ASU 2020-01: Clarifying Accounting for Equity Securities

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2020-01 to resolve inconsistencies in how certain equity investments are accounted for when their required accounting model changes. The update clarifies the interactions between Equity Securities (Topic 321), the Equity Method (Topic 323), and Derivatives (Topic 815). It provides guidance for these changes and for specific derivative instruments linked to such investments, ensuring accounting is more comparable across organizations.

Core Accounting Changes

ASU 2020-01 introduced two main clarifications to the accounting literature, focusing on specific, event-driven changes in investment accounting. The first addresses the transition of an investment from being measured at cost, less impairment, with adjustments for observable price changes—a method called the “measurement alternative” under Topic 321—to the equity method of accounting under Topic 323. This situation occurs when an investor’s ownership stake or influence over the investee increases to a level of “significant influence.”

The update specifies that when an observable transaction triggers the switch to the equity method, the company must first remeasure the existing investment to its fair value immediately before applying the new accounting method. This remeasured carrying value then becomes the initial basis for the equity method investment. This prevents a company from having to retroactively apply the equity method, which would be complex and costly.

The second core change provides a scope exception for certain derivative contracts. It clarifies the accounting for forward contracts and purchased options to acquire securities that, once settled or exercised, will be accounted for under the equity method. Before this ASU, there was uncertainty about whether these instruments should be treated as derivatives under Topic 815.

The new guidance states that an entity should not consider the future accounting for the underlying security when determining if the contract falls under the scope of derivative accounting. Instead, the instrument must be evaluated against the other characteristics of a derivative outlined in Topic 815. This clarification ensures a more consistent application of derivative accounting rules to these specific types of contracts.

Scope and Applicability

The guidance in ASU 2020-01 applies to all entities that have investments accounted for under the measurement alternative within Topic 321, available for equity investments that do not have a readily determinable fair value. The update is also relevant for any entity applying the equity method of accounting under Topic 323 or derivative accounting under Topic 815.

The standard is triggered by specific, defined transactions. The first key transaction is an observable event for an identical or similar investment of the same issuer that requires an investment to be remeasured. This event must also be the trigger that causes the investor to gain significant influence, thereby necessitating a transition from the measurement alternative to the equity method.

A second set of transactions covered by the ASU involves forward contracts and purchased options on securities to acquire an investment that, upon settlement or exercise, will be accounted for under the equity method. The update clarifies how to determine if these specific instruments should be accounted for as derivatives.

Effective Date and Transition

The Financial Accounting Standards Board established a two-tiered timeline for the adoption of ASU 2020-01. For public business entities, the amendments were effective for fiscal years beginning after December 15, 2020, and for any interim periods within those fiscal years. This meant that for a company with a calendar year-end, the rules applied starting January 1, 2021.

For all other entities, including private companies and not-for-profit organizations, the board provided a delayed effective date. These entities were required to adopt the new guidance for fiscal years beginning after December 15, 2021, and for interim periods within that fiscal year.

The transition method mandated by the ASU is prospective application. This means companies apply the new rules to qualifying events or transactions that occur on or after the date of adoption. There is no requirement to go back and adjust the financial results of prior periods. Early adoption of the standard was permitted for all entities, including in an interim period, for financial statements that had not yet been issued or made available for issuance.