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Comments Letters Show Few Supporters of Equity Method Simplification Proposal

A FASB proposal to simplify two narrow areas of guidance for the equity method of accounting has few fans, comment letters show. The proposal would eliminate the basis difference related to equity investments. It also would scrap a requirement to retroactively use the equity method of accounting if an investment qualifies for the method because of an increase in the level of ownership.

A majority of businesses, audit firms, and professional groups weighing in on the FASB’s proposal to simplify two parts of the equity method of accounting have told the board that the plan would increase costs and lead to misleading financial statements.

Released in June via Proposed Accounting Standards Update (ASU) No. 2015-280, Investments — Equity Method and Joint Ventures (Topic 323) , the proposal is meant to simplify how companies account for stakes they hold in other companies.

It eliminates the requirement for an equity method investor to account for the basis difference— the difference between the cost of an investment and the investor’s proportionate share of the net assets of the investee. It also scraps the requirement to retroactively use the equity method of accounting for prior periods if an investment qualifies for equity method accounting as the result of an increase in the level of ownership.

Comments were due August 4.

While most of those responding to the proposal said they applauded the FASB for trying to tackle a complex area of accounting, they said the plan would not make accounting simpler, and many said it would increase their costs.

Plum Creek Timber Corp., in Seattle, Washington, wrote that while eliminating the requirement to account for the basis difference would reduce some costs, the savings would be offset by the requirement to test equity method investments for impairments. They also would be required to periodically write-down equity investments to fair value.

“We believe that the accounting for equity method investments is relatively complex,” the company wrote. “However, we believe the existing guidance does a reasonably good job of reflecting the economic reality of such investments in the financial statements.”

OGE Energy Corp., the parent company of Oklahoma Gas and Electric Co., expressed similar concerns about the proposal.

“We have found that accounting for the basis difference has not added cost or complexity to our financial statement reporting,” the corporation wrote. “While we understand the concern of determining the acquisition date fair value of an investee’s assets and liabilities, we believe having significant influence over an investee should ensure the information necessary to perform the assessment is available. If an investor can’t obtain the necessary information to perform a fair market appraisal, it is our belief it would raise serious questions about their ability to exert influence over the equity investee, and whether the investment would qualify for accounting under the equity method.”

Financial Reporting Advisors, LLC, an accounting and SEC reporting advisory services firm, said it did not support the proposal.

“We acknowledge that not accounting for the difference between what was paid for an investment in the equity securities of an investee and the investee’s book value is simpler than the current accounting model,” the firm wrote. “However, not accounting for deferred taxes, pension and other postretirement liabilities, asset retirement obligations, and leases would also be simpler. That does not mean we should ignore them and thus the underlying economic activity that gives rise to them.”

The Institute of Management Accountants said it was conflicted on the merits of the proposal. The organization said it agreed that the equity method of accounting was complex, but members of its Financial Reporting Committee were “bothered by the results of ignoring basis differences altogether in certain cases.” It suggested the FASB perform further outreach before proceeding.

PricewaterhouseCoopers LLP said it supported the elimination of the requirement to retroactively adopt the equity method. It did not agree, however, with the proposal to eliminate accounting for basis differences.

“We believe this proposal would reduce the usefulness of financial reporting because it would not faithfully represent an investment’s performance in relation to its underlying economics,” the firm wrote.

KPMG LLP offered similar comments.

“We believe it would be most appropriate for the FASB to retain the current accounting for equity method basis differences,” the firm wrote. “If the current equity method is retained, we believe modest changes could be made to simplify application of the equity method by clarifying or emphasizing that, depending on the facts and circumstances, basis differences may be accounted for based on the primary or predominant sources of the difference or on a composite basis which may be evaluated based on the predominant assets and liabilities of the investee.”

Eli Lilly and Co. was one of the few supporters of the proposal. The drugmaker said it supported it because investees are often private companies that the company does not control, and gaining access to the financial information required to determine the acquisition date fair values is often challenging.

Wells Fargo & Co. also supported the proposal. The bank said in addition to the changes in the proposal, the board should also consider eliminating the need to separately account for dilution gains and losses. It also called on the FASB to add interpretive guidance on the application of what is called the hypothetical liquidation at book value method.

Under existing guidance in Topic 323, Investments, Equity Method and Joint Ventures , formerly Accounting Principles Board (APB) Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock , a business determines the fair value of the assets and liabilities acquired in the same manner as a business combination. The business’s proportionate share of the difference between the fair value of the investee’s identifiable assets and liabilities assumed and the book value of recorded assets generally must be accounted for in net income.

Instead of accounting for the basis difference of an equity method investment, a business would recognize its equity method investment at its cost. It would no longer determine the acquisition date fair value of the assets and liabilities assumed.

In addition, the proposal would eliminate the requirement that when an investment qualifies for the use of the equity method because of an increase in the level of ownership, an investor must adjust the investment, results of operations, and retained earnings retroactively as if the equity method had been in use in previous periods.

The proposal is part of the FASB’s so-called Simplification Initiative, a larger project in which the FASB tackles narrow areas of complexity in current accounting and attempts to offer quick solutions.

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