When and how do you impair an equity method investment?

Question

AcadiFi · Accepted Answer

This is an underappreciated topic that does appear on the CFA Level II exam. The equity method investment is a single-line item on the balance sheet, and it can be impaired:

**IFRS Approach:**

Under IAS 28/IAS 36, the investor must assess at each reporting date whether there is objective evidence of impairment. Indicators include:
- Significant financial difficulty of the associate
- Breach of contract (e.g., default on debt)
- The investor grants concessions to the associate
- It becomes probable the associate will enter bankruptcy
- A sustained decline in the associate's market value

If indicators exist, compare the **carrying amount** of the investment to its **recoverable amount** (higher of value-in-use or fair value less costs to sell). Any excess is an impairment loss.

**US GAAP Approach (ASC 323):**

The investor evaluates whether the decline in fair value below carrying amount is **other-than-temporary (OTT)**. Factors include:
- Length and magnitude of the decline
- Financial condition of the investee
- Intent and ability of the investor to hold the investment

**Example:**

Cedarpoint Ventures holds a 30% stake in Arclight Sensors (carrying amount: $15.2M). Arclight has reported losses for three consecutive quarters, lost a major customer, and its estimated fair value has dropped to $9.8M.

- Carrying amount: $15.2M
- Recoverable amount / fair value: $9.8M
- Impairment loss = $15.2M - $9.8M = **$5.4M**

The loss goes through the income statement, and the investment balance resets to $9.8M. Future equity method pickups start from this new base.

**Critical difference:** Under IFRS, impairment reversals are permitted if the recoverable amount later increases. Under US GAAP, impairment reversals are **prohibited** for equity method investments.

| Feature | IFRS | US GAAP |
|---|---|---|
| Trigger | Objective evidence | Other-than-temporary decline |
| Measurement | Recoverable amount | Fair value |
| Reversal | Allowed | Not allowed |

This IFRS vs. GAAP distinction on reversals is a favorite exam testable point. Practice these scenarios in the AcadiFi question bank.

When and how do you impair an equity method investment?

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