The ASC (Accounting Standards Codification) provides guidance on classification of various types of investments under US GAAP. Proper classification is crucial as it determines subsequent measurement and accounting treatment. This article will explain key factors to consider when classifying equity investments such as scope assessment, equity/debt distinction, existence of derivatives, control assessment, etc. Requirements under ASC Topics 320, 323, 815 and 946 will be covered. Both private equity funds and individual investments will be discussed through examples, with a focus on fair value measurement.
Assess if the investee should be consolidated first
The first step is to evaluate if there is a control relationship that would require consolidation under ASC 810. Typical control indicators include owning over 50% voting rights or having power over financial and operating policies. If consolidation applies, no further ASC classification is needed. If not, further analysis on the nature of the investment is required.
Evaluate if embedded derivatives exist and need bifurcation
Under ASC 815, certain features like net settlement clauses may indicate an embedded derivative that needs separate accounting. If so, the host and embedded portions should be bifurcated and measured accordingly.
Debt vs. equity classification rules per ASC 320
ASC 320 provides a detailed definition on whether an investment represents debt-like or equity-like interests. Preferred shares with redemption requirements, convertible instruments with debt components etc. need special considerations. The conclusion drives subsequent measurement.
For equity investments, test if readily determinable fair value exists
Under Topic 320, equities traded in active markets, mutual fund interests and certain restricted stocks are considered to have readily determinable fair values (RDFV). Such RDFV equities would follow ASC 320 for measurement and disclosures.
Non-RDFV equities fall under ASC 323 scope
Equity investments not having RDFV are covered under ASC 323. However, ASC 946 exempts application of ASC 323 for investment companies’ portfolio holdings, requiring fair value accounting instead.
Classification conclusions significantly impact measurement
Proper ASC classification drives subsequent measurement methods. Key alternatives like fair value, equity method and cost method have vastly different income statement impacts over the investment life. Careful upfront analysis is imperative before acquisition.
In summary, intricate ASC requirements apply for classifying various equity investments. Control assessment, bifurcation of embedded instruments, debt vs. equity distinctions, existence of RDFV and applicability of ASC 946 exceptions need to be carefully analyzed first. Classification conclusions then dictate ongoing measurement methodology. Examples here cover both individual securities and portfolio holdings of investment funds.