The measurement alternative under ASC 321-10-35-2 lets an entity carry a qualifying equity investment at cost, adjusted downward for impairment and up or down for observable price changes in orderly transactions involving the same issuer’s identical or similar securities. It exists for stakes in private companies, LLCs, and limited partnerships where no market price is available and the net asset value practical expedient does not apply. Elections are made investment by investment, and all adjustments flow through net income in the period they occur.
Which Investments Qualify
An equity security is eligible only if it meets three conditions at once. It must lack a readily determinable fair value (RDFV), it must not qualify for the NAV practical expedient under ASC 820-10-35-59, and it must fall within the scope of Topic 321.1Financial Accounting Standards Board. Accounting Standards Update 2020-01 – Investments Equity Securities (Topic 321) That scope covers equity securities not consolidated and not accounted for under the equity method, including common and preferred stock, partnership and LLC interests, unincorporated joint venture interests, and rights to acquire ownership such as call options and forward purchase contracts.
A security has an RDFV in three situations. Sales prices or bid-and-asked quotations are currently available on an SEC-registered exchange or publicly reported over-the-counter market; restricted stock qualifies only if the restriction lifts within one year. The security trades on a foreign market comparable in breadth and scope to a U.S. exchange. Or the investment is in a mutual fund or similar structure where fair value per share is determined, published, and 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 tests.
If the NAV practical expedient is available for the investment, the measurement alternative is off the table. The entity must measure the investment at fair value through net income, or at NAV if that election is made.
Making and Reassessing the Election
The measurement alternative is not automatic. An entity elects it affirmatively, and the election is made separately for each individual investment. Two positions in different private companies can be treated differently, one at fair value through earnings and the other under the measurement alternative.
Eligibility has to be reassessed each reporting period. If a security develops an RDFV or becomes eligible for the NAV practical expedient, the alternative no longer applies, and the difference between carrying value and fair value at that point runs through earnings.
An entity may also voluntarily switch to fair value measurement at any time. Two consequences follow. All identical or similar investments of the same issuer, including future purchases, must also be measured at fair value. And the switch is irrevocable. Once an entity leaves the measurement alternative for a given issuer, it cannot come back.
Assessing Impairment
Each reporting period, management performs a qualitative assessment of whether a measurement-alternative investment is impaired. The question is whether indicators suggest fair value has fallen below carrying value; a full valuation is required only when they do.
The codification lists five categories of indicators:
- Deterioration in the investee’s fundamentals, including declines in earnings, credit rating, asset quality, or business prospects.
- Adverse changes in the investee’s regulatory, economic, or technological environment.
- Downturns in the general market conditions of the investee’s geographic area or industry.
- 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 conditions such as sustained negative operating cash flows, working capital shortfalls, or noncompliance with debt covenants or statutory capital requirements.
Two aspects of the assessment surprise preparers coming from older guidance. 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 a “temporary” decline. The only question is whether fair value is less than carrying value, not whether the decline is expected to reverse.
The qualitative step by itself produces no journal entry. It only decides whether the entity has to move to a quantitative measurement.
Recording the Impairment Loss
When indicators point to impairment, the entity estimates fair value under ASC 820. For a private company investment, that generally means a discounted cash flow analysis, comparable company multiples, or reference to recent comparable transactions. The impairment loss equals carrying value minus estimated fair value and is 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. Even if the investee recovers and fair value climbs back above the pre-impairment carrying value, U.S. GAAP does not permit reversal of the earlier loss. Subsequent increases can only be captured through the observable price change mechanism.
Observable Price Change Adjustments
The second adjustment mechanism updates carrying value when an orderly transaction in the same issuer’s identical or similar securities provides new pricing evidence. The entity adjusts carrying value to that observed fair value as of the transaction date. The adjustment can move up or down, and the gain or loss flows immediately through net income.1Financial Accounting Standards Board. Accounting Standards Update 2020-01 – Investments Equity Securities (Topic 321)
An orderly transaction under ASC 820 assumes enough market exposure before the measurement date for customary marketing activities. A new equity financing round where the investee issues shares to outside investors at a negotiated price is a common example. A block sale from one investor to a willing buyer can also qualify. Forced liquidations and sales made under duress do not.
Entities must make a reasonable effort to identify observable transactions in the same issuer’s securities, but the standard does not require an exhaustive search. The expectation is a process that captures pricing events known or reasonably knowable as of the balance sheet date without undue cost. Some transactions also do not create an observable price at all. Shares issued to employees as compensation, or settlements of preexisting option contracts at previously established terms, generally do not qualify, because those transactions reflect something other than a current arm’s-length exchange.
When the Traded Security Is Only Similar
If the observable transaction involves a similar rather than identical security of the same issuer, the entity has to compare the two instruments. Relevant differences include voting rights, distribution preferences, liquidation priorities, and conversion features. If the securities are close enough to use, the entity adjusts the observed transaction price for those differences before recording the change in carrying value. Significant judgment applies here, and the analysis often requires the same valuation work the measurement alternative was designed to reduce.
Disclosure Requirements
Under ASC 321-10-50-3, entities using the measurement alternative disclose the following in every interim and annual reporting period:
- The carrying amount of all investments measured under the alternative, reconciled to the balance sheet.
- Impairments and downward adjustments from observable price changes, on both a current-period and cumulative basis.
- Upward adjustments from observable price changes, on both a current-period and cumulative basis.
- Narrative information sufficient for users to understand the quantitative disclosures and the factors management considered.
Upward and downward adjustments are disclosed separately on a gross basis; netting them is not permitted. Because each impairment or observable price adjustment is a nonrecurring fair value measurement, the applicable nonrecurring fair value disclosures under ASC 820-10-50 also apply. Interim disclosures present impairments and observable price adjustments on both a quarter-to-date and year-to-date basis, matching the income statement periods presented.
Practical Pitfalls
The qualitative impairment assessment needs genuine analysis. Auditors push back on boilerplate conclusions when an investee has posted losses for multiple consecutive periods or breached financial covenants, and a check-the-box memo will not hold up in that setting.
The observable price change mechanism requires more monitoring infrastructure than entities usually anticipate. Spotting a new financing round at a company where you sit on the board is easy. Spotting a secondary sale between two other investors in a company where you hold a passive minority stake is not. Investor relations contacts, board observer rights, and periodic inquiries are the sorts of processes needed to satisfy the reasonable-effort standard without conducting an exhaustive search.
Sequencing matters when an impairment indicator and an observable price change appear in the same period. Both mechanisms apply, and the net effect goes to earnings. If the observable transaction predates the balance sheet date and the impairment assessment reflects conditions as of the balance sheet date, the order in which the two adjustments are applied can change the ending carrying value. Careful attention to transaction dates and period-end conditions is what keeps the sequence right.