ASC 321-10-35-2 gives an entity a way to measure equity investments that have no readily determinable fair value without having to remeasure them to fair value every reporting period. Under this measurement alternative, the investment sits on the balance sheet at cost, adjusted downward for impairment and adjusted up or down for observable price changes in orderly transactions involving the same issuer’s identical or similar securities. Every adjustment runs through net income in the period it occurs. The alternative is most useful for holdings in private companies, limited partnerships, and LLCs, where no market quote exists to drive a recurring fair value measurement.1Financial Accounting Standards Board. Accounting Standards Update 2020-01 – Investments Equity Securities (Topic 321)
Which Investments Qualify
Three conditions must be met. The security has to lack a readily determinable fair value (RDFV). It cannot qualify for the net asset value practical expedient under ASC 820-10-35-59. And it has to fall within the scope of Topic 321, which covers equity securities that are neither consolidated nor accounted for under the equity method. That includes common and preferred stock, interests in partnerships, unincorporated joint ventures, and LLCs, as well as rights to acquire ownership such as call options and forward purchase contracts.1Financial Accounting Standards Board. Accounting Standards Update 2020-01 – Investments Equity Securities (Topic 321)
An equity security has an RDFV if any one of three conditions is satisfied. Sales prices or bid-and-asked quotations are currently available on an SEC-registered securities exchange or a publicly reported over-the-counter market, with restricted stock qualifying only if the restriction terminates within one year. The security trades on a foreign market comparable in breadth and scope to a U.S. exchange. Or the security is an interest in a mutual fund or similar structure (including some limited partnerships and venture capital entities) that publishes a fair value per share used as the basis for current transactions.2Financial Accounting Standards Board. Readily Determinable Fair Value Most private company stock, LLC membership interests, and limited partnership interests fail all three and therefore lack an RDFV.
If an investment is eligible for the NAV practical expedient, the measurement alternative is off the table. The entity measures it at fair value through net income or, by election, at NAV. The alternative is reserved for investments where neither a market price nor NAV is available.
Electing the Alternative
The measurement alternative is not a default. An entity has to affirmatively elect it, and the election is made separately for each individual investment. Two holdings in different private companies can be accounted for differently, with one carried at fair value through earnings and the other under the alternative.
Eligibility has to be reassessed each reporting period. If the security develops an RDFV or becomes eligible for the NAV expedient, the alternative no longer applies. The entity moves to fair value measurement, and the difference between the carrying value and fair value on that date runs through earnings.
An entity may also voluntarily switch to fair value measurement at any time, but two consequences come with the switch. All identical or similar investments of the same issuer, including future purchases, have to be measured at fair value as well. And the election to move to fair value is irrevocable. There is no going back.
Testing for Impairment Each Period
Every reporting period, management has to evaluate whether a measurement-alternative investment is impaired. The first step is qualitative. The question is whether impairment indicators suggest fair value has dropped below carrying value, without requiring a full valuation unless those indicators are present.
The codification lists five categories of indicators to consider:
- Deterioration in the investee’s fundamentals, including meaningful decline in earnings, credit rating, asset quality, or business prospects.
- Significant adverse changes in the investee’s regulatory, economic, or technological environment.
- A downturn in the general market conditions of the geographic area or industry where the investee operates.
- A bona fide purchase offer, a sale offer by the investee, or a completed auction for the same or a similar investment at a price below carrying value.
- Going-concern factors such as sustained negative operating cash flows, working capital shortfalls, or noncompliance with debt covenants or statutory capital requirements.
Two features of the assessment catch preparers off guard. There is no significance threshold. If fair value is below carrying value by any amount, the investment is impaired. And ASC 321 does not recognize the concept of a “temporary” decline. The question is simply whether fair value is less than carrying value, not whether a recovery is expected.
The qualitative assessment itself produces no journal entry. Its job is to decide whether a full fair value measurement is required. If the indicators point to fair value below carrying value, the entity moves to the quantitative step.
Measuring and Recording the Loss
Once the quantitative step is triggered, the entity has to estimate the investment’s fair value under ASC 820. For a private company holding with no market price, that generally means discounted cash flow models, comparable company multiples, or analysis of recent comparable transactions. The alternative was designed to spare entities exactly this work, but impairment testing still requires it when indicators appear.
The impairment loss equals the difference between carrying value and estimated fair value, recognized immediately in net income. The written-down amount becomes the new cost basis for all future impairment assessments and observable price adjustments.1Financial Accounting Standards Board. Accounting Standards Update 2020-01 – Investments Equity Securities (Topic 321)
Impairment losses are permanent. If the investee’s fortunes reverse and fair value climbs back above the pre-impairment carrying value, U.S. GAAP does not permit reversal of the previously recognized loss. Later increases can only be captured through the observable price change mechanism. Losses are recognized faster than recoveries by design.
Observable Price Change Adjustments
Separate from impairment, the alternative includes a mechanism for updating carrying value when observable transactions supply new pricing evidence. If the same issuer’s identical or similar securities trade in an orderly transaction, the entity adjusts the carrying value to fair value as of the date of that transaction. The adjustment can go either way, and the resulting gain or loss flows through net income immediately.1Financial Accounting Standards Board. Accounting Standards Update 2020-01 – Investments Equity Securities (Topic 321)
An orderly transaction, as defined under ASC 820, assumes enough market exposure before the measurement date to allow customary marketing activities. A new equity financing round where the investee issues shares to outside investors at a negotiated price is a clear example. A block sale by an existing investor to a willing buyer can also qualify. A forced liquidation or a sale completed under duress does not.
Entities have to make a reasonable effort to identify observable transactions involving the same issuer’s securities. An exhaustive search is not required. The expectation is a process that captures pricing events known or reasonably knowable as of the balance sheet date without undue cost. Not every transaction creates an observable price. Securities issued to employees as compensation, or settlements of preexisting option contracts at previously established terms, generally do not qualify, because the transaction reflects something other than a current arm’s-length exchange.
When the Transaction Involves a Similar Security
If the observable transaction involves a similar rather than identical security of the same issuer, the analysis gets more involved. The entity has to compare the rights and obligations of the security it holds against those of the security that traded. Voting rights, distribution preferences, liquidation priorities, and conversion features all matter. If the two are similar enough to use, the entity adjusts the observed price for the differences before recording the carrying value change. This is where significant judgment enters, and it often calls for the same valuation expertise the alternative was meant to reduce.
Required Disclosures
ASC 321-10-50-3 requires specific disclosures in every interim and annual reporting period:
- The total carrying amount of all investments measured under the alternative, reconciled to the balance sheet.
- The amount of impairments and downward adjustments from observable price changes, on both a current-period and cumulative basis.
- The amount of upward adjustments from observable price changes, on both a current-period and cumulative basis.
- Qualitative information sufficient for financial statement users to understand the quantitative disclosures and the factors management considered.
Upward and downward adjustments have to be disclosed separately on a gross basis. Netting them into a single figure is not allowed. Because each impairment or observable price adjustment is a nonrecurring fair value measurement, the entity also has to comply with the applicable nonrecurring fair value disclosures under ASC 820-10-50. In interim periods, impairments and observable price adjustments should be presented on both a quarter-to-date and year-to-date basis, consistent with the income statement periods presented.
Where Preparers Get Tripped Up
The qualitative impairment assessment calls for genuine analysis. Auditors push back on boilerplate conclusions that ignore deteriorating investee fundamentals, especially when the investee has reported losses for multiple consecutive periods or breached financial covenants.
The observable price change mechanism also demands more infrastructure than entities initially expect. Identifying a new financing round at a portfolio company is easy when you sit on the board. Identifying a secondary sale between two other investors in a company where you hold a passive minority stake is harder. Investor relations contacts, board observer rights, and periodic inquiries are the kind of process that satisfies the reasonable-effort standard without turning into an exhaustive search.
Sequencing matters when both an impairment indicator and an observable price change land in the same period. Both mechanisms have to be applied, and the net effect recorded. The order of application can affect the carrying value when the observable transaction predates the balance sheet date and the impairment assessment reflects conditions as of the balance sheet date. Transaction dates and period-end conditions have to be tracked carefully to get the result right.