the equity method of accounting for investments
I. Three methods are principally used to account for an investment in equity securities along with a fair value option.
A. Fair value method: applied by an investor when only a small percentage of a company’s voting stock is held.
1. Income is recognized when dividends are declared.
2. Portfolios are reported at fair value. If fair values are unavailable, investment is reported at cost.
A. Consolidation: when one firm controls another (e.g., when a parent has a majority interest in the voting stock of a subsidiary or control through variable interests, their financial statements are consolidated and ...view middle of the document...
C. Dividends declared by the investee create a reduction in the carrying amount of the Investment account.
I. Special accounting procedures used in the application of the equity method
A. Reporting a change to the equity method when the ability to significantly influence an investee is achieved through a series of acquisitions.
1. Initial purchase(s) will be accounted for by means of the fair value method (or at cost) until the ability to significantly influence is attained.
At the point in time that the equity method becomes applicable, a retrospective adjustment is made by the investor to convert all previously reported figures to the equity method based on percentage of shares owned in those periods.
3. This restatement establishes comparability between the financial statements of all years.
A. Investee income from other than continuing operations
1. Income items such as extraordinary gains and losses and discontinued operations that are reported separately by the investee should be shown in the same manner by the investor. The materiality of these other investee income elements (as it affects the investor) continues to be a criterion for separate disclosure.
2. The investor recognizes its share of investee reported other comprehensive income (OCI) through the investment account and the investor’s own OCI.
A. Investee losses
1. Losses reported by the investee create corresponding losses for the investor.
2. A permanent decline in the fair value of an investee’s stock should be recognized immediately by the investor.
3. Investee losses can possibly reduce the carrying value of the investment account to a zero balance. At that point, the equity method ceases to be applicable and the fair-value method is subsequently used.
A. Reporting the sale of an equity investment
1. The equity method is consistently applied until the date of disposal to establish the proper book value.
2. Following the sale, the equity method continues to be appropriate if enough shares are still held to maintain the investor’s ability to significantly influence the investee. If that ability has been lost, the fair-value method is subsequently used.
I. Excess investment cost over book value acquired
A. The price paid by an investor for equity securities can vary significantly from the underlying book value of the investee company primarily because the historical cost based accounting model does not keep track of changes in a firm’s fair value.
B. Payments made in excess of underlying book value can sometimes be identified with specific investee accounts such as inventory or equipment.
C. An extra acquisition price can also be assigned to anticipated benefits that are expected to be derived from the investment. For accounting purposes, these amounts are presumed to reflect an intangible asset referred to as goodwill. Goodwill is calculated as any excess payment that is not attributable to...