EITF ABSTRACTS. Dates Discussed: September 23 24, 1998; November 18 19, 1998; January 21, 1999

Transcription

1 EITF ABSTRACTS Issue No Title: Accounting by an Equity Method Investor for Investee Losses When the Investor Has Loans to and Investments in Other Securities of the Investee Dates Discussed: September 23 24, 1998; November 18 19, 1998; January 21, 1999 References: FASB Statement No. 114, Accounting by Creditors for Impairment of a Loan FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities FASB Statement No. 118, Accounting by Creditors for Impairment of a Loan Income Recognition and Disclosures FASB Statement No. 167, Amendments to FASB Interpretation No. 46(R) FASB Interpretation No. 46, Consolidation of Variable Interest Entities FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities FASB Staff Position FIN46-6, Effective Date of FASB Interpretation No. 46 APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock AICPA Audit and Accounting Guide, Audits of Investment Companies AICPA Statement of Position 78-9, Accounting for Investments in Real Estate Ventures ISSUE 1. Topic No. D-68, "Accounting by an Equity Method Investor for Investee Losses When the Investor Has Loans to and Investments in Other Securities of an Investee," provides the FASB staff position that Opinion 18 requires an investor that owns common (or other voting) stock and also (a) owns debt securities (including mandatorily redeemable preferred stock), (b) owns preferred stock, or (c) has extended loans to the investee to continue to report losses. [Note: See Status section.] Paragraph 13 of Statement 114, as amended by Statement 118, provides that when a loan is impaired, a creditor shall measure impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate. Paragraph 12 of Statement 115 Page 1

2 provides that investments in both debt securities not held to maturity and equity securities that have readily determinable fair values shall be carried at fair value. 2. The issue is, when an investor is required to account for a common stock investment using the equity method, how the equity method loss pickup from the application of Opinion 18 (when the carrying amount of the common stock has been reduced to zero) interacts with the applicable literature relating to investments in the other securities of the investee (either Statement 114 or Statement 115). EITF DISCUSSION 3. The Task Force reached a consensus that in situations where (a) an investor is not required to advance additional funds to the investee and (b) previous losses have reduced the common stock investment account to zero, the investor should continue to report its share of equity method losses in its statement of operations to the extent of and as an adjustment to the adjusted basis of the other investments in the investee. [Note: See STATUS section.] The order in which those equity method losses should be applied to the other investments should follow the seniority of the other investments (that is, priority in liquidation). For each period, the adjusted basis of the other investments should be adjusted for the equity method losses, then the investor should apply Statements 114 and 115 to the other investments, as applicable. 4. For purposes of this consensus, other investments in the investee include, but are not limited to, preferred stock, debt securities, and loans to the investee (collectively referred to as loans and securities). The cost basis of the other investments is the original cost of those investments adjusted for the effects of other-than-temporary write-downs, unrealized holding gains and losses on Statement 115 securities classified as trading, and amortization of any discount or premium on debt securities or loans. The adjusted basis Page 2

3 is the cost basis adjusted for the Statement 114 valuation allowance account for an investee loan and the cumulative equity method losses applied to the other investments. Equity method income subsequently recorded should be applied to the adjusted basis of the other investments in reverse order of the application of the equity method losses (that is, equity method income is applied to the more senior securities first). 5. The Task Force reached a consensus that when the investor has loans and securities of the investee that are within the scopes of Statements 114 and 115, respectively, the investor should perform the following in order to determine the amount of equity method loss to report at the end of a period: a. Apply Opinion 18 to determine the maximum amount of equity method losses. b. Determine whether the adjusted basis of the other investment(s) in the investee is positive. i. When the adjusted basis is positive, the adjusted basis of the other investments should be adjusted for the amount of the equity method loss based on its seniority. For investments accounted for in accordance with Statement 115, this adjusted basis becomes the security's basis from which subsequent changes in fair value are measured. ii. When the adjusted basis reaches zero, equity method losses should cease being reported; however, the investor should continue to track the amount of unreported equity method losses for purposes of applying paragraph 19(i) of Opinion 18. (If one of the other investments is sold at a time when its carrying value exceeds its adjusted basis, the difference between the cost basis of that other investment and its adjusted basis at the time of sale represents equity method losses that were originally applied to that other investment but effectively reversed upon its sale. Accordingly, that excess represents unreported equity method losses that should continue to be tracked before future equity method income can be reported. Refer to Exhibit 98-13A, year 20X7, for an example that illustrates this concept.) c. After applying Opinion 18, apply Statement 114 and Statement 115 to the adjusted basis of the other investments in the investee, as applicable. Apply appropriate generally accepted accounting principles to other investments that are not within the scopes of Statement 114 or Statement Refer to Exhibit 98-13A for an example that illustrates application of this consensus. Page 3

4 7. The provisions of this consensus are effective for interim or annual periods beginning after December 31, 1998, and should be applied on a prospective basis. 8. The Task Force expressed a desire to address whether the percentage used to determine the amount of equity method losses should be based on the ownership percentage of the common stock or the ownership percentage of the security that is being reduced for the equity method losses. The Task Force may ask the EITF Agenda Committee to consider that issue at a future meeting. STATUS 9. At the September 23, 1999 meeting, the Task Force reached a consensus on Issue No , Percentage Used to Determine the Amount of Equity Method Losses, that an investor should not recognize equity method losses based solely on the percentage of investee common stock held by the investor. 10. At the January 19 20, 2000 meeting, the SEC staff made an announcement in Topic No. D-84, Accounting for Subsequent Investments in an Investee After Suspension of Equity Method Loss Recognition When an Investor Increases Its Ownership Interest from Significant Influence to Control through a Market Purchase of Voting Securities, that the SEC staff believes that in the circumstances in which an investor increases its ownership interest from one of significant influence to one of control through a purchase of additional voting securities in the market, and where no commitment or obligation to provide financial support existed prior to obtaining control, the acquisition should follow step acquisition accounting. 11. Interpretation 46(R), as amended by Statement 167, addresses consolidation by business enterprises of variable interest entities, which include some corporations that may have been accounted for by investors under the equity method. That Interpretation Page 4

5 requires a variable interest entity to be consolidated by an enterprise if that enterprise has a variable interest (or a combination of variable interests) that provides the enterprise with a controlling financial interest. Paragraphs 14 14G of Interpretation 46(R), as amended by Statement 167, provide guidance on determining whether an enterprise has a controlling financial interest in a variable interest entity. 12. Interpretation 46 was issued in January The consolidation requirements of Interpretation 46 apply immediately to variable interest entities created after January 31, The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. 13. FSP FIN46-6 deferred the effective date for applying the provisions of Interpretation 46 for: a. Interests held by a public entity in variable interest entities created before February 1, 2003, if the public entity has not issued financial statements reporting that interest in accordance with Interpretation 46. The application of Interpretation 46 to those interests is deferred until the end of the first period ending after December 15, b. Nonregistered investment companies accounting for their investments in accordance with the specialized accounting guidance in the investment company Guide. 14. Interpretation 46(R) was issued on December 24, 2003, and replaced Interpretation 46. An enterprise with an interest in an entity to which the provisions of Interpretation 46 were not applied as of December 24, 2003, must apply the effective date and transitions provisions in Interpretation 46(R) to that entity. Application by public companies of Interpretation 46 or Interpretation 46(R) to entities commonly referred to as special-purpose entities is required no later than as of the end of the first reporting period that ends after December 15, Public enterprises must apply Interpretation 46(R) to Page 5

6 all entities no later than the end of the first reporting period that ends after March 15, 2004 (public enterprises other than small business issuers) or December 15, 2004 (small business issuers). Nonpublic enterprises must apply Interpretation 46(R) to entities created after December 31, 2003, immediately and to all other entities by the beginning of the first annual period beginning after December 15, An enterprise that has applied Interpretation 46 to an entity prior to the effective date of Interpretation 46(R) shall either continue to apply Interpretation 46 until the effective date of Interpretation 46(R) or apply Interpretation 46(R) at an earlier date. 15. Statement 167 was issued in June 2009 and amends Interpretation 46(R). Statement 167 shall be effective as of the beginning of each reporting entity s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. 16. At the June 30 July 1, 2004 meeting, the Task Force reached a consensus on Issue No , "Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than Common Stock," that for purposes of applying Opinion 18, the term "common stock" includes "in-substance common stock" (as defined under Issue 02-14). Therefore, an investor that has the ability to exercise significant influence over the operating and financial policies of the investee should apply the guidance under this Issue only when it has an investment(s) in common stock and/or an investment that is insubstance common stock. 17. No further EITF discussion is planned. Page 6

7 Exhibit 98-13A ILLUSTRATION OF THE APPLICATION OF THE EITF CONSENSUS ON ISSUE Investor owns 40 percent of the outstanding common stock of Investee; the common stock investment has been reduced to zero at the beginning of 20X1 because of previous losses. Investor also has invested $100 in preferred stock (classified as an available-forsale security) of Investee (40 percent of the outstanding preferred stock of Investee) and has extended $100 in loans to Investee (which represent 40 percent of all loans extended to Investee). Investor is not obligated to provide any additional funding to Investee. In accordance with paragraphs 19(a) and 19(k) of Opinion 18, Investee's operating income and losses in the table below have been adjusted for intercompany interest on the loan and dividends received or receivable on the preferred stock. As of the beginning of year 20X1, the carrying value of Investor's total combined investment in Investee is $200, as follows: Carrying Balance Common stock $ 0 Loan $100 Preferred stock $100 Assume the following facts for years 20X1 through 20X7: Year 20X1 20X2 20X3 20X4 20X5 20X6 20X7 Investee Operating Income/(Loss) $(200) (400) ,000 Carrying Value of the Loan under Statement 114 $ Fair Value of the Preferred Stock under Statement 115 $ * * Preferred stock was sold for $90 on January 2, 20X7. Page 7

8 20X1: a. In accordance with Opinion 18, record the equity method loss (40% $200 = $80) to the cost basis of the preferred stock (the next level of capital) at the time that the common stock investment becomes zero. Equity method loss 80 Preferred stock investment 80 b. In accordance with Statement 114, record a valuation allowance for the impaired loan. Loan loss expense 5 Loan loss valuation allowance 5 c. In accordance with Statement 115, record the mark-to-market adjustment for the available-for-sale preferred stock investment (market price of $90 less the carrying amount after entry (a) of $20, equals $70 unrealized gain). Preferred stock investment 70 Unrealized gain other comprehensive income 70 The total P&L charge is $85 ($80 for the equity method loss and $5 for the loan). Other comprehensive income (OCI) is credited $70 for the preferred stock investment. The carrying amount of the total combined investment in Investee is reduced to $185 ($0 for the common stock investment, $95 for the loan, and $90 for the preferred stock investment), and the balance in accumulated OCI is a credit of $70. The adjusted basis of the total combined investment in Investee is reduced to $115 ($0 for the common stock investment, $95 for the loan, and $20 for the preferred stock investment). Page 8

9 20X2: a. In accordance with Opinion 18, record the equity method loss (40% $400 = $160) to the adjusted basis of the preferred stock of $20 and, because the adjusted basis of the preferred stock will then be reduced to zero, record the remaining equity method loss to the adjusted basis of the loan (the next level of capital). The total equity method loss recorded would be limited, however, to the adjusted basis of the total combined investment in Investee of $115; therefore, $45 of equity method losses are unreported. Equity method loss 115 Preferred stock investment 20 Loan 95 b. In accordance with Statement 115, record the mark-to-market adjustment for the available-for-sale preferred stock investment (market price of $90 less the carrying amount after entry (a) of $70, equals $20 unrealized gain). Preferred stock investment 20 Unrealized gain OCI 20 The total P&L charge is $115 (equity method loss). OCI is credited $20 for the preferred stock investment. The carrying amount of the total combined investment in Investee is reduced to $90 ($0 for the common stock investment, $0 for the loan, and $90 for the preferred stock investment), and the balance in accumulated OCI is a credit of $90. The adjusted basis of the total combined investment in Investee is reduced to $0 ($0 for the common stock investment, $0 for the loan, and $0 for the preferred stock investment). 20X3: No equity method income or loss (40% $0 = $0). a. Because the adjusted basis of the loan was reduced to zero in 20X2 as a result of applying equity method losses to the loan, no entry is needed to reflect the Statement 114 reduction in carrying amount from $95 to $60. b. In accordance with Statement 115, record the mark-to-market adjustment for the available-for-sale preferred stock investment (market price of $50 less the carrying amount of $90, equals $40 unrealized loss). Unrealized loss OCI 40 Preferred stock investment 40 Page 9

10 OCI is debited $40 for the preferred stock investment. The carrying amount of the total combined investment in Investee is reduced to $50 ($0 for the common stock investment, $0 for the loan, and $50 for the preferred stock investment), and the balance in accumulated OCI is a credit of $50. The adjusted basis of the total combined investment in Investee remains $0. 20X4: a. In accordance with Opinion 18, record the equity method income (40% $400 = $160). However, in accordance with Opinion 18, Investor resumes applying the equity method only after its share of that income equals the unreported equity method losses of $45. Therefore, the equity method income to be reported for the period is $115 ($160 $45). The adjusted bases of the other investments are restored in the reverse order of the application of the equity method losses (loan first, then preferred stock). Loan 95 Preferred stock investment 20 Equity method income 115 b. In accordance with Statement 115, record the mark-to-market adjustment for the available-for-sale preferred stock investment (market price of $90 less the carrying amount of $70, equals $20 unrealized gain). Preferred stock investment 20 Unrealized gain OCI 20 The total P&L credit is $115 (the equity method income after Investor's share of unreported equity method losses of $45 in 20X2). OCI is credited $20 for the preferred stock investment. The carrying amount of the total combined investment in Investee is increased to $185 ($0 for the common stock investment, $95 for the loan, and $90 for the preferred stock investment), and the balance in accumulated OCI is a credit of $70. The adjusted basis of the total combined investment in Investee is increased to $115 ($0 for the common stock investment, $95 for the loan, and $20 for the preferred stock investment). Page 10

11 20X5: No equity method income or loss (40% $0 = $0). a. In accordance with Statement 114, record a valuation allowance for the impaired loan. Loan loss expense 50 Loan loss valuation allowance 50 b. In accordance with Statement 115, record the mark-to-market adjustment for the available-for-sale preferred stock investment (market price of $55 less the carrying amount of $90, equals $35 unrealized loss). Unrealized loss OCI 35 Preferred stock investment 35 The total P&L charge is $50 (from the loan). OCI is debited $35 for the preferred stock investment. The carrying amount for the total combined investment in Investee is reduced to $100 ($0 for the common stock investment, $45 for the loan, and $55 for the preferred stock investment), and the balance in accumulated OCI is a credit of $35. The adjusted basis of the total combined investment in Investee is reduced to $65 ($0 for the common stock investment, $45 for the loan, and $20 for the preferred stock investment). 20X6: No equity method income or loss (40% $0 = $0). a. In accordance with Statement 114, adjust the valuation allowance for change in the expected future cash flows from the loan. Loan loss valuation allowance 50 Loan loss expense 50 b. In accordance with Statement 115, record the mark-to-market adjustment for the available-for-sale preferred stock investment (market price of $90 less the carrying amount of $55, equals $35 unrealized gain). Preferred stock investment 35 Unrealized gain OCI 35 The total P&L credit is $50 (from the loan). OCI is credited $35 for the preferred stock investment. The carrying amount of the total combined investment in Investee is increased to $185 ($0 for the common stock investment, $95 for the loan, and $90 for the preferred stock investment), and the balance in accumulated OCI is a credit Page 11

12 of $70. The adjusted basis of the total combined investment in Investee is increased to $115 ($0 for the common stock investment, $95 for the loan, and $20 for the preferred stock investment). 20X7: a. Record the sale of the preferred stock. Cash 90 OCI 70 Preferred stock investment 90 Gain on sale of security 70 b. In accordance with Opinion 18, record the equity method income (40% $1,000 = $400). While Investor has recorded losses for all prior Investee losses, $80 of such recorded losses (representing the difference between the cost basis of the preferred stock investment of $100 and its adjusted basis of $20) have effectively been reversed in entry (a) by recording a $70 gain on the sale of the preferred stock when an actual loss of $10 (representing the difference between the cost basis of the preferred stock investment of $100 and the proceeds of $90) was incurred. Accordingly, only $320 of equity method income should be recorded ($400 $80). Investment in investee (common) 320 Equity method income 320 c. In accordance with Statement 114, adjust the valuation allowance for change in the expected future cash flows from the loan. Loan loss valuation allowance 5 Loan loss expense 5 The total P&L credit is $395 ($70 gain from the sale of the preferred stock, $320 for the equity method income, and $5 from the loan). The carrying value of the total combined investment in Investee is increased to $420 ($320 for the common stock investment and $100 for the loan), and the balance in accumulated OCI is $0. The adjusted basis of the total combined investment in Investee is increased to $420 ($320 for the common stock investment, $100 for the loan, and $0 for the preferred stock investment). Page 12

13 Suggested Index Entries for EITF Issue No Accounting by an Equity Method Investor for Investee Losses When the Investor Has Loans to and Investments in Other Securities of the Investee INVESTMENTS: EQUITY METHOD Accounting by an Equity Method Investor for Investee Losses When the Investor Has Loans to and Investments in Other Securities of the Investee Page 13