Changing from the Equity Method to the Fair Value or Cost Less Impairment Method
Accounting for an equity method investment may need to be changed to the fair value method or the cost less impairment adjusted for observable prices changes method because the investor has sold some of its holdings in the investee and no longer has significant influence.
When an equity Investment is changed to the fair value or cost less impairment adjusted for observable price changes method, the cost basis that should be used for the newly classified investment is the carrying value of the equity investment at the time of the change. However, several adjustments to that value are needed first.
1) The investor's investment account needs to be adjusted so it is current as of the date of the event that caused the change in accounting methods. The investor's share of net income or loss in the investee for the period up to the event should be recorded.
2) If the event that gave rise to the change in method was a partial sale, the gain or loss on the sale can be computed after the accounts have been adjusted for the investor's share of net income or loss in the investee for the period up to the sale. The investor's gain or loss is equal to the difference at the time of the sale between the selling price and the investor's carrying amount of the stock sold. The gain (loss) is reported on the investor's income statement in the non-operating gains/losses section.
3) The remaining holdings are remeasured to fair value immediately after recording the partial sale and a gain or loss is recorded in earnings.
Read Notes :- Which good are included in inventory
° If the equity security accounted for under the equity method has a readily determinable fair value (that is, it is traded on an active secondary market), the fair value is the current market value.
° If the equity security accounted for under the equity method does not have a readily deter- minable fair value and the investor estimates its fair value at its cost minus impairment adjusted for observable price changes in accordance with ASC 321-10-35-2, the investor's own sale of a portion of its investment is an observable transaction if the investor determines that the price it received per share represents the fair value of the security.
Therefore, after recording the sale and the gain or loss on the sold shares, if the security does not have a readily determinable fair value, the investor re measures its remaining holdings at fair value based on the price it received per share for the shares it sold (assuming the investor
Determines that the price it received represents the fair value) and recognizes a gain or loss on the remaining shares. 77
The adjusted carrying value of the retained portion of the investment at the time of the change becomes the cost basis for the remaining investment under the fair value or cost less impairment adjusted for observable price changes method.
Although the change represents a change in accounting principle, the investment account is not adjusted retroactively. Going forward, the investor accounts for the retained portion of the investment at fair value or cost less impairment adjusted for observable price changes, as appropriate. The investor records future dividends received as dividend income, although any dividends received in excess of the investor's share of the investee's post-disposal net income are considered a return of capital and are credited to the investment rather than to income.
The Fair Value Option for Equity Method Investments
For a specific security that would otherwise be reported using the equity method, an investor may choose the fair value option instead, with all gains and losses related to changes in its fair value reported on the income statement. The option is applied to a specific instrument on an instrument-by-instrument basis and is available only when the investor first purchases the financial asset. If an investor chooses the fair value option, the investor must apply the fair value method consistently as long as they own the security.
If the fair value option is used for an equity investment where the investor has significant influence, the investor does not report its proportionate share of the investee's income or loss, and dividends received by the investor are credited to dividend income and do not reduce the investments account. The equity invest- ment is carried in a separate account and its fair value is increased or decreased as appropriate to reflect unrealized gains and losses. The other side of the entry is an unrealized gain or loss on the income statement