Equity Method — Establishing Significant Influence & Selecting the Appropriate Accounting Approach

1. Why “significant influence” matters

Before an investor can apply the equity method, it must demonstrate significant influence (SI) over the investee. SI gives the investor power to participate in—though not control—the investee’s key financial and operating policies.

Determining SI correctly drives recognition, measurement, presentation, and disclosure under both US GAAP (ASC 323) and IFRS (IAS 28). Once SI exists, the equity method is generally mandatory unless an irrevocable fair-value election (ASC 825 or IFRS 9 FVTPL for certain venture-capital entities) is made.

2. Core frameworks at a glance

Area	US GAAP (ASC 323)	IFRS (IAS 28)
Presumptive threshold	≥ 20 % voting interest	≥ 20 % voting interest
Rebuttable?	Yes—evidence can overcome or establish SI below/above 20 %	Yes—same principle
Additional bright line	> 5 % for LPs/LLCs with separate capital accounts	None
Optional exit from equity method	Fair-value option (ASC 825-10)	FVTPL election for each investee held by VC-type entities
Recent standard-setting activity	ASU 2023-02 expands proportional-amortization to other tax-credit structures	IASB ED (Sept 2024) proposes clarified PPA and full gain recognition on intra-entity transactions

3. Establishing significant influence

3.1 Ownership presumptions

• ≥ 20 % voting stock → SI presumed.

• < 20 % voting stock → No SI presumed.

Either presumption may be rebutted with predominant evidence to the contrary. For limited partnerships or LLCs that maintain capital accounts, US GAAP imposes a lower > 5 % bright-line test.

3.2 Positive indicators of influence (non-exhaustive)

• Representation on the board or equivalent governing body

• Participation in policy-making (budget, dividends, strategy)

• Material intercompany transactions

• Interchange of key managerial personnel

• Provision of essential technical information or know-how

• Currently exercisable potential voting rights (convertibles, options, forward purchases)

3.3 Negative or counter-indicators

Circumstances that can override the 20 % presumption include:

• Another shareholder (or a coalition) unilaterally controls the board

• A stand-still or similar agreement prevents participation

• Inability to obtain timely financial information

• Litigation or government intervention that suspends voting rights

3.4 Potential voting rights—practical guidance

Only rights that are currently exercisable or convertible factor into the SI analysis. Consider:

• Economic barriers—deep out-of-the-money options may still confer SI if exercise price is nominal

• Protective vs. substantive rights—vetoes that merely protect the holder do not create SI

• Aggregation—evaluate rights held by all parties to understand actual governance power

4. Choosing the accounting approach once SI exists

The decision hierarchy is:

1. Measurement alternative (US private entities). Certain non-marketable equity investments may be carried at cost adjusted for observable transactions or impairments.

2. Fair-value option (ASC 825). If elected at initial recognition or upon obtaining SI, the investment is measured at fair value through earnings each period. The election is irrevocable.

3. FVTPL election (IAS 28 §18). Venture-capital-type investors can irrevocably elect fair value through profit or loss on a per-investe basis.

4. If none of the above applies, use the equity method.

Decision Point	Lock-in?	Typical users	Disclosure highlights
Measurement alternative (US)	No—can switch to fair value if readily determinable	Private tech start-ups, PE funds	Significant judgments; fair-value events
Fair-value option (ASC 825)	Irrevocable	Financial institutions, insurers	Methodology; hierarchy level; unrealized gains/losses
FVTPL election (IAS 28)	Irrevocable per investee	Venture-capital funds	IFRS 7 fair-value disclosures; rationale for election

5. Documenting the judgment

Regulators frequently challenge SI conclusions, so maintain:

• Governance analysis—board minutes, shareholder agreements, voting-rights tables

• Ownership waterfall—current and potential voting interests, fully diluted

• Transaction histories—put/call arrangements, stand-still clauses

• Internal-control evidence—who receives financial data, attends operating reviews, participates in budgets

• Periodic reassessment triggers—ownership changes, loss of board seat, new financing rounds

6. Current developments & emerging issues

• FASB ASU 2023-02 (effective 2024/25) extends the proportional-amortization model to tax-credit equity investments beyond LIHTC. Investors opting in must still perform SI analysis to determine whether ASC 323 applies.

• FASB ASU 2023-05 introduces initial recognition rules for newly formed joint ventures (effective 2025), indirectly affecting equity-method Day-1 measurement.

• IASB Exposure Draft (Sept 2024) proposes:

  • Requiring a notional purchase-price allocation when SI is first obtained or an incremental stake is purchased

  • Full gain or loss recognition for all upstream and downstream transactions

  • Clarifying that impairment triggers reference the carrying amount, not cost, and removing the “significant or prolonged decline” test

7. Example

Scenario

• Investor A buys 18 % of Investee B’s voting shares and negotiates one board seat (out of five).

• Investor A also holds warrants that are immediately exercisable for an additional 4 %.

• There are material technology-sharing agreements and monthly operational meetings.

Analysis

• Aggregate voting power (fully exercised) = 22 % → exceeds 20 % threshold.

• Board representation, policy participation, and technology dependency are strong positive indicators.

• Conclusion: Investor A has significant influence and must apply the equity method unless it elects the ASC 825 fair-value option at acquisition.

8. Practical take-aways

1. Start with governance, not percentage. Ownership presumption is merely a shortcut.

2. Update the assessment continuously. Significant influence can be gained or lost without buying or selling shares.

3. Be deliberate with fair-value elections. They are irrevocable and affect profit volatility, KPIs, and covenants.

4. Track basis differences early. Even at 20 % you may need a full purchase-price allocation if forthcoming IASB changes are finalized.

5. Align tax accounting. State-level DRD and Section 243(a) benefits often follow book SI determinations.