongoing effort to quickly address complexity in financial reporting in a cost-effective manner (54 DTR G-2, 3/20/15).
The board in June 2015 issued a proposal, Investments—Equity Method and Joint Ventures (Topic 323): Simplifying the Equity Method of Accounting, and about 40 comment letters (109 DTR G-4, 6/8/15).
In those redeliberations, FASB decided to finalize only the implementation aspect of the proposal. This allows companies to retroactively adopt the equity method of accounting if an investment qualifies for use of the equity method as result of an increase in ownership or influence.
The second aspect of the proposal, which would have eliminated the requirement for companies to account for the basis difference as if the investment was a consolidated subsidiary, was spun off as a separate project.
A basis difference refers to the amount by which the cost of acquiring an equity method investment exceeds an investor's interest in the net assets of an investee.
A number of respondents were opposed to the proposed guidance, citing, among other concerns, increased cost and complexity, staff accountants told the board.
During May 11 discussions, FASB considered amending its proposed decision to provide investors with an option. This would provide investors with an irrevocable election—determined on an instrument-by-instrument basis—so that they wouldn't have to assess the initial basis difference of an equity method investment or subsequently account for it. In tandem, the board considered providing the option for private companies.
Another alternative discussed was requiring equity method investments to be measured at fair value. Under this alternative, changes in fair value would be recognized through net income, consistent with provisions for marketable and non-marketable equity securities.
A third alternative was amortization, when applicable, of the basis difference over the useful life of the predominant source of the basis difference.
Ultimately, the board couldn't gather enough votes for any of the alternatives to move ahead with the project.
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