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Chapter 1 - The equity method of accounting for investments. When you finish this chapter, you should: Expanded coverage of the fair-value option for reporting investment of equity securities including a numerical example and four new/revised end-ofchapter problems; provided new coverage of International Accounting Standard 28, “Investment in Associates,” with comparisons to U.S. GAAP; included a new discussion question examining the relation between managerial compensation and historical use of the cost method for significant influence investments. | Chapter One The Equity Method of Accounting for Investments McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Accounting for Investments in Corporate Equity Securities GAAP recognizes 3 ways to report investments in other companies: Fair-Value Method Consolidation Equity Method The method selected depends upon the degree of influence the investor has over the investee. LO 1 1- 2 At present, generally accepted accounting principles (GAAP) recognize three different approaches to the financial reporting of investments in corporate equity securities: • The fair-value method. • The consolidation of financial statements. • The equity method. The financial statement reporting for a particular investment depends primarily on the degree of influence that the investor (stockholder) has over the investee, a factor typically indicated by the relative size of ownership.1 Because voting power typically accompanies ownership of equity shares, influence increases with the relative size of ownership. The resulting influence can be very little, a significant amount, or, in some cases, complete control. Fair Value Method 1- Investments classified as Trading Securities: Held for sale in the short term. Unrealized holding gains and losses are included in earnings (net income). Investments classified as Available-for-Sale Securities: Any Securities not classified as Trading. Unrealized holding gains and losses are reported in shareholders’ equity as other comprehensive income (i. e., not included in net income). Investments in equity securities are recorded at cost and subsequently adjusted to fair value. 1- 3 Initial investments in equity securities are recorded at cost and subsequently adjusted to fair value if fair value is readily determinable; otherwise, the investment remains at cost. • Equity securities held for sale in the short term are classified as trading securities or available-for-sale securities. • Equity securities . | Chapter One The Equity Method of Accounting for Investments McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Accounting for Investments in Corporate Equity Securities GAAP recognizes 3 ways to report investments in other companies: Fair-Value Method Consolidation Equity Method The method selected depends upon the degree of influence the investor has over the investee. LO 1 1- 2 At present, generally accepted accounting principles (GAAP) recognize three different approaches to the financial reporting of investments in corporate equity securities: • The fair-value method. • The consolidation of financial statements. • The equity method. The financial statement reporting for a particular investment depends primarily on the degree of influence that the investor (stockholder) has over the investee, a factor typically indicated by the relative size of ownership.1 Because voting power typically accompanies ownership of equity shares, influence .
