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The Equity
Method of
Accounting
for
Investments
McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
1-2
Reporting Investments in
Corporate Equity Securities
GAAP recognizes 3 ways to report
investments in other companies:
Fair-Value Method
Consolidation
Equity Method
The method is selected based upon
the degree of influence the investor
has over the investee.
1-3
Trading Securities
Held for sale in the short term.
Unrealized holding gains and losses are
included in earnings (net income).
Available-for-Sale Securities
Any Securities not classified as
Trading.
Unrealized holding gains and losses
are reported in shareholders equity
as other comprehensive income (ie,
not included in net income).
1-5
Consolidation of Financial
Statements
Required when the investors
ownership exceeds 50% of investee,
except where control does not actually
rest with the majority investor
Contractual agreements
Bankruptcies
Government restrictions
One set of financial statements
is prepared which consolidates
all accounts of the parent company and
all of its controlled subsidiary
companies, as though they were a
single entity.
1-6
Equity Method
Representation on the
investees Board of Directors
Participation in the investees
policy-making process
Material intercompany transactions
Interchange of managerial
personnel
Technological dependency
Extent of ownership in
relation to other investor
ownership percentages
1-8
Special Procedures
for Special Situations
Reporting a
change to
the equity
method. Reporting investee
income from sources
other than continuing
Reporting operations.
investee
losses.
Reporting the
sale of an equity
investment.
1-9
Reporting a Change
to the Equity Method
An investment that is too small to
have significant influence is recorded
using the fair-value method, but
When ownership grows to the point
where significant influence is
established . . .
. . . all accounts are restated so that the
investors financial statements appear as if the
?
equity method had been applied from the date
of the first [original] acquisition. - - APB
FASB ASC (para. 323-10-35-33)
1-10
Reporting Investee Income from
Sources other than Operations
When net income includes
elements other than
Operating Income, these
elements should be
presented separately on the
investors income statement.
Examples include:
Discontinued operations
Extraordinary items
Prior period adjustments
1-11
A permanent
decline in the
investees fair
market value is
recorded as an
impairment loss and
the investment
account is reduced A temporary
to the fair value. decline is
ignored!!!
1-12
Reporting the Sale of
an Equity Investment
If part of an investment is
sold during the period . . .
INVESTOR INVESTOR
Downstream Upstream
Sale Sale
INVESTEE INVESTEE