Companies Buying Stock in Other Businesses Get Accounting Clarity

Companies that buy stock in other businesses should get accounting clarity in early 2020 on how to measure certain types of equity securities.

A unanimous Financial Accounting Standards Board on Nov. 20 confirmed the bulk of a proposal that spelled out which accounting guidance investments must follow when they meet specific criteria. The forthcoming update aims to clarify when a business must follow what is called the equity method of accounting, as outlined in ASC 323, versus broader guidance dealing with the classification and measurement of financial instruments, as prescribed in ASC 321.

The difference matters because the classification affects how the instrument gets measured. How something gets measured, in turn, can affect a company’s earnings.

Investments that qualify for the equity method of accounting generally are recorded at the cost of the investment. Equity investments, on the other hand, are measured at fair value with changes recorded through net income. If there is no readily determinable fair value, they can be measured at cost minus impairment, if any.

The forthcoming update will clarify that businesses should consider “observable transactions” to determine whether to apply or discontinue the equity method of accounting.

In addition, certain forward contracts and options that don’t have to be accounted for as derivative instruments do not have to be analyzed to determine if they need to be accounted for under the equity method of accounting, FASB agreed.

The board decided to research whether it needs to provide guidance on how to recognize losses when an investor has investments in the investee. Preliminary research suggests it’s not a pervasive issue in public companies, so the board plans to focus on privately held businesses.

“The pervasiveness of this, to me, doesn’t seem to be particularly high and I think outreach will hopefully confirm that as well,” FASB member Marsha Hunt said.