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Equity interest accounting – The measurement alternative and more · PwC's accounting podcast

• 0:00
  SPEAKER_01: Thought leadership from PwC's National Office.
• 0:06
  SPEAKER_03: Welcome to PWC's Accounting Podcast.
• 0:10
  SPEAKER_03: I'm Heather Horn.
• 0:11
  SPEAKER_03: Today we're wrapping up our series on the Loans and Investments Guide, and we're going back to the basics with a discussion of the accounting for equity investments, a topic that transcends industries and company size to impact almost everyone.
• 0:26
  SPEAKER_02: If you think about how some of our some companies get these equity investments, some of them they're making it for investment purposes.
• 0:34
  SPEAKER_02: Like they're it's part of their investment strategy.
• 0:37
  SPEAKER_02: Others, the reason is more complicated.
• 0:39
  SPEAKER_02: You know, it's a it's a vendor, it's a it's a customer, it's someone you're sort of making a bit of a strategic investment in that you want to be able to see what's going on and then jump in if the company that you're investing in becomes more successful or has a product that launches and things like that.
• 0:56
  SPEAKER_02: So there's a lot of strategic reasons why you might be in these instruments.
• 1:01
  SPEAKER_02: Um think about which accounting model you apply, like Chris said very, very carefully.
• 1:05
  SPEAKER_02: Like what's the financial reporting implications of fair value through PL?
• 1:08
  SPEAKER_02: What are people going to think about the measurement alternative where you can have sudden shocks in earnings, either you know, upward or impairments downward that, you know, sort of kind of pop in a given quarter.
• 1:26
  SPEAKER_03: That was Chip Curry, who's joined by Chris Chidot, both partners in PWC's national office with extensive experience on this topic.
• 1:35
  SPEAKER_03: They'll help break down the accounting and share some helpful insights.
• 1:38
  SPEAKER_03: So let's start the episode.
• 1:41
  SPEAKER_03: Chip, Chris, thanks so much for joining me today for our series around topics from the loans and investments guide.
• 1:47
  SPEAKER_03: And I think today's topic is one that almost everyone will have dealt with at some point and probably on a semi-regular basis.
• 1:55
  SPEAKER_03: And that would be accounting for equity investments.
• 1:58
  SPEAKER_03: And I know that this is not an area that's always completely straightforward.
• 2:02
  SPEAKER_03: So maybe before we start things off, it would be helpful just to understand a roadmap of the accounting guidance.
• 2:08
  SPEAKER_03: So Chris, can I go to you for that?
• 2:10
  SPEAKER_00: Yeah, sure.
• 2:11
  SPEAKER_00: So, you know, when you're talking about equity instruments, there's a lot that you can wind up needing to think about.
• 2:17
  SPEAKER_00: And um you really need like a disciplined uh approach to kind of walking through all the different aspects that you can find yourself in.
• 2:26
  SPEAKER_00: For for the majority of uh folks, like you really want to start off with uh uh consolidation, right?
• 2:32
  SPEAKER_00: So that's kind of the first place to start with with equity instruments and you know, do you um have control of the entity through your interest?
• 2:41
  SPEAKER_00: And if so, um, you know, would you be required to consolidate that in that entity?
• 2:46
  SPEAKER_00: Because that kind of trumps all the potential accounting.
• 2:50
  SPEAKER_00: Yes.
• 2:50
  SPEAKER_00: You know, and obviously, you know, consolidation is you bring all their assets and liabilities on onto your books and and and do all the fun consolidation accounting that you don't want me talking about.
• 3:01
  SPEAKER_03: All right.
• 3:01
  SPEAKER_03: So let's assume for the purposes of today's podcast, we're not consolidating.
• 3:06
  SPEAKER_03: So then what?
• 3:07
  SPEAKER_00: So then the next thing is to think about whether the um instruments that you have are either derivatives or would uh provide you with um what's called significant influence and and leads you into equity method accounting.
• 3:20
  SPEAKER_00: So you know, probably for um derivatives, um it likely depends on what kind of instrument that that you are invested in.
• 3:27
  SPEAKER_00: You know, probably a straightforward share is is generally not going to be a derivative.
• 3:31
  SPEAKER_00: Um but oftentimes um equity instruments could be in the form of um options or warrants or or purchase forwards, um, forward sales uh and and full purchases, and and those could uh actually be derivatives uh depending on if generally it comes down to if there's a net settlement um feature, either because the uh the entity is public and so it's generally going to be readily convertible to cash, um, or there could be net share settle features or or other things that could provide net settlement.
• 4:01
  SPEAKER_00: So that that's usually kind of the next next place to go.
• 4:04
  SPEAKER_00: Um equity method is kind of uh you know a hybrid, if you will, of um almost a pseudo-consolidation for your relative ownership percentage, um, all mushed into one kind of line item in a way.
• 4:16
  SPEAKER_00: Um again, I'm not sure you want me talking too much about equity method, uh, other than I know that uh you know you need to think about it.
• 4:23
  SPEAKER_00: But uh we'll leave those for other days.
• 4:27
  SPEAKER_03: Yeah, I th I th derivatives, yes, and I think equity method, if we don't go, we should be adding that one.
• 4:32
  SPEAKER_03: So yes, more to come on that.
• 4:34
  SPEAKER_00: Excellent.
• 4:34
  SPEAKER_00: So some of you have gotten through you know no consolidation, no derivative, and no equity method.
• 4:40
  SPEAKER_00: Um you think you were done, but uh you're not really done.
• 4:43
  SPEAKER_00: If uh for your listeners have have listened to the uh the debt instrument um podcast, they may already know that there's another step.
• 4:51
  SPEAKER_00: And that is that a legal form equity instrument could actually wind up being a debt instrument.
• 4:57
  SPEAKER_00: I think probably the most common example of that is a preferred stock instrument that's either mandatorily redeemable or redeemable at the option of the investor.
• 5:05
  SPEAKER_00: Definitionally, those are debt instruments because they somewhat are less like uh a direct ownership of the entity and are more like a debt relationship between the investor you and and the entity you're invested in.
• 5:20
  SPEAKER_00: So that's the fourth category of equity instruments before you actually get to equity instruments.
• 5:25
  SPEAKER_03: All right.
• 5:26
  SPEAKER_03: So now let's assume I finally made it.
• 5:28
  SPEAKER_03: I don't have any of those other accounting models that are applicable.
• 5:32
  SPEAKER_03: Then I'm in the scope of ASC 321.
• 5:35
  SPEAKER_03: But maybe one more question before we actually start to get into that, because Chris, this is a case where this is not, oh, I've acquired this investment, I'm gonna evaluate it once and I'm I'm finished and I decide which model I'm in.
• 5:48
  SPEAKER_03: You may need to reassess.
• 5:50
  SPEAKER_00: Uh that's correct.
• 5:51
  SPEAKER_00: And yeah, I mean, the kind of like you said, we're at a point where we we're in the scope of ASC 321, which is accounting for equity uh instruments.
• 6:01
  SPEAKER_00: But you're right, like you need to continually assess um whether that's the right place to be or not.
• 6:07
  SPEAKER_00: And again, there's a number of things that could impact uh that that assessment.
• 6:11
  SPEAKER_00: Uh you know, we talked about equity method and consolidation.
• 6:15
  SPEAKER_00: Well, ownership percentages can change, you know, over time.
• 6:18
  SPEAKER_00: Either you buy more securities, you sell more securities, uh, the entity may do a transaction that increases or decreases your ownership percentage.
• 6:26
  SPEAKER_00: All of that could lead to either consolidating or deconsolidating.
• 6:30
  SPEAKER_00: Uh, if you kind of lose your ownership uh lose your control, could be in or out of the uh equity method of accounting.
• 6:37
  SPEAKER_00: Um, and so that could be one place where uh an assessment can change the model that you're in.
• 6:43
  SPEAKER_00: We talked about the preferred stock example for debt security.
• 6:47
  SPEAKER_00: You know, there could be contingent features or you could have redemption provisions that lapse or expire, and so they you know go away and it's no longer redeemable, and now it is more like a true equity ownership.
• 7:00
  SPEAKER_00: Um, and so that could flip-flop between a debt security and uh equity security.
• 7:05
  SPEAKER_00: Uh we talked about derivatives sometimes.
• 7:08
  SPEAKER_00: Um instruments that are not derivatives at inception wind up being a uh derivative.
• 7:13
  SPEAKER_00: So for example, we talked about a public company could provide a net settlement feature because it's readily convertible to cash.
• 7:20
  SPEAKER_00: So if I initially invest uh I have an uh um option or a warrant in a private company, and then they do an IPO, um, that may now say, oh, what I have is readily convertible to cash, now I'm a derivative.
• 7:33
  SPEAKER_00: So yes, there's a lot of things that could change and and you know force you in or out of 321 or or something else, and and that's something that you need to continually uh assess.
• 7:43
  SPEAKER_03: All right.
• 7:44
  SPEAKER_03: And so then Ship, maybe bringing you into the conversation, if I have an equity security and I've concluded all those other models don't apply, then I should apply AST 321.
• 7:56
  SPEAKER_03: Is that correct?
• 7:57
  SPEAKER_02: Yeah.
• 7:57
  SPEAKER_02: I mean, you know, one other thing we do find is so you've worked your way through the model that that Chris kind of kind of articulated, and and now you're left in, you know, with with 321.
• 8:07
  SPEAKER_02: And I think there's still a little bit of confusion around kind of even the scope of 321.
• 8:12
  SPEAKER_02: And and I think I think part of that is if you actually read the codification, which is it's great.
• 8:18
  SPEAKER_02: It's a lot of fun.
• 8:19
  SPEAKER_03: I was gonna say absolutely.
• 8:22
  SPEAKER_03: All our listeners are like running out to do that right now.
• 8:24
  SPEAKER_02: Yeah.
• 8:24
  SPEAKER_02: I mean, you know, you've got a vacation coming up, grab the codification, great pool side read.
• 8:29
  SPEAKER_02: But if but if you were to read 321, you'll see the words equity security, equity security, equity security all the way, all the way through through that.
• 8:37
  SPEAKER_02: And so when people see that, they think, oh, this would only apply to something that is actually an equity security.
• 8:42
  SPEAKER_02: Securities have a definition under gap.
• 8:45
  SPEAKER_02: But that's not true.
• 8:46
  SPEAKER_02: That's um so like when you actually kind of double-click and look further, if you look in the scope section of 321, it notes that 320 applies to all ownership interests.
• 8:56
  SPEAKER_02: So that would include investments in partnerships, it would include unincorporated joint ventures, limited liability companies, things where they're equity instruments, but they wouldn't necessarily meet either the accounting or the legal definition of a security.
• 9:11
  SPEAKER_02: So a lot of people see the word equity security, they sort of stop and you're like, no, no, no, it could apply to these other instruments as well.
• 9:17
  SPEAKER_02: Um, another area where I think there's some confusion is the definition of an equity security in 321, or that 321 refers to.
• 9:27
  SPEAKER_02: And Chris mentioned this a little bit earlier.
• 9:29
  SPEAKER_02: It includes the right to acquire.
• 9:31
  SPEAKER_02: So think like call options to purchase securities, or forward purchase contracts to purchase securities, or dispose of.
• 9:39
  SPEAKER_02: So think forward sales and and and things like that, and ownership in in entities at fixed or determinable prices.
• 9:47
  SPEAKER_02: So now you might be confused because you might say, like, well, hold on, Chris said some of these are derivatives.
• 9:52
  SPEAKER_02: Yes, yeah, chips just said they meet the definition of equity security.
• 9:56
  SPEAKER_02: And, you know, where where that really comes down to is what Chris was mentioning.
• 10:00
  SPEAKER_02: If you have a forward or an option contract and the the forward option has net settlement.
• 10:06
  SPEAKER_02: So it either can be net cash, net share, or the asset that you would purchase is readily convertible to cash, you're gonna get sucked into the derivative standard.
• 10:14
  SPEAKER_02: So you're gonna be in like, what was it, step two, Chris, of your thing you get pulled out and the derivative standard.
• 10:20
  SPEAKER_02: But if you don't have that, if you have like a warrant, for example, like a purchased option to, and the only way you can exercise it is by gross physical settlement, paying the exercise price and receiving those shares.
• 10:32
  SPEAKER_02: If those shares are not readily convertible to cash, if it's like, say, a private company, as Chris mentioned, you won't be in A15, but you will be in 321.
• 10:42
  SPEAKER_02: And so that's another area where people kind of get confused, is like I said, they read that definition of equity security or they read that language equity security, and they don't realize it applies to these other instruments as well.
• 10:53
  SPEAKER_02: And there are a couple of scope exceptions in 321 that are spelled out, like things like federal home loan bank stock and things like that, where you know there's already a different specialized accounting model for those things.
• 11:05
  SPEAKER_02: But that's another area I think of confusion is just this whole equity security is a is is not really just limited to equity securities.
• 11:13
  SPEAKER_03: All right, that's helpful.
• 11:14
  SPEAKER_03: Chris, any other examples you give where there's some surprise that ASC 321 applies instead of a different model?
• 11:22
  SPEAKER_00: Yeah, I mean, there are some um instruments that um folks have maybe been surprised about.
• 11:28
  SPEAKER_00: Um I think probably the most common example would be uh a mutual fund investment that only invests in debt securities.
• 11:35
  SPEAKER_00: You know, it certainly feels like you have debt security, you know, it may kind of value a price like a debt security.
• 11:43
  SPEAKER_00: Um you may um invest in it because you're looking to invest in debt securities.
• 11:48
  SPEAKER_00: Um but as Chip said, you know, it's an ownership interest in a fund.
• 11:52
  SPEAKER_00: You know, it so therefore it's a it's an equity instrument.
• 11:54
  SPEAKER_00: You know, and a lot of people say, well, shouldn't I look through that?
• 11:58
  SPEAKER_00: I mean, that's just kind of on paper.
• 12:00
  SPEAKER_00: Really uh what I have is you know, it's a debt instrument, it's a collection of debt instruments, and you know, the answer is no.
• 12:06
  SPEAKER_00: You don't look through what you have.
• 12:08
  SPEAKER_00: What you have is an ownership interest.
• 12:10
  SPEAKER_00: So you would account for it as a equity uh investment, an equity instrument.
• 12:15
  SPEAKER_00: You know, Chip mentioned too, um, you know, purchased options and forwards uh that are not derivatives.
• 12:20
  SPEAKER_00: You know, some folks think, well, if I intend to imply uh the equity method of accounting, I I think it qualifies.
• 12:27
  SPEAKER_00: I mean, I should exclude that, right?
• 12:29
  SPEAKER_00: And and no, you know, although an equity method investment would not be part of ASC 321, uh, an option or a warrant to purchase uh an instrument may be an equity method once uh it's acquired.
• 12:43
  SPEAKER_00: And so once you actually have that significant influence would still be accounted for as an equity instrument under 321 while it's in that option or forward phase.
• 12:52
  SPEAKER_03: All right, a lot to think about.
• 12:54
  SPEAKER_03: And I would like to say that I've always uh disliked the fact that the equity method of accounting has that name, which is so close to accounting for equity securities, just adds confusion there.
• 13:06
  SPEAKER_03: So just you know, in case the FASB needs something to do, they they can take that on.
• 13:11
  SPEAKER_00: They are taking a gender request.
• 13:13
  SPEAKER_03: There you go.
• 13:14
  SPEAKER_03: Not sure that is high enough, but I do think it creates a lot of confusion.
• 13:18
  SPEAKER_03: I'm just saying.
• 13:19
  SPEAKER_03: Okay, but that said, let's we now know we're talking about accounting for equity securities, and we're in the scope of ASC 321 and as well the other things in the scope of 321.
• 13:30
  SPEAKER_03: I don't want to overly uh influence that.
• 13:33
  SPEAKER_03: So then what does the accounting look like?
• 13:36
  SPEAKER_00: Well, so we've finally determined after what was it, 17 million steps that you go through?
• 13:41
  SPEAKER_03: Pretty much.
• 13:42
  SPEAKER_00: Um that you're in ASC321.
• 13:44
  SPEAKER_00: Um, you know, the basic model is it's fair value through earnings, right?
• 13:50
  SPEAKER_00: Um and that's especially if uh you you have an instrument with a readily determinable fair value.
• 13:57
  SPEAKER_00: So what what is that?
• 13:58
  SPEAKER_00: What is a readily determinable fair value?
• 14:00
  SPEAKER_00: Well, if you think about uh an instrument uh that is maybe uh currently available on a securities exchange registered with the SEC or an over-the-counter market where uh the sales and and the prices are quoted and reported by the uh NASD, which is the National Association of Securities Dealers, automated quotations, um, or by the OTC Markets Group, uh if they have sales or bid-esque uh quotations, um, that's readily uh determinable fair value.
• 14:32
  SPEAKER_00: Outside the U.S., you know, if you think about like foreign markets, um, if there's uh uh uh securities traded in a foreign market that is of a similar breadth and scope to the U.S.
• 14:42
  SPEAKER_00: uh.
• 14:44
  SPEAKER_00: That would also um likely qualify for readily determinable um fair value.
• 14:50
  SPEAKER_00: Or investments in mutual funds are those that are similar to mutual funds, and they have a fair value per share that is determined and published and is the basis for current transactions, um, that would also qualify.
• 15:02
  SPEAKER_00: An instrument that has readily determinable fair value must be marked to market through through through earnings.
• 15:10
  SPEAKER_03: All right.
• 15:10
  SPEAKER_03: And that's fairly straightforward because you have this readily determinable fair value.
• 15:15
  SPEAKER_03: So recording the investment at fair value through earnings is not complex.
• 15:20
  SPEAKER_03: But there are many equity instruments where we do not have a readily determinable fair value.
• 15:25
  SPEAKER_03: So just take an investment in a private company, for an example.
• 15:28
  SPEAKER_03: So then, Chip, what model do we look to?
• 15:31
  SPEAKER_02: Yeah.
• 15:32
  SPEAKER_02: So like Chris said, the default model is fair value through PL for equity instruments that you invest in.
• 15:38
  SPEAKER_02: So equity investments.
• 15:40
  SPEAKER_02: So that's sort of the default model.
• 15:41
  SPEAKER_02: You would still fair value those through PL.
• 15:44
  SPEAKER_02: But 321 does provide for something you can elect into.
• 15:48
  SPEAKER_02: And you may hear that referred to as the measurement alternative.
• 15:53
  SPEAKER_02: So how does the measurement alternative work?
• 15:55
  SPEAKER_02: Uh well, first of all, it's something you have to make when you acquire the instrument.
• 15:59
  SPEAKER_02: So on the date you acquire the instrument, you elect that you want to apply the measurement alternative.
• 16:03
  SPEAKER_02: You cannot acquire instrument, do fair value through PL accounting, and then subsequently elect the measurement elective.
• 16:09
  SPEAKER_02: You have to elect the uh measurement alternative uh sort of at the acquisition date.
• 16:14
  SPEAKER_02: The model is basically based upon it goes on the balance sheet at cost and then you assess it for impairment.
• 16:20
  SPEAKER_02: Having said that, if the company identifies that there's been an orderly transaction where there is either the identical security that you own or a similar security issued by the same investor, then what you need to do is you need to then re-measure the security to fair value.
• 16:40
  SPEAKER_02: So if you think about it, it's like cost, assess it for impairment, and then if you see an observable price, that is a trigger to measure either the instrument up or down to its fair value.
• 16:51
  SPEAKER_00: Well, that's really the key part of the model, right?
• 16:53
  SPEAKER_00: Is you know, that there's a orderly transaction and observable um transaction price.
• 16:59
  SPEAKER_00: You know, the FASB really believed that all equity instruments should be marked to market.
• 17:06
  SPEAKER_00: And they understood, though, that there's a lot of difficulty uh and you know time and cost associated with trying to determine a fair value for something that is not otherwise readily determinable.
• 17:19
  SPEAKER_00: Um but they kind of figured, well, if there is a a transaction for a same or similar security, that transaction price would be a good data point um to determine fair value and take some of that burden off.
• 17:31
  SPEAKER_02: Yeah.
• 17:31
  SPEAKER_02: It was kind of like you said, it's it's it was an attempt to reach a middle ground, you know, between what they thought was the best accounting model, which was fair value through PL and the practicality of some of the difficulty in measuring, you know, Heather, to your point, like some certain non-public investments.
• 17:46
  SPEAKER_02: Um maybe a couple of other points just to highlight from uh on the measurement alternative.
• 17:50
  SPEAKER_02: So once you elect into the measurement alternative, you can elect to discontinue applying it and start moving to fair value through PL.
• 17:59
  SPEAKER_02: The theory being that's where the FASP really wanted you anyway.
• 18:02
  SPEAKER_02: So if you want to opt in, you can't go backwards.
• 18:05
  SPEAKER_02: You can't start with fair value and go to measurement alternative, but you can go from measurement alternative to fair value.
• 18:10
  SPEAKER_02: Um so there's a couple of consequences, is if you start with measurement alternative and then you want to elect out and do real fair value accounting.
• 18:18
  SPEAKER_02: So the first, not surprising, is that is an irrevocable election.
• 18:21
  SPEAKER_02: Once you're on fair value, you can't come off.
• 18:23
  SPEAKER_02: The other consequence of electing out of measurement alternative is you now have to measure any investment you have either in the same security or similar investments of the issuer at fair value through PL.
• 18:39
  SPEAKER_02: And that includes future purchases.
• 18:43
  SPEAKER_02: So you elect it and then you opt out.
• 18:46
  SPEAKER_02: You're sort of binding your hands with the ability to elect measurement alternative going forward for future acquisition.
• 18:52
  SPEAKER_02: So definitely something to keep in mind.
• 18:53
  SPEAKER_03: Okay, so Chip, I actually had a question that I jotted down.
• 18:56
  SPEAKER_03: So maybe this is a good time to pause and answer it.
• 18:59
  SPEAKER_03: So you mentioned at the beginning of this segment, and you also just reiterated the fact that you can elect the measurement alternatives like once at the point of acquisition.
• 19:11
  SPEAKER_03: So if I acquire some shares of a private company and I do not elect the measurement alternative, and then next year I acquire more shares in that same company.
• 19:22
  SPEAKER_03: Am I able to elect it then for the new shares?
• 19:26
  SPEAKER_02: Yes.
• 19:27
  SPEAKER_02: You can you can elect the measurement alternative sort of on an inch my inch my basis, unless you have elected the measurement alternative.
• 19:37
  SPEAKER_03: And then un-elected.
• 19:38
  SPEAKER_02: And then unelected.
• 19:39
  SPEAKER_02: That is the one time you now get bound and you're stuck with fair value through PL for all future acquisitions.
• 19:46
  SPEAKER_02: If you never apply the measurement alternative, or you apply it and you don't unelect it, if you acquire something in the future, you can choose again fair value or measurement alternative for those newly acquired instruments.
• 19:58
  SPEAKER_03: Okay.
• 19:58
  SPEAKER_03: So then that was my second question that I think you just answered.
• 20:01
  SPEAKER_03: So now I have two tranches of the same securities.
• 20:04
  SPEAKER_03: And for the second tranche, I elected the measurement alternative.
• 20:08
  SPEAKER_03: I can't change my mind about the first tranche.
• 20:11
  SPEAKER_02: Correct.
• 20:11
  SPEAKER_02: Once you're on fair value through earnings, it's done.
• 20:13
  SPEAKER_03: That's it.
• 20:14
  SPEAKER_03: Yeah it's over.
• 20:15
  SPEAKER_03: Okay.
• 20:15
  SPEAKER_03: That's very helpful.
• 20:16
  SPEAKER_03: All right.
• 20:16
  SPEAKER_03: Uh, you probably have some other points here then about applying the measurement alternative.
• 20:22
  SPEAKER_02: Yeah.
• 20:22
  SPEAKER_02: So I guess similar to a theme that Chris mentioned early, there is a requirement to do reassessment.
• 20:28
  SPEAKER_02: So if you elect the measurement alternative and the instrument no longer qualifies for measurement alternative, you have to stop.
• 20:35
  SPEAKER_02: So the example would be you invested in non-public security, the company goes public.
• 20:40
  SPEAKER_02: Now it has a readily determinable fair value because that security trades on an exchange, no more measurement alternative.
• 20:46
  SPEAKER_02: You have to go to fair value through PL.
• 20:47
  SPEAKER_02: Okay.
• 20:48
  SPEAKER_02: That makes sense.
• 20:49
  SPEAKER_02: Which makes sense.
• 20:49
  SPEAKER_02: Because now it's readily determinable fair value.
• 20:51
  SPEAKER_02: And there's no, you know, sort of impediment from a practical perspective of computing for value.
• 20:56
  SPEAKER_02: And I guess the last thing I'd mention that goes back to something Chris said earlier about investments in funds.
• 21:02
  SPEAKER_02: If you have an investment in an instrument that qualifies for what's referred to as like the nav practical expedient.
• 21:09
  SPEAKER_02: So in the fair value guidance, so 820, there is sort of a practical expedient that says if instead of having to compute full fair value, you can use the net asset value of a company and just mark to that and you know, assume effectively use that as a practical expedient to fair value, if it doesn't have a readily determinable fair value and the investee is sort of an investment company or it's applying investment company accounting.
• 21:36
  SPEAKER_02: So if the instrument is eligible for that nav practical expedient, you can't apply the measurement alternative.
• 21:42
  SPEAKER_02: And again, the theory is if it's eligible for the nav practical expedient, well, marking to nav is not that difficult.
• 21:49
  SPEAKER_02: The fund publishes nav, you mark to it.
• 21:51
  SPEAKER_02: So you don't need a measurement alternative.
• 21:54
  SPEAKER_02: So that's another just kind of reminder from a scope or applicability standpoint.
• 21:58
  SPEAKER_03: All right.
• 21:59
  SPEAKER_03: I think Chuck that's Helpful because I think this question does come up and the companies, a lot of companies have investments that are accounted for using NAV.
• 22:06
  SPEAKER_02: So it's absolutely the that practical expedient is something that is used frequently in the equities, you know, investments accounting for you know instruments that qualify.
• 22:16
  SPEAKER_03: All right.
• 22:16
  SPEAKER_03: So it's almost like they have a different alternative to the measurement alternative.
• 22:19
  SPEAKER_03: Correct.
• 22:20
  SPEAKER_03: Or a different, yes.
• 22:20
  SPEAKER_02: Or said differently, you don't get multiple bytes at the practicality, you get one.
• 22:25
  SPEAKER_02: And for that, yeah.
• 22:26
  SPEAKER_03: Yeah.
• 22:27
  SPEAKER_03: All right.
• 22:28
  SPEAKER_03: And then I guess another um question, you mentioned, I think this came up a couple of times, that if you're following the measurement alternative, if there is an observable transaction, then you need to measure it at fair value.
• 22:41
  SPEAKER_03: But then I think impairment also comes into play here.
• 22:44
  SPEAKER_03: So what is the impairment model under the measurement alternative crust?
• 22:48
  SPEAKER_00: Yeah.
• 22:49
  SPEAKER_00: So maybe it's a little easier to start off with what is it not?
• 22:54
  SPEAKER_00: It is not uh in other than temporary impairment.
• 22:57
  SPEAKER_00: So folks may be used to some of the you know old OTTI views and thoughts, and you would kind of say, well, it may have a temporary, you know, blip in the fair value, but it'll recover it and and we'll be fine.
• 23:11
  SPEAKER_00: Well, that doesn't fly with the uh measurement alternative impairment model.
• 23:16
  SPEAKER_00: There are no thresholds for significance, there's no defined triggers or anything like that.
• 23:22
  SPEAKER_00: You know, it's it's kind of simply um to the extent any of this is simple.
• 23:26
  SPEAKER_00: Um, but simply if you there's a reason to believe that the fair value is below the carrying value, um, you would need to compute what the fair value is and record the impairment difference.
• 23:37
  SPEAKER_03: All right.
• 23:38
  SPEAKER_03: And then just to be clear, so let's say in period, like I acquire it in the first period, and second period, I there is an observable transaction, so I write it down.
• 23:48
  SPEAKER_03: Now, let's say a year later, there's another observable transaction and the value goes up.
• 23:54
  SPEAKER_03: Then at that point, I'm actually able to write it back up even above the original carrying amount.
• 23:58
  SPEAKER_03: So it's it's pseudo fair value based on these observable transactions.
• 24:03
  SPEAKER_00: Well, that's the observable transaction, right?
• 24:06
  SPEAKER_00: So yes, I mean that's a data point for a new fair value.
• 24:09
  SPEAKER_00: But on the other hand, if I had uh you know, determined that there was an impairment, so I wrote down the investment, not because there was an observable transaction, but because I had reason to believe the fair value was lower.
• 24:21
  SPEAKER_00: You know, let's say that there was a significant line that was discontinued, or a new competitor came in and put a lot of pressure on my revenues.
• 24:31
  SPEAKER_00: Well, me being the entity that I'm invested in, I should say.
• 24:34
  SPEAKER_00: Yeah, so those could be reasons to believe that there is a decline in the fair value.
• 24:39
  SPEAKER_00: I would have computed it.
• 24:40
  SPEAKER_00: If now I say, oh, but you know, we just developed this new product and things are looking tremendously great.
• 24:46
  SPEAKER_00: Well, if there wasn't an orderly transaction, an observable uh you know, um price, or excuse me, an observable transaction, um I can't decide to compute the fair value and now recover from that.
• 25:00
  SPEAKER_00: It has to be a true fair value transaction.
• 25:03
  SPEAKER_03: Trevor Burrus If you're under this um measurement alternative.
• 25:06
  SPEAKER_03: Trevor Burrus, Jr.
• 25:06
  SPEAKER_03: Right, because otherwise you're you know, you're practically picking and choosing when you want to apply fair value, basically.
• 25:13
  SPEAKER_03: But to your point, you're saying even if you're under the measurement alternative, you need to do an impairment evaluation.
• 25:20
  SPEAKER_03: Aaron Powell Right.
• 25:21
  SPEAKER_00: I well, I would say it maybe a little differently in that if you're under the measurement alternative, you must do an impairment.
• 25:27
  SPEAKER_00: Because otherwise you're already recording fair value.
• 25:29
  SPEAKER_03: Yes, so you don't need to do that.
• 25:30
  SPEAKER_03: All right, that's helpful.
• 25:32
  SPEAKER_03: And then maybe I I know this may be a bit beyond what we're planning to talk about, but when we think about an observable transaction, if you know the example I gave at the very beginning of this measurement alternative was, you know, shares for a private company.
• 25:46
  SPEAKER_03: And so what would be an observable transaction in that context?
• 25:51
  SPEAKER_03: And again, for our listeners' benefit, this may not be complete.
• 25:54
  SPEAKER_03: It's just to give some feeling of it.
• 25:56
  SPEAKER_03: So either of you, Chris?
• 25:57
  SPEAKER_00: Well, I mean, it could be that you know there's a a new investor in the company and they invest in in shares of the company, and they're either the same or similar to the instrument you own.
• 26:10
  SPEAKER_00: Um, that could be an observable transaction.
• 26:13
  SPEAKER_00: Um it could be that um there was a publicized sale of an investment from one investor to the other.
• 26:21
  SPEAKER_00: So it doesn't have to come like from a new issuance from the company.
• 26:24
  SPEAKER_00: That's another example.
• 26:26
  SPEAKER_02: I mean another example that people don't think about is you buy more of the security or you sell some of the security.
• 26:34
  SPEAKER_02: That could create an observable transaction as well, which makes the model a little bizarre, right?
• 26:40
  SPEAKER_02: Because assuming you're not in a in a world where you think there's an impairment where you have an idea that fair value could be below amortized cost, you could effectively trigger a remeasurement of your investment by selling a portion of it.
• 26:53
  SPEAKER_02: And selling a portion creates an observable price, and then that would create a remeasurement event.
• 26:58
  SPEAKER_02: So, you know, that's there are some definitely some interesting elements to the application of the model.
• 27:05
  SPEAKER_02: But the model is, like you said, cost assess for impairment.
• 27:09
  SPEAKER_02: Chris made some very important points about impairment.
• 27:11
  SPEAKER_02: There's no triggers, there's no significance thresholds.
• 27:14
  SPEAKER_02: If you have any inclination whatsoever of fair value is below cost, you got to go compute fair value and see if it's impaired.
• 27:21
  SPEAKER_02: And then you always have to look for observable transactions because if there's an observable transaction of the same security or similar security, then you also have to react.
• 27:29
  SPEAKER_03: So, from a practical point of view, are we seeing that many companies are calculating fair value frequently or quarterly anyway?
• 27:37
  SPEAKER_03: Because they this question of could there be an impairment?
• 27:41
  SPEAKER_00: Yeah, I mean, you know, so I think a lot of times people think about like, you know, is this uh measurement alternative, you know, all that practical or helpful?
• 27:51
  SPEAKER_00: Yeah.
• 27:52
  SPEAKER_00: Um, because it's it's kind of hard, right, to sort of sit back and say, clearly there's no decrease in fair value.
• 28:00
  SPEAKER_00: And perhaps you know, if if things have really taken off well for the company since, like, you know, maybe it's a little clearer, but you know, just kind of a from a day-to-day perspective, you know, some companies are you know, kind of left with or or put in a position where they have to compute a fair value just to make sure they're not in in an impairment.
• 28:19
  SPEAKER_00: And so it's almost like you're doing the fair value anyway, but you only get to take the bad.
• 28:24
  SPEAKER_03: Yeah, the downside.
• 28:25
  SPEAKER_03: Yeah.
• 28:26
  SPEAKER_03: Interesting.
• 28:26
  SPEAKER_03: And so, Chris, any other sort of points you'd make or questions you'd advise companies to think about before they elect the measurement alternative?
• 28:35
  SPEAKER_00: Well, that you know, there's probably a lot of processing controls around um applying the uh the measurement alternative.
• 28:42
  SPEAKER_00: You know, you really need to have um a well-thought-out approach.
• 28:46
  SPEAKER_00: Um, you know, you first you need to identify if there are observable transactions, right?
• 28:52
  SPEAKER_00: So you need a process to to do that.
• 28:54
  SPEAKER_00: You know, I mean, you know, the FASBY you know says, you know, it doesn't have to be something that's you know exhaustive.
• 29:00
  SPEAKER_00: You don't have to kind of scorch the earth to make sure there was no transaction, but there should be a robust process to determine if there was a transaction in the first place.
• 29:09
  SPEAKER_00: And then if there was, you need to then determine, well, is that the same security that I have or is that a similar security?
• 29:16
  SPEAKER_00: Because it's it's not just that it's the exact same issuance, it's the exact same class, it's the exact same you know type of security or exact same security, I should say, you know, legally, um, it could be a similar security.
• 29:30
  SPEAKER_00: And then if you have those, uh then you need to think about the transaction price.
• 29:35
  SPEAKER_00: I mean, it's not simply marked to transaction price, it's mark to fair value.
• 29:39
  SPEAKER_00: You still need to follow the concepts under ASC 820 as to what a fair value is.
• 29:45
  SPEAKER_00: And the transaction price may be the fair value or it may simply be a data point from which I need to adjust, you know, for differences between, especially if you're in the the the perspective of having a similar security.
• 29:58
  SPEAKER_03: All right, that's very helpful.
• 29:59
  SPEAKER_03: So this is not going to be based on an exhaustive survey of all companies that could potentially be using this measurement alternative, but from your guys' experience, do companies generally elect this when it's available to them, or it really is there's not, you can't really see a trend.
• 30:16
  SPEAKER_00: Aaron Powell I'm not sure I would say that there's an end-all be-all either way.
• 30:20
  SPEAKER_00: I think that we see companies on both sides of it.
• 30:23
  SPEAKER_00: I mean, yeah, there are plenty of elections of the measurement alternative.
• 30:27
  SPEAKER_00: Um part of the reason why we get a lot of questions on that.
• 30:29
  SPEAKER_00: Yeah.
• 30:30
  SPEAKER_00: Um but I'm you know, there's just as many that, you know, have a process, uh uh a robust process around the fair value.
• 30:37
  SPEAKER_00: And like I said before, you know, sometimes you they you kind of get forced into having to do a fair value anyway, just to prove there's no impairment and and you wind up only being able to take the bad news and not the good news.
• 30:49
  SPEAKER_00: So why go through all that hassle and you know have only the downside risk?
• 30:53
  SPEAKER_00: So yeah, you you have companies on both sides of it.
• 30:55
  SPEAKER_02: Yeah.
• 30:56
  SPEAKER_02: I mean, I think you definitely do.
• 30:57
  SPEAKER_02: And I think you have companies that always regret the decision they made, right?
• 31:00
  SPEAKER_02: Like either way, right?
• 31:02
  SPEAKER_02: Either way.
• 31:02
  SPEAKER_02: Like, man, I really wish I would have elected the measurement alternative because what happened?
• 31:07
  SPEAKER_02: I have a lot of PL volatility because I bought the instrument, price went way up.
• 31:11
  SPEAKER_02: And I didn't would never had to worry about impairment, but now I'm marking it to market all the time.
• 31:15
  SPEAKER_02: And so there's a lot of PL volatility.
• 31:17
  SPEAKER_02: You have other people who say, like, oh man, I don't wish I didn't elect the measurement alternative for the reasons that Chris said.
• 31:23
  SPEAKER_02: And and you know, I have to build all these processes and things like that to to deal with it.
• 31:28
  SPEAKER_02: Um, so I think you've got companies on both sides.
• 31:30
  SPEAKER_02: Now, again, if you regretted electing the measurement alternative, you can elect out of it.
• 31:35
  SPEAKER_02: Yes, but not but not without dealing with the ramifications of, you know, you have to move other things to fair value through PL and you're kind of locked in going forward.
• 31:45
  SPEAKER_03: So yeah.
• 31:45
  SPEAKER_03: And I guess maybe one last point is that this is on a security by security basis.
• 31:51
  SPEAKER_03: So you can have some securities that are following the measurement alternative and then others that are not.
• 31:57
  SPEAKER_03: This is not like an election that applies to all similar investments.
• 32:02
  SPEAKER_00: Other than as Chip mentioned before, if you kind of elect out and get into the fair value.
• 32:06
  SPEAKER_03: Very good, very good point.
• 32:07
  SPEAKER_03: Thank you.
• 32:08
  SPEAKER_03: There's always an asterisk when it comes to accounting.
• 32:11
  SPEAKER_03: Seems like it.
• 32:12
  SPEAKER_03: So all right.
• 32:13
  SPEAKER_03: Well, that's definitely a lot to think about.
• 32:15
  SPEAKER_03: Definitely much more complicated than maybe what people you know think on the surface.
• 32:20
  SPEAKER_03: Oh, it's an equity investment, it's fair value through earnings.
• 32:23
  SPEAKER_03: So it's very important reminders there.
• 32:25
  SPEAKER_03: Again, you guys both know this.
• 32:26
  SPEAKER_03: I always like to wrap things up with a some key reminders.
• 32:29
  SPEAKER_03: So maybe Chris, starting with you, any reminders you'd give in terms of as people are thinking about their equity investments and accounting?
• 32:37
  SPEAKER_00: Yeah, I mean, it's maybe twofold in the same answer.
• 32:41
  SPEAKER_00: And it's, you know, you need to really have a disciplined, developed approach and process.
• 32:47
  SPEAKER_00: And it's, you know, when I say for multiple things, one is as we've talked through, there's what, five, six, seven different um places you can wind up in consolidation, you know, equity method, derivative, debt security, equity security, right?
• 33:02
  SPEAKER_00: So you really need to understand um what you're investing in and have a uh disciplined approach to thinking about that.
• 33:10
  SPEAKER_00: But once you are there, you know, you really need to make sure you have robust um processes around fair value.
• 33:17
  SPEAKER_00: And you know, if you are going through the measurement alternative around identifying, you know, um transactions and prices and things like that.
• 33:26
  SPEAKER_00: So, you know, disciplined, well thought out, robust process is probably the key takeaway for me.
• 33:32
  SPEAKER_03: All right.
• 33:32
  SPEAKER_03: The great reminder, Chip.
• 33:34
  SPEAKER_02: Yeah, no, I think I think Chris, you're you're absolutely right.
• 33:37
  SPEAKER_02: I mean, if you think about how some of our some companies get these equity investments, some of them they're making it for investment purposes, like they're it's part of their investment strategy.
• 33:48
  SPEAKER_02: Others, the reason is more complicated.
• 33:50
  SPEAKER_02: You know, it's a it's a vendor, it's a it's a customer, it's someone you're sort of making a bit of a strategic investment in that you want to be able to see what's going on and then jump in if the company that you're investing in becomes more successful or has a product that launches and things like that.
• 34:07
  SPEAKER_02: So there's a lot of strategic reasons why you might be in these instruments.
• 34:12
  SPEAKER_02: Um, think about which accounting model you apply, like Chris said very, very carefully.
• 34:16
  SPEAKER_02: Like what's the financial reporting implications of fair value through PL?
• 34:20
  SPEAKER_02: What are people going to think about the measurement alternative where you can have sudden shocks in earnings, either, you know, upward or impairments downward that, you know, sort of kind of pop in a in a given quarter.
• 34:32
  SPEAKER_02: So that would be my advice.
• 34:34
  SPEAKER_02: Just really think it through and to echo what Chris said.
• 34:36
  SPEAKER_02: Whatever choice you make, make sure you have all of the controls, processes, and procedures to apply that accounting model and be prepared to change as facts change.
• 34:46
  SPEAKER_03: All right.
• 34:46
  SPEAKER_03: Well, great reminders, and it's always such a pleasure to talk to both of you.
• 34:50
  SPEAKER_03: Thanks so much for joining me today.
• 34:53
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• 35:15
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