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Accounting for investment in equity shares of another firm

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Describe the various methods of accounting for an investment in equity shares of another company.

Identify the sole criterion for applying the equity method of accounting and guidance in assessing whether the criterion is met.

Explain the rationale and reporting implications of the fair-value option for investments otherwise accounted for by the equity method.

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Solution Summary

Your discussion is 529 words and a reference and gives you a T account to show the equity method activity. Implications of the fair value method are shared.

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Describe the various methods of accounting for an investment in equity shares of another company.

US GAAP now uses the "acquisition method."

There are three "levels" in accounting for ownership of one firm in another firm. If you own very little and have no influence over the other firm, you use the cost method (which may be adjusted to market value if a trading security or available-for-sale and the shares are traded on an active market.) The cost method means that you record the purchase at historical cost (what you paid) and any dividends are reported as dividend income.

If you can influence the investment, meaning you likely own a substantial percent of the other firms, but less than 50% of it (or enough to control it), you use the equity method. This method used an adjusted historical cost. The initial purchase price is adjusted up or down for the firms' percentage share of profits and losses of the subsidiary. In addition, ...

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Carol Sargent, PhD
Education
  • BSc, University of Virginia
  • MSc, University of Virginia
  • PhD, Georgia State University
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