When a company makes an investment in an associate company, accounting for the investment using the equity method is an appropriate approach. This method accounts for investor influence over the company’s financial and operating policies. It also takes into account the time lag when reporting the financial results of the investee. The article discusses a scenario in which a large investor acquires 40 percent of Little Company stock in Year One. The Big Company pays $900,000 for the stock.
Accounting for investments in associate companies under the equity method
Accounting for investments in associate companies under the equity basis requires certain details and assumptions. This type of accounting is a complicated process and requires time to analyze and evaluate figures. It also does not allow the investor to show dividends from his associates as revenue but must be accounted for as a reduction to the investment. In this form of accounting, the investment is the proportion of the associated company’s net income that the investor owns.
Generally, the equity method is appropriate when an individual or group of companies holds shares of another and exerts substantial influence over it. It requires the reporting of investments, the asset value of an associate company, and any income or expense related to the investment. The process is also applicable when there are common joint ventures and partnerships among several companies in an industry or region.
The equity method requires the investor to account for its investments in associates and joint ventures using the equity method. This type of accounting is required in separate financial statements of the investor. It is not required in cases where an investor has no subsidiaries. In this case, the investor would account for the investment in accordance with IAS 39.
Under IFRS, the carrying amount of an associate is remeasured to its fair value at the time of the acquisition. This measure also applies to previously held interests that decrease to a’regular’ financial asset. The difference between the fair value of the retained interest and the proceeds of its disposal is recognised in the P&L.
The equity method is applied when the investor exerts significant influence over the investee’s financial and operating policies. However, it is difficult to discern at which point one company gains significant influence over another entity. Some examples of this influence include the percentage of ownership and membership on a board of directors.
Difference between cost method and equity method
A cost method is a simpler and more straightforward way to account for investments. It records the initial investment at its cost and increases or decreases it on a periodic basis to reflect its earnings. The equity method, on the other hand, accounts for dividends as an asset on the investor’s balance sheet. As a result, cash distributions made from a company do not affect the carrying balance of the investment.
Cost method and equity method reporting have a few differences, but they are both valid ways to account for an investment. With the former, an investor records the investment at its original cost, while with the latter, the investor adjusts its value periodically to reflect his or her share in the company’s income and loss. This allows investors to report more accurately about the business situations they are involved in.
The equity method is used when a company has a 20% or more of the stock in another company. An investor must also be able to have substantial influence over the investee. The investor must be able to influence the company’s decisions, for example, by holding a board position.
The equity method reports the carrying value of an investment based on its net assets and results. For example, an investor owns a 10% stake in Tech Corp and the company reports a dividend of $100,000. This would result in a net income of $250,000, and the investment’s carrying value would decrease accordingly.
The ASPE has three classifications whereas IFRS only has two. Unlike IFRS, ASPE offers the investor a choice when it comes to accounting for his or her interest in a jointly controlled enterprise. ASPE allows the investor to use the cost method or the equity method, while IFRS requires the use of the equity method for joint venturers and associates.
Impact of investor influence on company’s financial and operating policies
Accounting for private investment is affected by the level of investor influence. Majority and minority ownership, for example, are handled differently depending on whether the investor is active or passive in the company. A company should seek to choose an investor with long-term value creation in mind. Listed companies are more likely to be influenced by investors than mid-cap ones. However, even if the investor is passive, he can still influence the company’s financial and operating policies.
Time lag in reporting investee’s financial results
The decision to record an investee’s financial results on a lag can be made on an investment-by-investment basis, and each investment should be evaluated separately to determine whether a lag is appropriate. While ASC 323 does not specify a maximum lag period, it does provide a useful guideline of three months.
A lag period is a change in accounting principle. It applies when an entity has changed its reporting period, whether or not that change is caused by a parent or investor’s ability to obtain the financial results. In addition, a lag period may be extended if the investor or parent can no longer obtain the financial results on the same day that they did in the previous period.
Income adjustments to equity investment from investee’s net income or loss
The equity method acknowledges a material economic relationship between an investor and an investee by recording the investor’s share of net income or loss as an income adjustment to the equity investment. This adjustment is made whenever the investee distributes its net income or loss to its shareholders.
Once the equity investment reaches the end of its useful life, it no longer qualifies for the equity method of accounting. The final carrying amount of an equity investment is the amount of equity investment less all deductions for the reduced amount of ownership. This amount contributes to the calculation of the carrying amount of the “new” asset, and the excess is recorded as a current period gain.
Another type of income adjustment to an equity investment is an impairment loss. This loss may occur when the fair value of an asset is reduced by other than temporary factors. A series of losses may indicate that an equity investment is not recoverable at its current fair value.
Income adjustments to equity investment from investees are made to account for intra-entity profits that will ultimately be realized by the investee. In some cases, an equity investment will have a credit balance if a company’s unrealized intra-entity profits are not realized. However, if such a profit is realized by a company, its share will be included in the Statement of Comprehensive Income.